What This Weekend's Announcements Mean for the Market

I was bargaining on a quiet week as there were only a handful of economic releases and no major earnings reports. But credit and liquidity issues ravaged the financial markets and resulted in plenty of white knuckles and shaky knees, climaxing on a particularly sour note on Friday and not quite delivering the birthday present I was hoping for.

Struggling to contain a crisis of confidence in credit markets, the Federal Reserve announced a new Term Securities Lending Facility (TSFL). The Fed will lend up to $200 billion of Treasury securities to primary dealers for a term of 28 days (rather than overnight) against collateral including federal agency debt, mortgage-backed securities of Fannie Mae and Freddie Mac and private AAA-rated residential mortgage-backed securities.

This program essentially aims to improve liquidity by allowing more thinly-traded securities to be used as collateral to borrow highly-traded Treasury securities. “… looks to me like the nationalization of duff loans, although the Fed has not actually purchased the mortgage securities,” remarked London-based David Fuller, author of the Fullermoney newsletter.

The auctions will take place on a weekly basis, commencing on March 27, and participating central banks include the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank.

Wobbling on the brink of collapse from a lack of cash, Bear Stearns received emergency funding on Friday from the Federal Reserve of New York and JP Morgan in the largest government bailout of a US securities firm. The rescue action failed to restore confidence among Bear’s customers and shareholders, who slaughtered the stock price by 47% and sent stock markets tumbling.

The Fed’s board unanimously approved the JP Morgan Chase and Bear Stearns arrangement and issued a press release stating that it was “monitoring market developments closely and will continue to provide liquidity as needed”./font>

Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance round-up.

Economy
The world’s major central banks’ efforts to inject liquidity into the financial system did little to quell investors’ fears as recession concerns remained elevated.

Economic data were mixed, although the reports did not have much impact on financial markets due to credit worries taking center stage. February retail sales fell by 0.6%, which was short of the expected 0.2% rise. On the positive side, however, the inflation numbers were better than expected as February CPI and CPI excluding food and energy came in flat. CPI is now up 4.0% year on year, and core CPI is up 2.3% year on year.

The better-than-expected inflation reading, together with the reeling stock market, caused pundits to up their expectations of the size of the FOMC’s March 18 rate cut. Fed funds futures now suggest a 64% chance (up from only 6% a week ago) of a 100 basis point cut, with the rest of the bets on a 75 basis point cut.

WEEK’S ECONOMIC REPORTS

Source: Yahoo Finance, March 14, 2008.

In addition to the FOMC’s interest rate announcement on March 18, the next week’s economic highlights, courtesy of Northern Trust, include the following:

1. Industrial production (March 17): The 0.5% drop in the manufacturing man-hours index in February suggests a 0.3% decline in industrial production. The operating rate is projected to have dropped to 81.2 in February. Consensus: -0.1%; Capacity Utilization: 81.3 vs. 81.5 in January.

2. Producer Price Index (March 18): The Producer Price Index for Finished Goods is expected to have risen by 0.3% in February, reflecting higher food and energy prices. The core PPI is most likely to have risen by 0.1% after a 0.2% increase in January. Consensus: +0.4%, core PPI +0.2%.

3. Housing Starts (March 18): Permit extensions for new homes fell by 1.8% in January, inclusive of a 3.0% drop in permits issued for single-family homes. The weakness in permits is indicative of fewer housing starts in February (970,000 versus 1.012 million in January). Consensus: 990,000.

4. Leading Indicators (March 20): Interest rate spread and money supply are the only two components likely to make a positive contribution in February. Stock prices, initial jobless claims, consumer expectations, vendor deliveries, and building permits are expected to make negative contributions. Forecasts of money supply and orders of consumer durables and non-defense capital goods are used in the initial estimate. The manufacturing workweek held steady in February. The net impact is a 0.4% drop in the leading index during February. If our forecast is accurate, this would be the fifth monthly decline in the index, which reinforces expectations of a recession. Consensus: -0.3%

Other reports: Current Account (Q4), NAHB Survey (March 17, Philadelphia Fed Survey (March 20).

Markets
The performance chart obtained from the Wall Street Journal Online shows how different global markets fared during the past week.

Source: Wall Street Journal Online, March 16, 2008.

Equities
International equity markets were again on the receiving end of credit market woes, including the Bear Stearns bailout. Global stock markets closed the week lower, with the MSCI World Index declining by 0.5%.

As was the case during the previous week, the Japanese Nikkei 225 Average and emerging markets again came under strong selling pressure and lost 4.2% and 2.2% respectively. China’s Shanghai Stock Exchange Composite Index (-7.9%) was at the forefront of selling pressure, having lost 35,0% since its peak in October 2007.

The major US indexes experienced a mixed week, with the S&P 500 Index losing 0.4%, the Nasdaq Composite Index closing unchanged and the Dow Jones Industrial Index gaining 0.5%. Gold and silver stocks (+5.0%) and oil services stocks (+1.2%) performed well, whereas brokers (-7.2%) were again dumped by nervous investors.

Bonds
The prices of US government bonds were pushed higher as investors sought the perceived safe haven of government debt. The yield on the 10-year US Treasury Note fell by 12 basis points during the week to 3.42%.

