The Week Ahead

First, a follow-up on Detroit. We wrote earlier that GM and the rest must be allowed to fail, figuring why pour good $ after bad. There is no way we taxpayers can finance their cash burn rate. Let them go into bankruptcy, taking their miserable unions with them. The world liquidity crisis is not the cause of their problem. The Three Stooges started losing billions years ago when the economy was healthy. And there is no equivalent in the scope of contagion compared to that of the just-past liquidity crisis. Naturally failure will impact the rubber, carpet, iron, glass industries, all the rest. But we are not yet Western Europe. Bite the bullet.

But wait cautions one acquaintance, be realistic. That is not politically viable. It’s not going to happen in Washington Bob. And what about owners of cars with no warrantee for example?

OK, maybe our friend has a point. A better option may be that detailed in yesterday’s WSJ: Paul Ingrassia, the paper’s Detriot bureau chief agrees that giving GM (apparently in the worst shape of the three, with the other two close behind) a blank check would be a grave mistake. "The company would just burn through the money and come back for more. Even more jobs would be wiped out in the end" (our earlier point). "Instead, in return for government aid, the board and the management must go. Shareholders should lose their paltry remaining equity. And a gov’t-sponsored receiver - someone hard-nosed and nonpolitical - should have broad power to revamp GM with a viable business plan and return it to private operation as soon as possible." Ingrassia continues, "That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others, and downsizing the company. The same basic rules should apply to Ford and Chrysler." And we might add that when in the process of restructuring, look to the so-called Detroit South where Toyota, Hyundai, and other foreign auto makers have expanded car production in recent years, although in states where unions are practically non-existent and labor is cheap.

Thus, if our plan is not politically viable, then as Ingrassia concludes, "a complete restructuring under a government overseer or oversight board has to be the price". Fine. Let’s do it. Democrats, are you listening?

The Week Ahead

World leaders will meet Nov/15. Watch the price of oil as an indicator of the odds for success. Crude is a useful tool in this regard. For example, one key reason crude rose just under 3% in after-hours trading Sun was the news that China has enacted a massive stimulus package, the view she might remain an engine for global demand. Oil is now softer, partly on today’s poor world corporate earning news which has temporarily at least, trumped that view. The price will reflect the tug-of-war between economic reality, and, hope for international cooperation to re-fire economic activity.

Friday’s Oct Retail Sales is this week’s key focus in the mind of the mkt crowd. Expectations are for a dismal figure. If there is a risk to this release, the figure may not be as bad as expected but it will be plenty bad nevertheless. Until Friday, look for more signs of corporate grief.

In the meantime, inter-bank liquidity continues to thaw, that initial crisis on the way to becoming history.

Robert Craven

Obama's Test #1

One more rescue and a new consciousness will be permanently embedded in the fabric of American culture. We will indeed have joined in lock step with Europe’s social democracies, where the bureaucracy has assumed most normal adult responsibilities.

"A healthy automobile manufacturing sector is essential to the restoration of financial market stability, the overall health of our economy, and the livelihood of the automobile sector's workforce,'' Pelosi and Reid said in a letter urging Paulson to use some of the $700bln for a $50bln loan to the Three Stooges. What Pelosi really meant was "Preserving an antiquated industry is essential...." Even then, her first point is false; the second point is only true if one’s horizon in measured in months; the third is true - but so what? Let them find other jobs for goodness sake. Taxpayers owe vehicle assemblers a living? Why? How are they singled out?

Sure vehicle sales are slow; we all know that. Here, auto sales are at the lowest level since 1961. Daimler sales worldwide are off something like 20%, y/y. Vehicle sales in the UK were down 23% last month from Sep. An Essex online car dealer last week offered two Dodge Avenger models for the price of one, an offer as the Guardian put it, "...is more usually seen on washing powder or packets of bacon." Change goes with the territory in a free mkt economy. It’s tough times for a lot of folk.

There can be no credible contagion argument favoring this industry. None. The same arguments supporting taxpayer repair of a world liquidity crisis do not apply. Let the unseen hand do its work. Failure, then the American phoenix of creativity. Out of this spontaneous order will spring a new invigorated vehicle industry. Out of taxpayer enabling will spring nothing but more problems, calling for an even more painful solution, end of the next cycle.

