“It’s such a fine line between clever and stupid.” – This is Spinal Tap
Records, it is said, are made to be broken. The financial markets took that maxim to heart last week and busted a whole bushel of them, prompting swift action by Congress. But just as it was getting the subpoenas ready to recall those naughty baseball players to find out whose pills were responsible (their main preoccupation this past summer), crestfallen lawmakers learned that the televised hearings would not, in fact, involve Barry and Roger, but a couple of guys named Hank and Ben.
That must have come as a nasty shock, especially to Pennsylvania Senator Jim Bunning, the Hall-of-Fame former pitcher who certainly looked more comfortable on the mound than he ever does talking economics. Bunning, who as a senator still makes a great baseball player, is one of those four-legs-good, two-legs-bad ideological oddballs who make comfortable careers out of denouncing the institutions they so assiduously try to be a part of. He was probably sitting there wondering how Paulson ever got out of triple-A.
I mean, that guy came up to us already and actually asked for juice, and we gave it to him, and all they did was take him deep every time, right? Fannie, Freddie, Lehman, boom, boom, boom, you know what I’m saying? And now he wants more? Maybe we oughta give that Ben feller the ball. But didn’t he get taken deep by Stearns? Bush leaguers, all of ‘em.
Well, let’s leave the good Senator with his ruminations on the demise of the American way (a topic skillfully framed, incidentally, by veteran Republican scribe Peggy Noonan in the weekend edition of the Wall Street Journal) and have a look at some of the records that were broken.
Monday saw the biggest one-day increase ever in the price of oil. That one is being investigated by just about everybody – was it just a short squeeze, or did somebody cork the bat, or was it a little bit of both? The latter answer wouldn’t surprise us, even though it might possibly have been the dumbest time in the history of commodity trading to have tried rigging a bid. Greed does funny things to people.
The oil move combined with the news of an impending $700 billion line of credit for Paulson (he must have one hell of a FICO score) to trigger the biggest one-day drop ever for the dollar against the euro. That move was helped along by the fact that for about the hundredth time this year, the entire market was caught piled up on one side of a trade, in this case long-dollar/short-Euro. We must be setting some kind of record this year as well for the number of times traders have been caught all standing by the same door.
How about household wealth? It declined for three quarters in a row for the first time ever, although that particular record only started being tracked in 1951. It’s a good thing we’re not in a recession, or we might really start feeling bad. Speaking of households, the house part set a record for the largest single-month drop ever in housing prices. Ironic that we just spent five years hearing that they never go down, isn’t it? That’s right sir, just sign right there and you can refinance when the time comes.
That price drop, incidentally, was fueled by the number of foreclosure sales in the mix. The good news is that the homeowner’s signature isn’t required for that stage of the process. It’s all part of the new efficiency of regulation-free markets.
You probably noticed that we also set a record for the largest bank failure ever, when regulators pulled the plug on Washington Mutual as soon as management stepped out of the room. It seems that the calming-of-the-waters effect that the feds had engineered by first gutting the GSE’s, then looking away desperately with fingers crossed when Lehman imploded, had had the bizarre and totally unexpected effect of making people nervous about their bank deposits.
Since each and every article about the spiraling crisis the last three weeks has prominently mentioned WaMu’s name, depositors took the unimaginable step of taking their money out, thereby gutting the bank’s deposit base. Wow, who could have ever seen that one coming? Try telling that to TPG, the Fort Worth-based private-equity group that just set the record for the largest ($1.35 billion) single private investment loss ever (WaMu) – and in only five months time. Some of the talking heads on CNBC were trying to talk up Paulson last week as a potential savior of our era, but I don’t think he’ll be getting a lot of nominations down there in Texas.
A couple of credit spreads set new records. The “TED” spread, or the difference between three-month treasuries and three-month LIBOR, blew out to 317 points in the early part of the week and were topped again during the week. Municipal bond yields, which are tax-free and thus typically trade at about two-thirds of treasury yields, shot up to about 125% of treasury yields, apparently also a record. That is about as dysfunctional a credit market as you can get.
Fed chair Ben Bernanke set a record, too, during his testimony about the mortgage relief legislation. When being queried about the events that led to the joint decision by the Fed and Treasury to seek emergency relief, he broke the record for disingenuousness by referring to the “unexpectedly rapid” collapse of AIG after Lehman failed.
