Gotta Have the Game


“Bernanke, you must concentrate on the game! The town is up to here with high players!” – a New York City banker (with apologies to Frank Loesser, Guys and Dolls)

When we handicapped the coming week in our last column, the lack of scheduled news on earnings or the economy suggested a continuation of the current trend, because that is the market’s usual way. So the market rated to keep going down, but three possibilities that could have turned the tide included another postponement of the European debt reckoning, China taking fright and changing its mind on tightening, or soothing words and coy promises from the Fed.

Alas for those who were leaning long and strong, none of those events came to pass. Not that any of them were odds-on – the Europeans, for example, seem to be more conflicted than ever about what to do, extend and pretend, or file for divorce? Even if another coat of lipstick on their debt pig is never more than an all-night meeting away, nothing looks imminent. Or perhaps more accurately, nothing is exactly what’s imminent.

As to China, one never knows. This is the first time that government has given birth to its very own property and lending bubble, and it will probably take them a while to come to grips with its reality, paternity, and what, if anything, can be done. Our crystal ball sees many Chinese billionaires soon retiring to prison life – isn’t it wonderful how other countries adopt our traditions? – but the going-away parties are probably still many months away.

Not that many months, though – pundits (e.g., Nouriel Roubini) are starting to speculate that China might face a hard landing after 2013. Given the peculiar nature of financial disasters, which have a knack of being able to transport themselves seemingly overnight from safely distant horizons to the axe coming through the back door, that probably means next year.

The last obvious hope of the three was the Fed, and market participants craned forward Tuesday afternoon in the hopes that Fed Chairman Ben Bernanke might offer to buy drinks for the house one more time. When he gave no signs of doing so, markets began to sell off again and apart from an unconvincing technical bounce on Thursday, steadily marched southward to further losses.

However, we did get one moment of comic relief. At the end of the Bernanke’s Q&A period – quite a new practice for a Fed chairman – JP Morgan (JPM) CEO Jamie “Diamond” Detroit (aka Jamie Dimon) did his best Nathan Detroit imitation, complaining to Lieutenant Bernanke that with all the heat on, how could the boys get a crap game on?

We must add that Diamond Detroit, like his avatar Nathan, does not gamble his own money. They both take a percentage off the top in return for holding the game. Last year Diamond’s take was $21 million. This year JP Morgan is on track to earn $20 billion in profits, presumably raising Diamond’s take, but really, what’s a measly $25 or $30 million anymore? Why, it’s hardly able to keep up with LeBron James.

In case you were wondering what’s keeping the country down, there it is. How’s a bank supposed to lend any money when it can barely park twenty billion simoleans in the till every year? And the Feds want them to keep some of it for a rainy day? Might as well stop having the game at all, for Pete’s sake. Who do they think we are, the Bailey Brothers Building and Loan?

Blaming business problems on the government is as old as civilization, so it’s not as if Dimon’s complaint broke new ground. The billing and cooing the next day from the media courtiers who draw their paychecks by flacking for big business was equally dated. But dumping brandy-and-cigars grousing on Bernanke at a press conference with a complaint normally reserved for private channels – and it certainly isn’t as if Dimon doesn’t have access – was a surprise, and must have been a calculated move.

The results were mixed so far as the press went, though not surprisingly found little traction with the public, most of whom make less than $25 million a year and most of whom have somewhat differing views on who was responsible for the crash. While it isn’t surprising that after more than three decades of deregulation, it must feel unnatural to the banks to have the pendulum swing back the other way, the evidence of the last decade hasn’t supported the notion that the banks know best.

As for us, we don’t have much sympathy either, though it isn’t because we don’t make $25 million a year (the injustice of it all!). As investors, we think the marketplace would be better off if the Gang of Four banks were broken up. The financial supermarket model has never worked well for any but the handful at the top of the compensation ladder. The sheer size of the largest banks makes the banker’s prime directive – know your customer – difficult to implement, and the vastly overrated idea of cross-selling has turned a lot of good specialists into error-prone generalists. Superbanks offer crummy returns and their blunders are dangerous.

The real problem for the banks is the same symptom that has always plagued the modern bank. A hot sector attracts credit, then a deluge as bankers convince themselves (a la Chuck Prince) that they have to be in the game. The bubble swells and bursts, the bankers swear off the sector, and would-be borrowers must find money elsewhere for a few years until the bad loans are all gone and institutional memory has faded.

