I was out of the office yesterday – so was unable to monitor market action and the news throughout the day. However the action seemed relatively benign. Congress has passed their “Sizzler” Economic stimulus package – waiting for the White House to sign off on it. So it looks like Ed McMahon might be stopping at your door with a $300, $600, or even $1000 check – if you are “lucky” enough to have a big family and make less than $75k.
----------------------------------------------------------------------
Why Economics is important – regardless of politics
While I was out yesterday, I had an interesting conversation with my Great Aunt (Rust-Belt Democrat) – she is looking great for being in her mid-80s and still a Spitfire. She wanted to push my buttons on politics (she thinks I am a Republican because I am not for socialism). I explained to her that I am nether Republican or Democrat. Since we were both waiting for the outcome of the operation while sitting in the hospital – of course National Healthcare came up. I was emotionally drained sitting there in the pre-dawn hours waiting and was not really in the mood for a political debate with my loving great aunt, I kept it simple. My issue (regardless of politics) is what is happening to this economy. Economics is important regardless if you are a Democrat or Republican – my issue – how do you PAY for national health care (estimated to exceed $800 billion per year)?
I gave her two real-world examples that she could understand WHY economics (regardless of party) is important. The IRAQ war (regardless of how we feel about) is a short-term massive front loaded payout. I reminded her of the time when her extended family came down to visit her and she decided (on her very limited retirement income) to take and pay for everyone to go to Disney World. I said this is analogous to going to War. She has to budget for traveling cost, paying for rooms, food, etc. How long are they going for, how many people is she paying for, etc. Why the time at Disney is finite – the cost is going to far exceed her modest income. She will be going into debt (if not already in debt) and be deficit spending the entire way. She might of not thought about all the expenses involved and find out later that she seriously in debt from such a vacation that will take her years to pay back. The national health care program has a similar problem – only it is recurring deficit spending. What if she wanted to buy her son cable TV (thus making the monthly payments) – but she decides without proper planning that she’ll add all the premium stations (HBO, Showtime, sport packages, etc.) After a few months of getting that bill for that GIFT (of Free Cable to her son) – she will soon realize that (because of the fixed modest income) that she can NOT afford it without cutting other monthly expenses. Does she continue to go into debt (ever so slowly each month) or cut her own expenses – maybe not buying as much food or dropping other services.
Regardless of politics – the budget and the economy is vital to making anything work. I didn’t want to debate the merits of National Health Care – but just explain to her my concern is first and foremost getting the deficit, budget, debt, and the economy in order FIRST before paying for anything else – which could put the country and thus the citizens further behind the eight ball.
She liked my analogies and conceded my point. Once the economy is in order, only then can the Democrats or Republican can decide to spend money.
The government is like a big business – it has many employees, offers many services, has many more debts. The country is bankrupt on paper and the only reason it doesn’t file for bankruptcy is that it can PRINT more money and can put itself further in debt. But if it was a public company – relying on revenues – it would have been out of business sometime ago. The printing of money (which we should not be printing) is not only putting the government further in debt – but sending the dollar (and thus our buying power) into the toilet.
----------------------------------------------------------------------------
Oil Slipping – will OPEC cut production?
OPEC has not increased production (and some have argued that OPEC is already only a few percent below maximum extraction rate as it is). Now with the US facing (or in) a recession and consumer spending dropping – oil with it is falling. The recent boost in the US dollar has also taken some of the premium out of the price (which T.B. Pickens had forecasted – I might say AGAIN correctly). However, the question of if the dollar can continue to hold and rally against other currencies is questionable and oil is still priced in dollars – will certainly bring volatility to the table.
Regardless of pinning their revenue on just the dollar and its short-term future, OPEC may cut some production lines to defend oil at $80 a barrel. They have indicated that if the price hits $80 it is in the cards for a reduction of output. However, it would be interesting to see how both India and China react to such a cut, even if the US slows – the ramping consumption in the fasting growing nations may slow but NOT decrease. However, it is rumored that if prices stay above the $85 level there are no plans to change production levels.
OPEC is more concerned about the dollar and oil is a direct representative of the dollar’s strength (inversely that is). The recent rise in the dollar has not offset the pull-off in oil, thus margins (strictly based on currency swaps) is falling. The fear of the weakening US economy is on the mind of every OPEC member. Today the dollar might see strength, but what about tomorrow – and if the Global economy slows down – the boost (or premiums) from the weaker dollar may not be enough to keep oil above $80.
