Rising Delinquencies Revive Credit Concerns, Hit Markets

Good Evening: The U.S. equity markets took another shot to the chin today when rising delinquencies for Home Equity Lines of Credit reminded investors just how important and impactful will be the rising rate of unemployment to our economy going forward. Known as HELOCs among credit cognoscenti, home equity lines join prime mortgages and credit cards as the latest floaters to wash up on the shores of credit this summer. The news caused further flight from economically sensitive equities and commodities, while the dollar and Treasurys both enjoyed a rally. Risk appetites were in clear retreat today, and your government has taken notice. In response to what has thus far been less than an 8% correction off the June highs in the S&P 500, new stimulus proposals are being trotted out, along with a misguided attempt to prevent “speculation” in the energy futures markets. In turn, I will speculate that our elected leaders (and the American public) would be far better served if the regulators focused less on suppressing prices they don’t like and more on forcing OTC derivatives to face the same high level of scrutiny exchange traded futures and options already receive.

With no official economic releases on tap today, stock index futures market participants had little to guide them as futures hovered just below yesterday’s closing levels. This downside trickle became a bit of a torrent once trading began in New York, however, and the major averages were down 1% or so after sixty minutes. Renewed rumblings from the world of credit certainly didn’t help. Out first was a report from Morgan Stanley warning investors away from junk bonds (see below). Considering the scorching rally many high yield issues have seen thus far in 2009 after being orphaned in late 2008, the MS call looks all the wiser due to the amount of flak they received today for dissing the sector.

Next came the HELOC news, and with more and more Americans falling behind on the first mortgage, is it any wonder an increasing number of them are falling behind on home equity lines as well? No doubt the rising number of jobless Americans is also playing a tragic part in this unfolding drama (see below). HELOC delinquencies are but one of the many reasons why , as I mentioned yesterday, unemployment might soon be upgraded from a lagging to a leading indicator. I also mentioned yesterday that the average hours worked data have hit a record low, but the impact can best be seen in the attached chart. Average weekly hours worked = incomes, so it looks less and less likely the green shoots will survive if the employment situation remains arid.

average-hours-worked-per-week-since-1990

After holding yesterday’s lows during the opening hours of trading, the major averages tried to rally near mid day. Unfortunately, the upticks disappeared along with the luncheon dishes, and the indexes began a slide that ended only when the bell rang. The economically sensitive materials names were once again hard hit, and this time they were joined by the beta sensitive technology sector. The flight from risk was also evident in the areas of the market that held in well (healthcare, staples, etc.). The Dow, S&P, and Russell 2000 all gave up 2%, while the NASDAQ and Dow Transports fell an even steeper 2.5% and 3.25%, respectively. Treasurys were mixed when a 3 year note auction stung the short end of the curve, while 10’s and 30’s benefited from the resulting unwinding of curve steepening trades. The dollar rallied against all but the yen, forcing commodities into another broad retreat. Falling energy prices (crude was down 2.3%) were the largest factor in today’s 1.5% decline in the CRB index.

If a revival of credit worries or fears of rising unemployment gives you pause as you consider the fate of the U.S. economy in the months ahead, fear not. The government — and Jim Cramer — have ready solutions at hand. Now that the capital markets are experiencing their first wobble since the March lows went in, the Obama administration is floating trial balloons about a second stimulus package. If a second stimulus package in 5 months does hit the President’s desk, I somehow doubt our elected officials will listen to PIMCO’s Paul McCulley, who today all but pleaded for a fiscally responsible one (see below). If that’s not an oxymoronic dream, then I would like to see a better example of one.

Also riding to the rescue of the voters is the new CFTC chairman, Gary Gensler. Mr. Gensler will soon hold hearings to decide whether the CFTC should take steps to reduce evil speculation in the oil futures market (see below). He is receiving some high profile, almost demagogic support from none other than CNBC’s Jim Cramer. Whether or not the oil market is mispriced from time to time is not the point, since all markets can become detached from the fundamentals in the short run. Messrs. Gensler and Cramer would have you believe that high energy prices are due to speculation and manipulation — not market forces. Perhaps these gentlemen need to be reminded that the futures markets are already the most heavily regulated of all the major markets, especially when compared to the wild west OTC derivative markets.

Mr. Gensler is new on the job, so maybe is yet unaware that “manipulation” is already illegal. If he can cite some examples, he can simply issue enforcement actions. “Speculation” is a tougher issue to deal with, but maybe the new CFTC chair hasn’t been told that all futures contracts — including those for oil — have speculative position limits in place. If the CFTC finds violations, then let them issue steep fines to either the broker dealers or the exchanges themselves until the offenders get the message. Better still, why are OTC energy swaps, caps, collars, floors, and options contracts not regulated at all? A “manipulator” can get in real trouble for violating the Commodity Exchange act in the futures markets, so the best way to remain in the shadows is to use OTC derivatives, which are subject to almost zero rules, regulations, or limits of any kind. I’ve said it before, and I’ll say it again: All OTC derivatives should be forced to clear on a proper exchange. Subject these obligations to the same transparency, rules, regs, and daily cash margin calls that are a hallmark of futures contracts, and our financial system will be on a firmer footing.

I wonder if the real issue is less one of speculation or manipulation than it is one of not liking the prices Mr. Market posts at the closing bell each day. If corn prices fall too far, then the farmers scream “manipulation” is costing them their livelihoods. If corn prices rise too much, then consumers cry “speculation” is the culprit. It’s the same with oil. Whether it’s the OPEC of yesteryear or the hedge funds of today, high energy prices are always blamed on somebody. The American investor class is quickly learning how to become the victim class when they listen to folks like Jim Cramer. I would only ask the host of Mad Money (and our elected officials) one question: Where were you when stock prices were flying high and home prices were obviously in a bubble? Is speculation and/or manipulation OK so long as the market in question is one where almost everyone wants higher prices? To paraphrase George Orwell, I guess some markets and prices are more equal than others.

— Jack McHugh

U.S. Stocks Fall, Sending S&P 500 to Lowest Level in Two Months
Delinquencies on U.S. Home-Equity Loans Reach Record
Junk Bonds Are ‘Dangerous’ After Rally, Peters Says
McCulley Says a New Stimulus Plan Must Show Restraint
Oil, Gas Market Speculation May Face Restrictions

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