Uh, what was that Ben? When Lehman blew up over the weekend, had somebody slipped the page “financial stocks rally” into your copy of the event tree? You should have checked around. Lehman’s bankruptcy filing wasn’t just red meat for the short-sellers, it was a shipment of hand-rubbed Kobe filet. After watching what happened to the holders who stood by Fannie-Freddie and Lehman, did you think that AIG shareholders were going to double down in support? The second Lehman’s papers hit the tape, AIG was alone in the desert with a sky full of vultures.
Not to be outdone by mere government agencies, many of our senators seized upon the opportunity stage offered by the crisis to look hopelessly self-serving and idiotic in front of a national audience. The first day of hearings was so disheartening the markets retched up another few percent just from watching. It was not one of our finer moments. Yet in a perverse way, it does validate the democratic process. They may be buffoons, but by golly they’re our buffoons, and we’ll probably survive the circus.
At least we hope so. Paulson & Co., it is almost universally agreed, haven’t pulled off the world’s greatest act of salesmanship with their relief plan. We can’t blame the public for cynically wondering if it isn’t all just a bailout plan to rescue Wall Street from its own excesses. Support for the plan is modest at best, while outrage at the situation is everywhere.
It isn’t just Wall Street, though. It’s years of winking and looking the other way by our regulatory agencies. It’s the last few millimeters of a long pendulum swing from an excess of regulation in the seventies to an excess of blind faith in unregulated market processes in the current day.
To the last, there is still a hard-core rearguard of zealots echoing the disastrous “liquidate everything” philosophy that helped turn the stock market crash of 1929 into the Great Depression of the 1930’s. That same philosophy contributed to the disastrous governmental decisions to butcher every company targeted by short-sellers. Note to Hank and Ben: didn’t either of you ever watch “Tarzan” as a kid? Shooting the wounded doesn’t comfort the survivors. It panics the herd.
As we go to press, our legislative fate still hangs in the balance. We believe, along with the market, that our legislators will find a way to drink the kool-aid and enact relief legislation. We most sincerely hope that they get it right, because although it’s our belief that this step shouldn’t have been necessary, it is now. One cannot put the genie back in the bottle. If we don’t get a plan, the Dow will vaporize another few thousand points in less than a week, and an economic cycle that starts with “D” awaits us on the other side. That’s no exaggeration, dear reader; we really are that close. Let’s hope we stay on the right side of the
On a completely unrelated note that has nothing at all to do with the markets, MarketWeek notes with sadness the passing of actor Paul Newman. An artistic icon of the twentieth century, Newman was a rare example of a Hollywood success who perfected his craft while shunning celebrity, staying married to the same woman for fifty years, donating generously to charity and by all accounts retaining a gracious modesty (like I said, nothing at all to do with Wall Street).
He will be missed.
The Economic Beat
The economic week led off quietly with the news that the Richmond Fed’s manufacturing survey, which is not widely followed, indicated that manufacturing weakened further in its area. Given the dramatic twists and turns in the mortgage relief legislation package, it wasn’t surprising that most economic news was given short attention.
Existing home sales fell in August, and mortgage purchase applications fell during the week. Although the sales number fell short of consensus, inventories came down. We said last week that that might be the case, though whether or not it was from homes being pulled off the market, as we suggested, isn’t clear. Home prices recorded a big drop, the largest ever, caused in large part by the high percentage of foreclosure sales in the mix – estimated to be between thirty and forty percent of the total.
Given the tight credit conditions, it’s perhaps not surprising that new home sales fell even more, a drop of (-11.2)%, or about 50,000 homes short of the consensus estimate. That’s a big miss, and on a per capital basis is probably the lowest rate ever. Although the actual number of homes available for sale decreased, the anemic rate meant that months of inventory increased. Naturally, the homebuilders rallied. Given that nothing else is working, I can almost understand, but it was a dismal report.
Keeping those reports company were the latest data on durable goods and jobless claims. Initial claims nearly touched the 500,000 level (493,000), and continuing claims ratcheted back up again over 3.5 million. Although the weekly number was inflated by claims related to Hurricane Ike, it was still a big number that had economists revising estimates higher for the eventual peak.