Elsewhere in the world, bond yields declined in Germany, edged up in the UK and were mixed in Japan.

Currencies
The past week saw the US dollar yet again recording lifetime lows on a trade-weighted basis (-0.9%), as well as against the euro (-2.1%) and Swiss franc ( 2.5%). As larger-than-previous Fed funds rate cut expectations weighed on the greenback, it also hit a 12-year low against the Japanese yen (-3.0%).

The dollar’s record-breaking slide prompted complaints from Jean-Claude Trichet, European Central Bank President, and Fukushiro Nukaga, Japanese Finance Minister. Henry Paulson, US Treasury Secretary, also re-emphasized that he was backing a “strong dollar”.

“We’re on an intervention watch,” Stephen Jen, Morgan Stanley’s London-based head of foreign-exchange research, said. “While I don’t think we have reached the threshold yet, the argument in favor of it is gradually becoming compelling.”

Commodities
The weak dollar aided a 0.5% rise in the Dow Jones-AIG Commodity Index. Gold bullion rose by 2.7% and hit an all-time intraday peak of $1,009.0 an ounce. At the same time crude oil surged by 4.8% and registered a record intraday high of $111.00 a barrel.

Crude’s advance occurred even though the US government’s weekly energy report showed stockpiles had increased by a much larger than expected amount, but possible supply interruptions in Nigeria caused concerns.

Gold jumped by $16 on the news of the Bear Stearns rescue operation, and was also helped by negative real interest rates in the US, the plunging dollar and the strengthening oil price.

As far as other commodities were concerned, agricultural commodities scaled new peaks, but industrial metals experienced some profit-taking.

Political decisions on money flows, labor and technology are “substantially constraining supply growth” of commodities, Goldman analysts including Jeffrey Currie in London wrote in a recent report. “This will likely support the ongoing structural bull market in commodities until these policy-driven investment constraints are removed and/or demand is adjusted.”

However, other analysts are beginning to question the sustainability of the commodities rally. Albert Edwards, global strategist at Société Générale, said: “The unfolding US consumer recession is likely to suck liquidity away from the Emerging Market (EM) region as the US current account deficit declines and EM accumulation of foreign exchange reserves slows sharply. As EM asset prices slide and decoupling arguments evaporate, commodity prices will react sharply as recent speculative ‘safe haven’ froth unwinds.”

Now for a few news items and some words (and graphs) from the investment wise that will hopefully assist to make sense of markets’ action during the shortened week ahead (including option and futures expiration on Thursday).

Source: About.com

Bill King (The King Report): Special alert – critical week ahead
“With rumors about Lehman, UBS, Ford, WaMu and others swirling, if global central banks and governments do not act before Europe opens, there could be something historic on Monday. The US Contagion is now directly threatening all countries with a global meltdown.

“Sunday night is critical. Asia doesn’t matter. But Europe cannot be allowed to tumble.

“Everyone is talking dollar intervention. But there is no one home at the BoJ due to political hankering over the post. I think that the only way to have a significant intervention is to have the ECB, BoE, Bank of Canada and Australia Reserve Bank cut rates sharply.

“In fact, I’d have Volcker make the call and say he is running the deal and it will be similar to the Hunt bailout in 1980. After a couple quarters, you can hike rates if you like.

“There should be other interventionist action and lending facilities proffered. But the global markets need the shock & awe of global coordinated rate cuts of significant magnitude.

“We must reiterate, the only thing preventing a public panic, because they don’t understand the magnitude of credit market problems, is that the stock market is not crashing. And solons know this.

“Hopefully this will buy time.”

Source: Bill King, The King Report, March 14, 2008.

The Wall Street Journal: Wilbur Ross on the banking system

Source: The Wall Street Journal, March 11, 2008.

Jim Sinclair (Mineset): Economic forces converge like never before
“Never in economic history has there been a night like tonight. I am writing later than usual because of the enormity of all the converging forces. The euro reaches for $1.60, the Middle East oil producers are in shock, and the IMF tells the world to ‘plan for the worst’.

“The reason this missive is late is because I am reverberating at the speed of the disintegration. These cursed OTC derivatives and their makers, who incidentally made the international banking community rich beyond your wildest dreams, are now unwinding at lightening speed.

“Do you think any entity with any OTC derivative now has faith in the paper?

“This paper is $550 trillion plus dollars in notional value. The horrible fact is that in bankruptcy notional value becomes real value with the capacity to destroy the world financial system.

“The above is no wild assumption. It is hard, cold fact.

1. Expect currency intervention to slow down the rise of the euro.
2. Intervention has never worked. It will not now. In fact, it will backfire so fast that the effort will be abandoned, making things even worse.
3. Intervention in currency, the dollar, will only provide the capacity for other central banks, oil producers and holders of high risk long US treasury paper to diversify out in huge amounts of decaying dollars at singular prices.
4. I could go through a tome on how intervention works, but accept that any rise in short rates will break the bank immediately. Intervention in the euro/dollar is another practical impossibility except as a bluff.
5. There is no practical solution to today’s TERMINAL problems and that means you are up to your eyeballs in alligators.
6. You must protect yourselves.

“This is it!”