The global recovery cross road is at hand. Certainly we are seeing a winding down of some companies and banks “seem” to be back on track. However there are some conflictive data both domestically and globally that is not inherently represented in the market. Friday did see a rally up to those resistance levels and the futures this morning, despite the GM’s bankruptcy looks even higher. The conflict is seeing the bond yields rally, dollar weaker, and commodity rally.
However, it is important to realize the market is always hyper sensitive relative to the economy – and thus it over-reacts to the downside, which we recently saw, and to the up side. Driven by perception, the math which is sometimes ignored needs time to catch up. Look how long GM lasted on fumes (a couple of years).
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GM (Government Motors)
This morning is the final chapter of the U.S.’s largest iconic company. For the last few years it has been losing vast sums of money, not because revenue had been down. Quite the opposite – in recent years 2004,2005,2006 they had sold more cars than ever and revenue was huge. The problem is the liabilities, debt, costs, and interest. The concept of margins, the core of the business model, had completely failed. Some economist, analyst, and business professors had pointed to the eventual GM failure for years, but were ignored. Mainly because no one could believe it – they didn’t WANT to look at the math.
So what does this mean. I am sure you will be hearing lots about it – since every news agency is talking about it all weekend and day. But let’s look at the break-down. In a normal Ch. 11 bankruptcy – a company sells off any assets, get’s the creditors off their back, and restructures – if it is able to. However, in GM’s case they have an added benefit, the U.S. Government. The Government is going to put in ANOTHER $30 billion (after a previous several injections of $20 billion plus). If it wasn’t for this latest round of government (tax payer) money, GM would fail after bankruptcy and they still could. Why would the government put another $30 billion in, because if they didn’t the first $20 billion is all but lost.
The fall out is going to be pretty massive, about another 20 to 25,000 layoffs, 11 to 12 factories closed, 1000s of dealerships close, part-markers fold or demised capacity. It certainly is going to be widely felt in this nation. It is also going to take months for it to be resolved, as assets need to be sold and the 100s of small fires need to be put out.
The financial fallout is unclear, however the big concern is debt financing by companies. The government has stepped in and changed the rules and those bond holders (pensions, investors, banks, etc.) are all out billions of dollars and collectively get about 10% of the new company, as the UAW and Government set the rules and get the largest piece of the pie. A video this morning (Bloomberg) showed a family that had put their nest egg in GM bonds, because they wanted low risk and guaranteed income with a AAA rated bond. Now they wonder why the government isn’t looking out for them. But the government responds this is a unusual case (GM and Chrysler) and that they would never step in unless necessary. However, economist point out that any company that may have to tap government loans in the past and future are now going to face higher rates and more difficulty raising debt. Who wants to loan money to a company that is supposedly first in line in a bankruptcy, if the government can just step in and change the rules
As per the market reaction – this was expected for days (if not weeks) – which seems to be priced into the market this morning. Of course it could be the market really hasn’t absorbed the reality. There is still much uncertainty how long it will take to get through, what will emerge, and the future.
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China Growing
China released data that they are showing significant signs of recovery, which has lead the world markets to rally. For me there was no doubt that China, even with its GROWTH slowing down is going to continue to expand. China has some serious concerns and that is the U.S. on several fronts. They have publicly asked for a new world reserve currency, concerned about the U.S. national deficit, and the credit security of the U.S. China has already lost about 3-4% this year in the U.S. dollar backed assets, and while they remain the biggest holder of bonds they have moved to purchasing short-term paper as the future is unclear. GM’s bankruptcy and the government tossing another $30 billion at the company is continued concern, because that $30 billion needs to be financed – and that means selling more treasuries and hopefully China will buy more. The treasuries have failed to raise the money needed and the Fed is printing money to fund the treasuries, another concern that China has mentioned.
So what to do? Send Geithner on a China road show! He is currently in China and I saw part of his speech which focuses on 3 topics. U.S. has a “strong dollar” policy, U.S. credit is AAA and is safe, and U.S. will reduce its deficit significantly to reduce the need to raise more capital. Of course all of this flies in the face or reality. Dollar is weak, AAA rating has been questioned and downgraded by foreign credit agencies, and the deficit has expanded to over 1.5 trillion.
