Panic in China

China just cut rates by 1.08%, the most since 1997. It's panic time in China. Predictably, this had juiced the markets. The Shanghai 25 has rebounded to almost 1900, from its low below 1700. I think this is a great opportunity.

Trade: bought FXP at $53.61. I think this is just a temporary bounce. We'll see what happens though, now that it looks like the Fed is engaging in direct monetization. Anything can happen.

Bullshit Assets

Jonathan Weil from Bloomberg has a nice explanantion of how Citigroup had negative equity of $8 billion as of last Friday's market close. Enter another accounting star: DTA's or Deferred Tax Assets. Companies can claim losses as assets according to how much they are entitled to in tax savings on future earnings. Wall Street, of course, loves turning losses into gains. Let's see if the government bailout accomplished anything. They gave Citigroup $29.5 billion in new equity by buying preferred shares, and they guaranteed up to $250 billion in losses on Citi's SIV assets. Citigroup's market cap is now $32 billion.

Weekly News Wrapup

Markets wary of Irish debt as fresh rescue looms

This is a disturbing pattern across Europe as the global credit crisis drags on, with extreme cases in Iceland, Ukraine, Russia, Hungary and Latvia. There are fears that investors could start to shun sovereign debt in Western states where banks have outgrown the underlying economy.

Ireland is vulnerable because financial services make up 9.8pc of GDP, including its 'Canary Dwarf' enclave of hedge funds. The liabilities of its lenders are twice Irish GDP. Britain, Switzerland, Belgium, Austria and Luxembourg are in the same boat.

Faith in bailouts is quickly being replaced by reality: there is too much debt. Bailouts just transfer the risk to the government.

In other news, out of 11,584 stock mutual funds in the U.S. How many have a positive return for 2008?

0.

Junk bond yields are now at almost 21%, which is greater than during the Great Depression. I expect the Federal Reserve to start buying junk bonds within the next six months.

I'm thinking it may be time to sock away some gold, just in case (real gold, not paper gold).

Let's see how long Friday's 1-hour rally lasts.

Treasuries

Posted on Winterwatch in response to a prediction of Treasury bond
collapse:

Go long bond. Go, baby, go. Treasuries won’t crash until they become the next bubble. Did they ever crash in Japan? No. Did Japan print and borrow
Trillions. Yes.

Also, think of all the pension funds, insurance co’s, etc. that have to invest in AAA… there aren’t many MBS left for them to invest in. Come to think
of it, there aren’t many inv. grade corporates out there either… Bullish for
bonds.

Inflation falling from 5% to -3% is hugely bullish for bonds.

Bernanke’s out of ammo and his next trick will be to buy bonds and push the yield curve down out to 3-5 years. Again, bullish for bonds.

Obama wants a pre-pack bankruptcy deal for automakers. Bullish for bonds.

That being said, I’m probably going to take profits here. Short term, the train has left the station, but watch for another shot.

Then again, the employment report comes out next Friday. Maybe I'll hold on. Not sure yet.

More Proof that the Financial System Remains Broken

The Treasury Buying Failed Money Market Fund's Assets. Markets have ceased to function. The only things that are getting done are guaranteed by the Treasury, the FDIC, the Federal Reserve, or some other government entity.





Forget about free markets. There are no markets.

Here is Bloomberg's yield curve chart, showing the 3-month Treasury at 0.01%. The 2-yr. closed yesterday at the unprecedented record low of 0.99%.

If Bernanke wants to monetize, he will have to push 1% all the way out to 3-5 years. The problem is too much debt, and deflation just makes debt worse. Unfortunately, defaults and other ways of lowering debt also make new invesment much less likely going forward.

Next trade: gold. Gold is up today by about $30 to $780. I expect many people will jump and crow about "inflation" when Bernanke makes a specific monetizing announcement. This won't be a huge position I take, maybe 1-2% more in OZN and 10% in GLD.

Trade

Bought 23 SDS (ultrashort S&P 500) at $126.71. The market has fallen off the cliff it's been teetering on the edge of for the past month. I expect another vicious downdraft that should take the S&P down below 700. I will reevaluate SDS when the S&P drops down around 660.