We expect Bush to hold the line. For the sake of his legacy, he better. Then it's up to Obama. A year ago in Detroit Obama assailed the US industry for failing to meet global demand for fuel-efficient cars. "The need to drastically change our energy policy is no longer a debatable proposition," he said. "It's not a question of whether, but how; not a question of if, but when. For the sake of our security, our economy, our jobs and our planet, the age of oil must end in our time." Well Mr Obama, the time has arrived. Will you adhere to this vision, or simply cave as you did with the Chicago machine? We’ll soon find out.

Robert Craven

Lao Tsu

The Oct Payroll figure fell more than expected (240k vs 200k consensus), unemp printed 6.5% vs expectations of 6.3%. Losses were widespread across most categories. Much of these losses (aggravated by the Boeing strike, -27k, which is now settled) are due to the collateral effects of the credit crunch, now slowly being repaired. So far in ‘08 1.18 million jobs have been lost, half those in the last 3 months.

As we predicted Nov/3, by today, the view for a full blown recession will be set in stone. It is. Our readers have known we are in a recession for a few weeks now. That is not news any more.


The Tao

Following yesterday’s loss in the US equity mkt, one news service declared, "Dow drops 443 in reaction to retail sales report." This is utter nonsense. World markets move for a whole range of reasons, too complex and complicated for any one mortal or organization to understand. After work, home and enjoying a cocktail, TV is on and the commentator assures you that this is why the mkt did this today. Fine. You go to bed secure, that must be it. This has nothing to do with insight but with selling advertising.

Lao Tsu said, "Those who know, do not speak; those who speak, do not know." Certainly Lao Tsu was not thinking of TV anchors; there were few around in his day. Instead, he was focused on core knowledge or wisdom; however, we have taken license to apply his wisdom to the mkt and why not? It works.

Whether through the medium of TV or radio or newsprint, no matter - analysts all talk to each other, and, the same sources. They all look at the same statistics and they all reach similar conclusions. Forecasters (mostly economists, ill equipped for the task) gather together for security in times of maximum price violence. The greater the uncertainty, the greater the similarity of predictions as the experts shout together in the dark. And in turn, the greater will be the collective surprise when their estimates miss the mark.

As Alan Watts noted, there is indeed a wisdom to insecurity. This is esp true in the financial world. There should be a fail safe - when we feel absolutely certain about being right there should be a gremlin assigned to the task to say, "OK, it is highly likely that you are wrong." Or, when the herd is supremely confident in one direction, it is time to take the other.

Robert Craven

Update

Reflecting official concern with slowing conditions, the Bank of England and the European Central Bank both cut their base rates today (as expected). The surprise was the magnitude of the BkofEng cut - 1 ½% (150 bp’s) - intended shock treatment for that economy. Immediately after, the gov’t urged lenders to pass on all of the cut to borrowers (mortgages pegged to the base rate) and almost immediately lenders explained why they will have trouble doing so. Only Lloyds pledged to pass on the entire cut at this writing. Nevertheless, the magnitude of the cut, putting the benchmark at the lowest level since 1955, will impact positively. This is a good thing because as we highlighted earlier, UK banks (and those of the EU) have a far scarier exposure to developing credits, ongoing, than we do.

At home, this am we saw so-called Chain Store sales for Oct (representing about 10% of total Retail Sales); they were below expectations for 60% of the stores reporting. This is not really news; much of this weakness is already priced in. Tomorrow’s Oct Payroll report is key. The employment data give the most comprehensive report on how many people are looking for jobs, how many have them, what they're getting paid and how many hours they are working. The number is expected to be lower by 200,000, and unemp higher at 6.3%. This would be the 10th consecutive decline in total employment; we last saw 6.3% in 6/03, then to a cyclical low of 4.4% in 3/07, last 6.1% (Sep). At one time we could generally predict the result of this key release for our clients, vs economists’ expectations; we are a tad rusty at the moment so we’ll have to wait and see.

