10/28/08 (18% interest rates? GM needs money!)

Traders,

Yesterday we rallied and showed some strength, but the last few minutes saw a sharp sell-off – which continued after the close in the late futures session for another 15 mins – sending fair value lower.
I was a little puzzled as to the sell-off at the close – perhaps it was short-term positioning that was closing. It wasn’t forced selling, but it was on big volume. I guess it will just be chalked up to another trade mystery in the world of uncertain market conditions.

The good news, while we did see a sell-off at the close the general support bands held. Additionally we saw ASIA rip to the upside in the overnight session – brining “hope” reflected in the future prices this morning that the late session sell-off was just fluke. Only time will tell.

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WE NEED MONEY TOO!

As banks and lending institutions are getting in-line for a chunk of the big bailout check, GM is trying to sneak in line too. GM has sold off and its net market capitalization is about 1% of Volkswagen! The GMAC finance division expanded from auto-loans to include mortgages as well and suffered for it. GM has many problems – and most of those rest on the balance sheets. Mainly a pension plan that killed the company, GM in recent years lead the world in sales and had the largest revenues in its history – but people forget it is NOT about revenues or how many cars you sell – it is about ONE THING – MARGINS! For every worker at GM, the company was paying pensions and healthcare on 4-5 retirees. There was no way they could maintain that model and expect to stay in business. They started borrowing billions per year just to pay for the billions in pensions and healthcare, in fact it got so ridiculous that they actually borrowed money just to pay the interest on the previous loans. GM was on a death spiral and GMAC and it’s loans were not helping. Sure – some blamed management – and they were probably at fault and need to take some accountability and responsibility. But 10s of billions in loans, 10s of billions in pensions and healthcare, a legacy system that would kill any company, topped with lending division that was giving out credit when the company was in massive debt – was headed for a cliff regardless of how many cars they sold.
Now CEO Wagoner is personally leading the lobby charge for federal aid and seeks to merge with Chrysler. They are eligible for the $25 billion for retooling plants – but they also need a good chunk of that $700 billion bailout package to get them through some of these credit problems they are having. However, Paulson would rather give them low-interest loans then hand them part of that $700 billion check. GM traditionally goes to CITI or one of the many other banks for money in some fashion from corporate bonds to over-night credit lines. However – with the banks tight with cash they too are going to the lender of last resort – The Government.
Can GM survive even with a merger with Chrysler? Will $10 billion they need NOW be enough? What does GMAC’s balance sheet really look like? Can they retool their plants quickly to meet the demand of lower MPG vehicles? There are many questions and the company has also been bogged down with Union problems – which will forever be its bane.

The concerning question is IF GM gets a chunk of that bailout check – others will want to get inline as well and feel entitled. Initially the bailout check of $700 billion was to take down toxic paper, but Congress agreed to let Ol’ Hank make his own decisions on how to spend that money. If he moves out of the realm of what the money was intended for – there could be some grumblings at Congress – but hey they gave Hank the check and the discretion to spend it has he sees fit.

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What happens in HYPER inflation?

Iceland collapsed a couple of weeks ago – their currency fell against the EURO and their banking system fully failed. Russia and the IMF came to the table to negotiate a loan or bailout package. Many economist watch Iceland as the “canary in the coalmine” because it is a small country with its own currency, banking system, and trade. It is very similar in many respects to the United States – in that it is a consumer nation based on deficit spending and consumer credit.
Iceland now is facing hyperinflation since their currency collapsed and the first defense against hyper-inflation is interest rates. Iceland secured a loan with the IMF and in a shocking move to defend the currency they raised interest rates to 18% - that is not a typo – eighteen percent. Many have said that may not be enough and may see rates go as high as 25% - since the currency has made significant drops against foreign currency baskets.
With IMF backing and the nationalization of their banking system (for the most part) – the question will this be attractive enough to draw foreign investments into the krona (Iceland’s currency). The raising of interest rates hopefully stops the flood gates from leaving the krona to safer pastures – the question – is 18% enough. The economy is expected to contract by 10% next year and part of the IMF deal was for the country to raise interest rates.
It is a powerful lesson to learn – dealing with a fiat currency. This nation saw interest rates in the 70s move significantly higher to halt inflation rise. The U.S. dollar is also a reserve currency, unlike the krona – and that should offer more stability. Yet – the pouring of money into the banking sector, the expansion of government debt, increase deficit spending, the contraction of credit lines is continuing to put pressure on CORE interest rates. We may see the PPI and CPI decrease in their “Headline” numbers because of oil prices coming off, but as Bernanke likes to focus on the “CORE” – that has already seen a rather surprising increase since last reported.
We may visit 1% Target Rates – perhaps even 50bps or 25bps or even 0 – but for how long before inflation starts to bite at our ankles in which we can’t ignore it. It is no doubt a tough balancing act between bailing out the banks and keeping inflation at bay. We have tipped 100% to one side of this scale – bailing out banks – the weight of that could and will send inflation higher.

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Futures Pre-market

We are seeing a good jolt to the upside in futures that had lost serious ground against fair value in the late session yesterday. It looks to be following Asia and Europe’s trend. Expect ARB traders to short futures into the opening and buy the cash basket which will send a good jolt to the upside when the market opens.
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Support / Resistance

We seemed to have rally off the support band – even with the late session sell off. Can we continue to the upside?

INDU 8000 – 8250 / 9000 (Closing above the 8250 area will give more weight to the support area. Keep an eye on the close.)

NDX 1150-1200 / 1300 (Again – it looks like we will be above the 1200 line – watch the close.)

SPX 850-900 / 1000 (A close in the upper 800s or even 900 would spell serious support.)

RUT 450 / 500 (The boarder market looks very sick – getting to or above 500 would show a broader sign of health and support.)

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Conclusion

We may be seeing some short-term support and could even rally higher to those resistance levels. It is going to take a while to see how well the money being poured into the system will unfreeze the credit markets. LIBOR 3-month came off some to under 3.5% - but still has a long way to go. Recession comes in waves – first we saw the Housing recession, then the bank freeze and market recession – next it is going to be the consumer recession which we really haven’t felt yet. It is quite possible for the market to find a bottom and stabilize at the lows – but we may also not see the kind of growth from the bottom as we once expected – even low single digit growth will be welcome. The problem is that consumers are tapped out of credit and it will take time (perhaps a year or two) before we see a bottom in the consumer recession.
I personally think we will see a bottom to the housing market mid 2009 and then it stabilize, we may see a bottom to the stock market around the same time (with lots of up-down volatility) – but it is going to take probably through 2010 – 2011 before we see a bottom in the consumer spending. That means companies will have to run very lean for some time – don’t expect a big expansion in fat middle-management anytime soon. Pay increases will be about doing more work and NOT seniority – many will be doing 2 maybe 3 or 4 peoples jobs. And easy credit will be a thing of the past for some time.
My big issue – is have we learned our lesson? Perhaps not – if the government is just reloading the system with money and “hoping” to get credit flowing again. This time maybe tighter regulations will be the rule of the day. Let’s hope the government can step back to their role as regulator and not participator. Hopefully the government learned their big mistake with Freddie and Fannie – however I am sad to think they have not.