This is just a trading play. I have very little leverage at this point, so I feel comfortable trying a new strategy. In the past, I would never have jumped on the downdraft like this. Instead, I would have tried to anticipate the market move. However, this might be a good trade, at least based on the fundamentals.

Decision Time

So I looked at the 30-yr. bond today to see the yield had fallen 20 (20!!!!!) bips to 3.77%. Since this is well below my revaluation point of 4.00%, it was time to decide what to do.

So, I made a little list:

Reasons to sell:

1. 20 bip moves are very rare
2. I might be able to buy back in @ 4.00%

That was about all I could come up with. But you don't get a 5% move in the long bond every day.

I also listed some reasons to hold on:

1. A big fall through the floor usually keeps going
2. If it bounces back to 4.00% I can buy more anyway, because I'm only halfway in
3. I've already taken my 4% profit for this month, and both trades were too early
4. The recent rally in bonds has taken the 10-yr from 3.9% down to 3.2%, or a 0.7% difference. The difference in the 30-yr. is 0.50%, which is a closer correlation than I was expecting. This tells me that the long bond will rise more than I thought, as I expect the 10-yr. to approach 2.5% next year.
5. And finally, with October's CPI report, the forward annual inflation rate is -12%. Deflation, even at -1% will be humongously bullish for bonds.

So I'm keeping the bonds. I will re-evaluate when it goes to 3.60%, or the ten year gets to 3%.

The Plague

Deflation is here. Bloomberg reports "Consumer Prices Drop 1%, Most on Record."
Year over year inflation is at 3.7%. The Fed is out of ammo, as the effective funds rate is almost 0%. Very soon, Bernanke will have to open up another can of alphabet soup for some more nifty ideas. Unfortunately, whatever he's done may have prevented collapse, but it's just slowing down the damage. The economy is nowhere near turning around.

Go Bonds! In fact, I'm thinking of buying more, as a hedge against Congress letting GM fail. Housing starts are now under 800,000 annualized. That's a 60% drop from the peak.

For a visual representation of deflation, see the link below:

http://www.youtube.com/watch?v=kcArEEvQZ-M&feature=related

skip to 2:40 for the good part.

Trade

I covered my short on DECK (Decker's Outdoor), maker of Uggs boots today. They could go lower, but they're now under $60. They have $5/share in cash and no debt. They're at a P/E of 10. They could go lower, but I won't get greedy. Can't argue with 42% profit in eight months.

Prediction

DOW 4000 by mid 2009.

Comment

Posted by me on Russ Winter's blog:

I would like to believe that everythings poised for a rebound. I think the withholding taxes chart is your best evidence that things aren’t that bad. Also, your chart of demand deposits is interesting.

First, withholdings. There are several things that make me question that data. What about state taxes? They’ve fallen off a cliff. I live in CA and the budget that was supposed to be balanced two months ago on spending cuts is now projected to be $25 billion behind over the next 18 months. Reason: loss of tax revenue. These two pieces of information are in direct contradiction, and I never like to rely on just one source.

Next, demand deposits. These spiked in mid-September or October. I don’t
see this as bullish at all. This is not money waiting on the sidelines to go
back in the market. (There’s a buyer for every seller anyway, so only IPO’s take money into the market.) This is not joe six-pack’s money. This is money that companies have parked at banks by drawing down their lines of credit. All of this is just an accounting change as banks move money from reserves to deposits.

Don’t believe me? Check out http://www.federalreserve.gov/releases/h3/Current/. This is the info on aggregate reserves of depository institutions. A year ago, they had reserves of their own; now those reserves all come from the Fed. The banks are enormously negative without the Fed.

For Oct. 2007, nonborrowed reserves were positive. Total borrowings from the Fed were only 254 mil. and reserve requirements were met with nonborrowed reserves.Flash forward to October 2008. Total borrowing from the Fed jumped by $360 billion from September. Nonborrowed reserves are a negative 360 billion.