Violence will continue in the equity mkt - really just a freak show. We have inquiries by those who wonder - is it time to buy? We only try to close the pattern early on general fundamentals. A rule we learned the hard way is this: in the financial mkts one must be right at the right time. One’s view re a stock, or stocks in general, or interest rates, or currency or sovereign credits may be correct and for the correct reasons. Yet if the mkt crowd does not agree they can convert you to crow bait in nothing flat as they rush the other direction, then just when you are getting up, they realize you were right, and flatten you a second time. Or from another prospective - how long can you hold your breath.

Robert Craven

Optimism

We gave reason for optimism, Oct/23 and Oct/29, that the worst of the liquidity crisis may be behind us. At this writing we are further encouraged that this is so, noting for example that interbank lending rates are tumbling, 90 LIBOR last at 2.71% from 4.82% just a little over three weeks ago. As expected Australia’s central bank cut its benchmark rate. Look for the EU and Bk of Eng to follow on Thursday. The heart of the system is beating again. There is a ton of work to do, many, many unknowns (at least to us), but the free-fall is history.

Our banking system is in relatively good shape compared to some others. Be thankful we are not Europe. As we highlighted earlier, here is the next potential avalanche (but it too is at least partially priced in by now). European and UK banks are five times more exposed to emerging markets than US banks. They alone hold what one observer called "the collective time-bomb of $1.6 trillion (£990bn) in hard currency loans to Eastern Europe – now starting to detonate in Hungary, Ukraine, Romania, and even Russia." This is their very own credit bubble. This will slow the world's recovery to be sure but it will not create another free fall; a system is now in place to prevent that.

The other prime consideration for all of us of course remains the US real sector. Yesterday’s manufacturing and veh sales data were worse than expected. Here of course we see the results of contagion. For example, the seizing up of the credit markets, plus course weakness in the labor markets put vehicle sales in the out house, sales of autos down over 10% to the lowest level since 1961. We have the key Oct payroll release on Friday. It will be very weak but at this point such weakness is priced in so that it will not be a shocker, our view.

In spite of lower US eco growth, lower Treasury yields and lower employment, the $ continues to strengthen vs all other major world currencies except the Yen. Why? Much is so-called "flight-to-quality" - world institutions seeking safety in US securities (still the world’s safest). And part is the great deleveraging as it has become known - problems elsewhere. Many investors have been following a version of the "carry trade," borrowing money in a low-yielding currency. All they had to do was earn a higher return from assets in higher yielding currencies than the cost of their financing. Since the two currencies with the lowest yields over the past year have been the dollar and the yen, those were the natural ones to borrow. However, when asset prices fall in Brazil, Russia, the Ukraine, Indonesia and elsewhere, this strategy is disastrous. Investors dash to sell assets and repay their debts. Since those debts were incurred in dollars and yen, that means they have to buy back those two currencies—hence their sharp recent rises.

Robert Craven

The Week Ahead

Over the near term we have two fronts to monitor; that is, two economic arenas, both of which will impact our individual lives. First of course is the so-called world sub-prime crisis, the liquidity panic/now solvency crisis, birthed due to lack of proper regulation of Fannie & Freddie. A flood of less-than-prime mortgage paper, collateralized for the final investor, is all over the world. No one knows what any of it is worth. Readers recall from past postings the chronology of this event. Key - trust evaporated between major world banks. They lied to each other and to their regulators. Inter-bank lending ceased, and with it, the heart of the world’s financial system nearly stopped beating. We know that temporary dams have been erected, most major world credits, to stop the free fall. We applaud this accomplishment. Most of these mechanisms followed Darling’s lead. Banking institutions are receiving capital injections from the US taxpayer. The taxpayer is receiving preferred stock in return. In the UK and EU there are similar measures. Next, in countries without the resources to rescue their own the IMF is extracting tough terms for money lent.

Second, we have the US economy in isolation - just how weak is it; what can we do, what ammunition does the Fed have left? These then are the two prime considerations for the US consumer. Let us address this second concern first.

This week we will have two important eco releases, one on the health of manufacturing and one of the overall employment situation. Today we will see the Inst For Supply Mgmt manufacturing survey for Oct (new orders, order backlogs, prices received, employment & inventories). This is a key release; it was through the floor for Sep - far below expectations after being flat for most of the year. On Fri we will see the Employment release for Oct. Although a coincident indicator, this remains the key release for each month. It is expected to be very weak and will no doubt cooperate. By Friday the view for a full blown recession will be set in stone.