Watch prices closely – there should be (as there recently has been) a inverse relationship to dollar strength. This will set the stage for OPEC’s stance.
---------------------------------------------------------------------------------
Futures Pre-Open
The futures are seeing some pressure – Asia was down, Europe is giving up some gains in different sectors, and the week has been draining for the longs. Yesterday (which I wasn’t here) didn’t seem like anything really got moving (up or down). I am sure there is some ARB trading in the pre-open, however the action should be light. The futures are front-running the cash – but not by much. Expect sell pressure on the cash basket at the opening.
-------------------------------------------------------------------------------
Support / Resistance
The downside slide has slowed – but not to any areas that would warrant taking a long shot bet.
INDU 12000 / 12500 (At 12250 we are at the PIVOT point – we could go either way. Today will either be a move to one of the two points – rather quickly or we sit still and close at 12250 – the close will be important.)
NDX 1700 / 1800 (Again we are at a pivot point 1750 – we could test either area or just sit tight – there is no news to get this thing moving – but optimism or pessimism could send us there fast. – don’t get long or short at this level)
SPX 1300 / 1400 (At 1336 we could move up to 1350 and close – if the action in the above two indices remain relatively quiet.)
RUT 700!!!! (the broader market seems to be keeping its head above water. If it can close above 700 – we could see strength in the narrow indices also tread water. But we NEED to close above 700! – it is a serious pivot point for the general broad market. )
---------------------------------------------------------------------------
Conclusion
The credit rating agencies and bond insurers are getting more headlines and it SEEMS that no one wants to come to terms with reality. The reality is that these credit rating agencies are PAID for those ratings – does that create a bias or vest interest in giving higher ratings? There is some serious issues here – since many state funds can NOT invest in anything below a certain rating – thus it is in the best interest of the ISSUER of that bond to get a rating high enough to meet that criteria. Therefore they pay a rating agency for that rating. We can only believe that the agency is unbiased, however it seems like paying for grades – doesn’t it?!?
With Fitch cutting 130,000 bonds, S&P publicly stating 250 billion in future write-downs, Moody’s and the Bond Insurers slinging accusations at each other, and now investigations from all sorts of state and federal agencies is sending a some trepidation into the market and some concerned. I recently met with the CFO of the local hospital to review 2007 financials and their 2008 budget. What I saw concerned me, but the CFO felt they were fine. They have $400 million invested via Northern Trust in to Corp. bonds – all AAA or AA rated (by Moody’s, Fitch, or S&P) according to LAST year’s rating. They also have $300 million in debt (some bond issuances) which they are paying a VARIABLE rate (eek!). We did the math – they are getting about 2% return –between the received interest from Northern Trust and the Interest payments on the debt. However, he has been told and actually believes this is ARBATRAGE. I said it is simply NOT arbitrage – you just have borrowed money to invest money – just because you are paying interest and receiving interest (which seems similar) they are not offsetting assets. Not only that, but they are paying over $2 million a year to Northern Trust for the investment – to make a 2% return. If any (of the many) bonds they invest drop below AA they HAVE to sell them, based on their charter. Also – every time they make an investment change they are required to receive an audit and revised credit rating. If the hospital’s credit rating (which is A) falls – their $300 million debt (which is broken into different components) can be triggered to higher rates and/all called in – which they currently can’t pay without liquidating their Bond investment. It is a spaghetti mess for sure. I said you are doing all this work for 2% return and paying someone $2 million to do that? I said – if I was your advisor – I would pay off the debt and invest the difference into a mixed basket of treasuries and foreign bonds (not Corporate). They could be in for a big surprise – if any of those corp. bonds get a rating change – or god forbid default. The hospital is also running about $20 million in the red every year and relies on tax revenue to make up the difference – which they are going to see about a 20% drop since foreclosures have increased and property values have fallen. Of course he said - well Moody’s is rating these things AAA or AA and they are insured by MBIA and AMBAC (both I noted were on the brink of bankruptcy).
The point of the story – how many more state pension funds and hospitals or similar investment portfolios are out there? If these ratings drop it could send a HUGE surge of forced selling of those positions – which on that scale could send serious negative pressure into the market. We know it COULD happen – the question is WILL it and/or When? I don’t know – but the risk is real – that’s for sure.
Stay hedged!
No comments:
Post a Comment