The durable goods data was discouraging. Overall they fell sharply by (-4.5)% and June and July were revised downwards. Nearly every category fell, and the business capital goods category fell by (-2.0)% as well. The only good thing that could be said about the report was that it puts additional pressure on Congress to act, but the flip side of that is the increasing market downside risk if the politicos mess it up, which they are certainly capable of doing.
The durables data was from August, and is somewhat belied by some of the recent new-orders strength in the Chicago and Philadelphia Fed surveys. However, it appears that the early September trend covered by the regional Fed surveys may have cratered – there is numerous anecdotal evidence of order cancellation going on around the globe, somewhat topped off by Excel Maritime’s (EXM) lament on Friday that dry cargo shipping is going to the dogs.
Second-quarter GDP was revised downwards to 2.8%, a largish bite out of the previous 3.2%, but the market paid it no attention. They shouldn’t, either, given that the government is still straight-facedly (and without explanation) using a figure of 1.3% as the price deflator for real GDP (if it used the gross domestic purchase measure of 4.2%, GDP would have been negative). One interesting revision was that the BEA discovered that the profits of financial corporations were negative after all in the second quarter. That must have come as a shock.
A consumer confidence revision came out Friday at 70.3, near the consensus, but the market rightly ignored it.
Looking ahead to next week, the calendar is very busy, although it may initially be overshadowed by the TARP plan, and central bank moves could dominate the tape later. Personal income and spending numbers for August are due on Monday, with both estimated on average to rise 0.2%. The consensus forecast for the PCE inflation indicator is for another rise of 0.2%, which would be welcomed by the markets (it ran at 0.3% the last two months, too high for the Fed’s liking).
Tuesday will see the Chicago PMI, which had a strongish reading last month and is cautiously expected to be above average for August. The Conference Board’s consumer confidence number will also be released, for which the cutoff should be around the 19th or so, so it might capture some of the impact of the recent front-page crises. The Case-Shiller home price index comes as well, and that one has showed some pockets of stability of late. In the current environment, any change in trend is almost sure to move the markets.
The ISM will report the results of its latest survey of manufacturing trends on Wednesday and of non-manufacturing trends on Friday. They are both expected to be about neutral, and some of the regional surveys have been conflicting. Market-watchers will want to see in particular if the weak durable goods number is born out by the ISM manufacturing number. The former probably will show up in the latest factory orders report, set for release on Thursday.
Wednesday will also see the release of August construction data – estimated to have fallen another (-0.5)%, and the ADP payroll report, which is getting heightened scrutiny these days, though it rarely comes at all close to the main jobs report. The latter, one of the two big enchiladas in the market’s diet (the other being FOMC meetings), is expected to arrive Friday with tidings of a loss of one hundred thousand jobs. That looks about right to us, although we caution that any month’s report should usually be taken with a healthy dose of salt. Even so, something larger than that would rattle everyone’s cage.
We promised you a name last week, and by golly we’re delivering one. That company is hard-drive maker Western Digital (WDC). After gobbling up competitor Komag last year (a name we also recommended), Western is the second largest such supplier in the country after rival Seagate (STX).
It’s hard enough to recommend anything but cash these days (and only T-bills, at that) with the travails of the markets, and a global slowdown/recession blooming. So why Western Digital?
To begin with, it’s cheap as dirt. At Friday’s close of $21.60, the stock price has fallen nearly in half from its 52-week high set back in the halcyon days of June. It’s trading at a post-tech-crash low of 5.6 times earnings, and even better, just north of three-and-a-half times operating cash flow. That’s cheap written large.
The balance sheet is in good shape too, with more than twice as much cash (about $4.95 a share) as long-term debt (about $2.15 per share), according to its annual SEC filing last month.
The question of the global slowdown still remains, however, and there are increasing rumblings of cutbacks in orders in the personal computer industry. Yet at this level, we think that those fears are well reflected in the price. In addition, the hard-drive business isn’t just desktops and laptops anymore. It’s mobile phones (especially smart phones), MP3 players, portable USB drives and other assorted digital devices needing more than card-based storage.
The sales growth of most consumer-related items looks certain to slow for at least another quarter or two, yet the mobile phone and PC business (led by laptop sales) has been surprising stable. They are practically consumer staples now, and perhaps something to treat oneself to when postponing bigger purchases such as autos or homes. At this valuation entry level, it seems awfully hard not to be looking smart a year from now.