Now you may think that the Fed lending will juice markets, but I don’t think so. They’re paying interest on those reserves that is higher than the borrowing rate. Why will banks lend this money out? If I lent you billions
at 0.5% and paid you 1% interest, would you put that in the stock market?

Slowdown in China

Bloomberg is reporting that China is going bust fast.

The International Energy Agency, the adviser to 28 oil-consuming nations, yesterday lowered its forecast for fuel demand in China, the world's second-largest energy user, by 200,000 barrels a day.

Sinopec is reducing output even as refining margins improve because of lower crude oil prices. China's fuel demand is falling as factories shut and airlines ground planes after the world's fourth-largest economy grew at
the slowest pace since 2003 in the third quarter. Stockpiles of petrochemicals including naphtha, a raw material for plastics, are at records.

What can we predict from this data? Lower prices for oil.

Today's rally was interesting, although not altogether surprising. Technical analysis would say that the market recently tested the recent bounce high (set on October 13) of 9400 by closing at 9600. It then promptly fell and closed yesterday at 8300, where it has support from the intraday low of 7800 set on October 12. We may be in a trading range here. However, I believe that the credit crunch is devouring the real economy like a plague of locusts. The fundamentals are really bad and getting worse, and stock analysts still predict a 25% increase in Q4'08 earnings. The recent trend of companies cutting their own estimates below analyst expectations shows the foolishness of these estimates.

Profit Time

I took a profit on covering ITB today @ $9.20.

First of all, I wanted to take something off the table in case the bottom holds and we get another rally. Also, the homebuilders have gotten creamed the last couple of days since Hanky Panky Paulson announced that the TRAP (not a Freudian slip) will not be used to buy mortgages from banks. TOL, which is arguably the best run homebuilder is 20% below book value, which should probably put a floor under them.

Then again, I covered GGP at $20.00 and they're now at $0.20. Left a lot of profit on the table with that one. Well, I will look to short ITB again if they go back over $12. In the meantime, I can't argue with 42% profit.

Shipping

This is an excerpt from Fearnleys report on shipping. Capitallinkshipping has these reports weekly.

Cape market continuing with zero activity and there is simply no spot market. Owners realising that firm cargoes are almost impossible to find
and a large number of ships (we guestimate around 100 ships) are kept
in waiting-positions, mostly in the Far East. For expensive tc ships this situation is disastrous and the much discussed counterpart risk is becoming increasingly serious. However FFA settlements of end last week
were concluded apparently without serious casualties. The cape index rate
still easing and the tc spot index now stand at usd 4193. Some bargain
hunters looking for modern capers and for 12 mos talking rates in the low usd 20 000.

Charter rates are now at $10,000 from a high of $185,000 this year. That's a 95% drop. Diana Shipping suspended their dividend going forward. In related news, shipping container inflows to the US are predicted to fall over 7% in 2009.

I don't see how I can be bullish on much except bailouts, the US dollar, and long-term Treasuries until the credit deflation shows some sign of easing. Right now, theres no good news that is not related to government guarantees and intervention.

Better Late than Never

Trade: I took a full position in 30-year Treasuries today at a 4.25% ytm. There are many who expect the oncoming deluge of Treasury supply (over $550 billion this quarter) to overflow the demand. However, I believe that long term, Treasuries will keep their strength as long as deflation continues and the dollar remains strong.

We also have a continuous creation of new demand as the rest of the world races each other to see who can get to a zer0-interest-rate-policy first. Just this week, the Bank of England cut 150 bips, the ECB by 50 and the Swiss National Bank by 50 as well. In Germany, factory orders dropped by 8%. 8%?!? And there won't be demand for Treasuries? Short-term, I am waiting to see what the employment report shows tomorrow. If it's real bad, look out below, stock market. The Treasuries will take off. If it's a mild report, then it may take a little longer. Either way, I expect yields will drop below 4% for the third time this year. When they do, I will reevaluate my position and decide whether or not to cash in.

Liquidity Trap

I just learned something from Paul Krugman. Maybe he does deserve the Nobel Prize after all.