The problem with the last episode is that the sector wasn’t a specialty niche, it was a core product, real estate, and not confined to a hot region, either, but nationwide. The banks, particularly the majors, are still sitting on a lot of sketchy loans. Lowering capital ratios won’t get the banks to lend more money anymore than allowing corporations to bring home overseas cash tax-free would get them to invest. Cash is not the problem.

Lowering capital regulations and regulatory barriers for banks would satisfy their thirst to put more resources into other activities, however, most likely the current fads of trading and derivative products, where the banks think they can earn fees and monopoly spreads without worrying about getting paid back.

Corporations, for their part, will hire more when demand tells them they need to increase labor inputs, not because they can sell more bonds or keep more after-tax earnings. Until they need to hire, bribing them to hire domestically will just transfer money from taxpayers to corporations without increasing employment. It’s natural for economic actors to press the government for favors and goodies, but let’s be clear about what they are and not mistake them for economic cures.

Coming back to equities, there isn’t much on next week’s busy calendar that looks likely to turn around the current malaise. The market is technically oversold, so a whiff of good news should be good for some kind of rebound. Monday is empty domestically, but there is a lot coming from China that could have an impact.

A nice pop in retail sales (Tuesday) would do the trick, or a big drop in weekly claims. But it still looks likely to us that the market will fade into a test of the 200-day exponential moving average on the S&P 500, which currently lies a little north of 1262, not far above the March low of 1256 (Friday’s close: 1271). That zone should provide at least a temporary bounce.

Apart from that, it’s beginning to look like we’ll have to wait until earnings season – or perhaps the end of the month – to reverse the market’s slide. The talk about the market’s “longest losing streak since 2002” is deceptive, given that some of the weeks were barely changed and the damage has not been great. It took only two weeks in March for the markets to rise by the same amount that took the last six weeks to give back.

Having talked itself into a dream of growth that wasn’t going to happen this year, the market will probably now panic over a double-dip scenario that isn’t going to happen either (unless Congress does something stupid with the debt ceiling). Bargains should begin to pop up soon, but right now looks like a good time to be in cash and on vacation.

The Economic Beat

The light week for data left the markets in their inertial drift downward. The Fed’s Beige Book was released Wednesday to little effect and without much positive to add. Although the economy was still characterized as expanding, the change from the previous report was noticeable, with four districts newly reporting deceleration.

Weekly claims came in a little higher than expected, but not enough to either frighten or soothe markets. As usual, the weekly increase was understated by the previous week’s upward revision. The four-week moving average fell, but the improvement in the last two weeks have come from the very high April 30th and May 7th weeks falling out of the calculus, not from any recent improvement. Barring a sharp drop next week, it will start to rise again.

The trade deficit improved in April, with much of the gain coming from a drop in imports of Japanese cars and parts. Not so encouraging and due to reverse, but it may help out the second quarter GDP print. Import-export price pressure eased slightly in May, with the trailing 12-month increase in imports rising to 12.5%, but the monthly increase of only 0.2% was the smallest since last year. The stock market decline took oil down with it.

Next week the release schedule picks up again. The three main legs of the economy will be reporting, beginning with May retail sales on Tuesday. The estimate is for a drop of 0.3% in total sales, due to declines in autos, and an increase of 0.3% overall. Both targets look eminently beatable, which could put a little pop into a market starved for a rally. Retail will compete with the Producer Price Index (PPI), which is expected to ease to an increase of only 0.1%; the combination of the two could be a plus. On the other hand, the National Small Business Optimism index arrives early that morning and it does get a bit of attention. We’d be surprised to see an improvement.

The bigger challenge may come from manufacturing and housing, the other two legs. The New York and Philadelphia regions report the results of their June manufacturing surveys Wednesday and Thursday respectively, and both have decelerated sharply in recent months (though that does leave the door open to a positive surprise). A sensitive number could be the Industrial Production report for May, also due Wednesday. Expectations are for a muted 0.2% increase, but even that might be a challenge. The Consumer Price Index (CPI) and the New York survey precede it that morning.

Homebuilding reports with the sentiment index on Wednesday and housing starts for May on Thursday. Builders haven’t given any indication of an uptick in recent presentations.

The week will end with a flurry: the preliminary June consumer sentiment reading, Leading Indicators and a quadruple-witching expiration day. The weekly earnings calendar is light, but Finisar (FNSR, Wednesday) and Research in Motion (RIMM, Thursday) are two notable reports. The former is a cloud darling, while RIMM hasn’t been anyone’s darling for some time. China reports a sizable chunk of data Monday night, including its CPI, PPI, retail sales and industrial production.

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