It clearly seems that we need China more than China needs us. Why, because they are our Bank of Credit. We need them to buy more debt to keep the debt cycle going. We can also look into China domestically which has down very well despite the global slowdown. Unlike the U.S. and Europe the majority of Chinese do not have access to credit, they spend/save what they earn. It is only recently that credit cards and credit has been made available and that is only a small portion of the population. That means the Chinese stimulus to the people went right to the bottom line – they could SPEND the money, rather than pay down debt. Additionally – their infrastructure has grown massively, roads, airports, buildings, etc. Chinese citizens are purchasing goods they never purchased before (cell phones, TVs, cars, games, etc.) China’s advantage is that they have the world’s largest population that is just coming into their own as consumers and China can look internally (even isolationist and protectionist) and continue to expand. Unfortunately in this country it is the opposite, we borrow from other nations and we buy other nations goods. We are a consumer nation and with GM gone are last hold of manufacturing is gone as well.
So how does this affect us? Well, I think we need to pay attention to China’s position publicly and their actual holdings. You don’t send the Treasury Secretary of the U.S. giving speeches about bond security, debt reduction, and credit ratings – if this nation is NOT concerned about the need of continual finance and getting China on board to buy more of our debt. The big question is for all their economic saber rattling can Geithner sell the goods? It’s hard for him to give that speech on the same day that GM filed bankruptcy and the government is printing more money ($30 billion) to bail them out. China might listen to Geithner, but what they are seeing tells a different story. Good luck.
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Consumer Spending and unemployment
Commerce department reported the second straight month that consumer spending is contracting. Whether they have the money or as some speculate they are saving because of the concern of rising unemployment is less clear. While the drop of -.1% was less than expected the concerns that the slowdown continues persist. The savings rate which rose by 5.7% is rather skewed with government payments linked to bailouts and stimulus.
Consumers may “Feel” better about the economy (as the consumer confidence shows), but their spending habits and savings tell a different story. Maybe a sobriety of the current situation is construed as feeling better, rather than coming to terms with reality. Regardless consumers are not spending.
Economist continue to raise their unemployment expectations and while the rise in the stock market may mask the economic slowdown, the confidence remains strong, for now.
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Futures Pre-market
The futures are making a big gap up – as the world markets rally after China released data that showed a recovery and commodities began to rally. GM on the other hand seems to have little if any factor. Future spreads are rather large, so expect to see futures come off a little into the opening as the spreads contract. Expect the market to open higher.
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Support / Resistance
Indices are at their resistances! May previous highs!
INDU 8600! (We will certainly open above it!)
NDX 1450! (We are right at this big resistance area!)
SPX 930! (We are right at this resistance level.)
RUT 515! (Again right at the resistance)
The indices are at those levels at the opening. The question is do they go higher, remain there, or come off. Between the China Growth, GM bankruptcy, and commodity story it is a mix bag.
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Gold 950+ (We could be at 1,000 soon)
Silver 15+ (16 looks like it could be in the cards today)
Oil 65+ (I would not be surprised if we see 70)
Dollar continues to fall the Pound broke through 1.60 and the Euro is above 1.40. Dollar is also falling against the YEN.
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Conclusion
We are certainly facing some unusual times as the market moves higher in the face of consumer contraction and GM bankruptcy. China continues to be concerned about the U.S. dollar and economics – Geithner is sent to ease those concerns and sell them on buying more debt. Inflation is a concern from overseas, but domestically we are only talking about deflation. That seems like a total disconnect to me.
The market seems to ignore the GM news (which was expected) and has embraced the China growth story and commodity rally story. Even though China’s growth may be to our determent economically speaking.
VIX is back below 30, yet intra-day volatility shows a different picture. Hidden volatility is ramping and we could be in for a knee jerk move up or down. Expect anything, but don’t try to make sense of it.
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