You still see people saying, in effect, “never mind the zero interest rate, why not just print more money?” Actually, the Bank of Japan tried that, under the name “quantitative easing;” basically, the money just piled up in bank vaults. To see why, think of it this way: once T-bills have a near-zero interest rate, cash becomes a competitive store of value, even if it doesn’t
have any other advantages. As a result, monetary base and T-bills — the two sides of the Fed’s balance sheet — become perfect substitutes. In that case, if the Fed expands its balance sheet, it’s basically taking away with one hand what it’s giving with the other: more monetary base is out there, but less short-term debt, and since these things are perfect substitutes, there’s no market impact. That’s why the liquidity trap makes conventional monetary policy impotent.

The latest announcement from the Fed is that they have raised the interest rate of bank reserves to equal the target rate. Today, they lent at 0.18%. What idiot wouldn't want to borrow at 0.18% and collect interest at 1%. No wonder there's $420 billion in bank reserves at the Fed. The money is just piling up in the vaults. Japan, here we come!

China

China will go into a depression. Just look at the news from Bloomberg. Chinese banks aren't lending to factory owners that need the cash. "Half the nation's toy exporters have closed this year, and 67,000 smaller enterprises filed for bankruptcy in the first half, according to government statistics." Loans to small businesses are defaulting at four times the rate of larger companies. Small businesses, however, are the backbone of the Chinese machine, providing "three-quarters of urban jobs and 60 percent of China's gross domestic product."

The problem with the Chinese economy is that it's all built on more and more debt. Loan growth has slowed to 6.2%. I remember reading a year or so ago that credit growth was running in the low 20's. That fueled GDP growth of 11%. Now that credit growth is 6%, GDP will probably drop to 3%.

The Crunch has Teeth!

Bloomberg is reporting that "Credit Card Bond Sales Plunge to Zero, First Time in 15 Years." Looks like the rugs being pulled out from under Joe the Plumber.

Top-rated credit card-backed securities maturing in three years traded at a gap, or spread, of 475 basis points over the London interbank offered rate during the week ended Oct. 30, JPMorgan Chase & Co. data show, 25 basis points higher than the previous week. The debt was trading at 50 basis points more than Libor in January.

The higher cost to sell the bonds makes it more expensive for banks and credit card companies to fund loans to customers. New York-based American Express Co. paid 160 basis points more than Libor at a Sept. 11 sale of the securities compared with 30 basis points over the benchmark at a similar sale in October 2007, Bloomberg data show.

A year ago, asset-backed credit card backed securities totaled over $17 billion. But the Fed's accepting asset-backed commercial paper, so it's okay. Not. American Express is toast. Burnt toast. I'm going to short them. Their book value per share is $11 and they're at $29. 3-month LIBOR is down to 2.5%, so AXP's cost of funding in the private market is 7.25%. Well, maybe I won't move so fast, because they're probably getting a lot of money from the Fed, and that's cheap.

The other thing I'm thinking of doing is selling PWE. At around $18, it's bounced almost 40% off the lows.

Bullish or Bullsh$t?

Barrons's is bullish on stocks.

MSNBC is bullish.

Marketwatch is bullish.

The Wall Street Journal is bullish.

62% of managers in Barron's Big Money poll are bullish.

I'm not bullish. Except on bonds. I will buy 30-year Treasuries sometime this week. I have student loan cash-flow issues to work out, otherwise I'd be buying those bonds right now instead of writing this. I think we're seeing a classic case of dead cat bounce. The market is up 300 points on a day when manufacturing contracts 3 times as much as expected. It is a hallmark of the bear market rally that the market ignores bad news. So, the only question I have for myself is, "Will the economy be worse six months from now?" I have very little doubt about it. Credit is still contracting. Iron ore companies are cutting production and steel prices are plunging. So my timing sucks. What else is new? Applying a little game theory to Barron's, we can conclude that the smart money's already in stocks. (If they're bullish, they've already been buying all last week.) Therefore, the bounce is almost over, and the next move will be to take some profits and run.