What can the Fed do? Not much. It has already injected floods of $ into the system but this is little more than pushing on a string at the moment. Impact now is mostly psychological. We must look to Washington. The assistance of a corporate tax cut to 25% and a cap gains cut to 10% will go out the door if McCain does not win; the period of recovery will then be extended.

Next, beginning Nov/15 we will gain some idea of what finance ministers have in mind for the new world financial landscape. The IMF seems to have inherited the lead role for now. Just this weekend Brown urged the Saudi’s to kick up their contribution as Iceland and others have already used up $30 bln of the IMF’s reserves, with Belarus, Turkey, Pakistan and Serbia, Hungary and Ukraine waiting in line.

Meanwhile, other policy tools are easing the liquidity panic at home. The Fed's new commercial paper facility, which began on Tuesday, helped to reignite that vital source of corporate funds. Treasury's capital injections into banks as noted above are also restoring confidence as they reach some of the struggling regional banks. And the key 90 day LIBOR rate continues to decline, last at 2.86% vs 3.50% just a week ago. This is very good news and means activity between US banks, and between US banks and other major foreign banks, continues to thaw. Look for the UK, the EU and Australia to join the global easing cycle this week (following moves in the US, Japan, HK, Norway, China, Tawain & India last week) which should push this rate even lower.

What shocks may be offered up this week? Look perhaps to emerging markets, where gathering economic woes are bound to lead to more bank losses, but primarily banks in Europe, no so much the US. An analyst at the Royal Bank of Scotland points out that European banks have more than seven times the claims on developing countries than their American rivals; in eastern Europe, the ratio is 25 to 1.

Robert Craven

Update

The Fed is expected to cut their key rate by 50 basis points today (½ of 1% to 1%), this following the coordinated 50 bp rate cuts of Oct/8 (ECB, BofE, Fed & 4 others). Japan may follow Friday, then the BofE and the ECB most certainly next week. China cut its key rate today, the third time in six weeks, claiming it does not want to join the funeral march.

Over the near term, the stock market will remain a freak show, maybe fun to watch but providing little insight. World credit markets remain key and these continue to thaw gradually, today’s 90 day LIBOR rate at 3.42% indicating modest to fair activity in world inter bank lending. The commercial paper market is moving thanks to Fed purchases of this short-term business credit. These are good things.

Government rescue packages are beginning to kick in, US, UK, EU. Other countries, originally laggards, are now coming around. Japan will increase its bank bailout scheme, S Korea will take "drastic steps," Kuwait’s central bank just rescued the Gulf Bank. Those governments lacking the resources to rescue their own are applying to the IMF, the most recent hike in Iceland’s key rate the price that country was required to pay for the assistance. A proposed new liquidity fund at the IMF may be approved as soon as next week, offering countries up to 5 times their IMF quota. Hungary, Iceland, Belarus, Ukraine and Serbia and Pakistan are in line. The politics of application of all of this - beyond our pay grade.

Background: As Bernanke’s bubble has burst, world commodity prices have collapsed and with that, so too the economies of developing countries who primarily exported these goods (and the whining ethanol lobby) This activity had been financed by western banks, not so much US but EU and Brit. So the vicious circle. With credit and demand scarce, shipping has collapsed, as good an indicator of world health as we can get. For example, a few months ago one payed about $240,000 as daily rental for a large container ship. That last printed $7340! Empty ships are everywhere. To see how things are intertwined, Greek families control a third of the global freight market for bulk goods. Thus, there is flight from Greek bonds. The UK’s Royal Bank of Scotland and HSBC financed the share of the shipping activity. Both these banks are this instant taking major chunks of UK taxpayer cash. And so it goes.

We continue to be fairly optimistic. We have no idea which bank will be next, but world authorities have moved quickly to address these situations. Only a sovereign default (Russia, Argentina) at this point would open new windows of risk.

We had earlier broached the idea of a Bretton-Woods-like conference; sure enough we will have such an event Nov/15 in Washington. A regional pre-event was recently concluded in Asia and things seemed surprisingly cooperative. We don’t know what to expect other than the world’s financial landscape will change forever, or at least, during our lifetime.

Robert Craven