Considering the backdrop, the Treasury market was unimpressive. For the week, two-year Treasury yields added 2 bps to 4.35%. Five-year government yields added one basis point to 4.29%, while bellwether 10-year Treasury yields were little changed at 4.35%. Long-bond yields were unchanged at 4.52%. The spread between 2 and 10-year government yields narrowed 2 to zero. Benchmark Fannie Mae MBS yields added one basis point to 5.59%, this week slightly underperforming Treasuries. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note dipped 0.5 to 33.5, while the spread on Freddie’s 5% 2014 note was unchanged at 34.5. The 10-year dollar swap spread declined one to 49.5. Investment-grade spreads were little change while junk bond spreads widened marginally. The implied yield on 3-month December ’06 Eurodollars rose 2 bps to 4.705%.
Corporate bond issuance dropped to $9 billion (from Bloomberg). For the week, investment grade issuers included Jeffries $500 million, National Gas $400 million, and Mack-Cali Realty $300 million.
Junk bond funds saw outflows rise to $129 million (from AMG). Junk issuers included Echostar $1.5 billion, AMC Entertainment $325 million and Corrections Corp $150 million.
Convertible issuers included Hutchinson Tech $225 million.
Foreign dollar debt issuers included Westpac Banking $2.25 billion, Italy $2.0 billion, and Panama $1.36 billion.
Japanese 10-year JGB yields added 2 bps this week to 1.47%, as the Nikkei 225 index sank 4.6%. Emerging markets were generally resilient. Brazil’s benchmark dollar bond yields fell 7 bps to 6.56%. Brazil’s Bovespa equity index rose 2%, increasing 2006 gains to 9.7%. The Mexican Bolsa dropped 2.9%, with y-t-d gains falling to 3.1%. Mexican govt. yields dipped 3 bps to 5.28%. Russian 10-year dollar Eurobond yields dropped 8 bps to 6.40%. The Russian RTS index surged 5%, with 2006 gains jumping to 15.9% (one-yr gain of 120%). Year-to-date, the major equity index in Greece is up 9%, Poland 9.6%, Hungary 9.5%, Romania 18.7%, and Turkey 11.8%.
Freddie Mac posted 30-year fixed mortgage rates fell 5 bps to 6.10%, the lowest in 13 weeks (up 43 bps in a year). Fifteen-year fixed mortgage rates declined 4 bps to 5.67% (up 52 bps in a year). One-year adjustable rates added 3 bps to 5.18%, with an increase of 107 basis points from one year ago. The Mortgage Bankers Association Purchase Applications Index fell 3% last week. Purchase Applications were down 2.5% from one year ago, with dollar volume up 1.3%. Refi applications jumped 9.9%. The average new Purchase mortgage increased marginally to $221,700, while the average ARM rose to $325,800.
Broad money supply (M3) declined $23.2 billion (week of Jan. 9) to $10.244 Trillion. Over the past 34 weeks, M3 has inflated $619 billion, or 9.8% annualized. Over 52 weeks, M3 has expanded 8.3%, with M3-less Money Funds up 8.6%. For the week, Currency dipped $0.7 billion. Demand & Checkable Deposits dropped $33.5 billion. Savings Deposits jumped $36 billion. Small Denominated Deposits added $3.4 billion. Retail Money Fund deposits gained $1.1 billion (5th straight week of gains), while Institutional Money Fund deposits declined $10.2 billion. For the week, Large Denominated Deposits rose $13.5 billion. Over the past 52 weeks, Large Deposits were up $262 billion, or 23.5% annualized. For the week, Repurchase Agreements sank $33.8 billion, while Eurodollar deposits added $0.9 billion.
Bank Credit expanded $13.5 billion last week to $7.502 Trillion. Over the past 52 weeks, Bank Credit has inflated $657 billion, or 9.6%. Securities Credit added $1.5 billion during the week. Loans & Leases jumped 12.2% over the past 52 weeks, with Commercial & Industrial (C&I) Loans up 15.5%. For the week, C&I loans gained $5.0 billion, and Real Estate loans jumped $11.0 billion (up $51.2bn in 6 wks). Real Estate loans have expanded 10.6% annualized over 20 weeks and 14.3% during the past 52 weeks. For the week, Consumer loans dipped $0.3 billion, and Securities loans fell $9.3 billion. Other loans gained $5.6 billion.
Total Commercial Paper declined $13.1 billion last week to $1.689 Trillion, reversing about a third of the previous week’s gain. Total CP expanded $280 billion over the past 52 weeks, or 19.9%. Last week, Financial Sector CP borrowings dropped $11.6 billion to $1.533 Trillion, with a 52-week gain of $274 billion, or 21.5%. Non-financial CP slipped $1.5 billion to $142.6 billion, with a 52-week rise of 4.2%.
Asset-backed security (ABS) issuance rose to $22 billion this week (from JPMorgan). Home Equity Loan ABS issuance comprised $12 billion.
Fed Foreign Holdings of Treasury, Agency Debt increased $1.8 billion to a record $1.533 Trillion for the week ended January 18. “Custody” holdings were up $189 billion over the past 52-weeks, or 14.1%. Federal Reserve Credit rose $562 million to $816 billion. Fed Credit expanded 4.2% over the past 52 weeks.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $543 billion, or 12.3%, over the past 12 months to a record $4.13 Trillion.
January 15 – Market News International: “China’s foreign exchange reserves rose 34% to $818.9 bln last year, as massive amounts of foreign direct investment, export earnings and ‘hot money’ chasing currency appreciation continued to pour into the country. Chinese reserves surged by $209 bln over the year and by $49.9 bln in the fourth quarter alone… The bank also said that new loan growth rose 12.98% to 2.35 trln yuan over the year, coming within the central bank's target of 2.5 trln, while outstanding loans were up 12.75% at 20.7 trln yuan.”
January 19 – Bloomberg (Halia Pavliva): “Russia’s foreign currency and gold reserves, the world's fifth-biggest, rose to a record $184.6 billion as of Jan. 13, as revenue increased from oil exports. The reserves, which have surged more than 46 percent, or about $58 billion, in 2005, added $2.3 billion in the week ending Jan. 13…”
Currency Watch:
January 18 – Associated Press (Scott Sonner): “‘Right now, the rest of the world owns $3 trillion more of us than we own of them,’ (Warren) Buffett told business students and faculty Tuesday at the University of Nevada, Reno. “In my view, it will create political turmoil at some point. ... Pretty soon, I think there will be a big adjustment…’ The U.S. trade deficit soared to a record $665.9 billion in 2004, and Buffett said he expects it to top $700 billion this year. ‘That’s $2 billion a day. We are like a super rich family that owns a farm the size of Texas. You sell off a little bit of the farm and you don’t see it.’ Fifteen years ago, the U.S. had no trade deficit with China, he said. ‘Now it’s $200 billion. If we don’t change the course, the rest of the world could own $15 trillion of us. That’s pretty substantial. That’s equal to the value of all American stock. That’s the big danger.’”
The dollar index was little changed on the week. On the upside, the Peruvian sol rose 2.8%, the Thai baht 1.1%, the Czech koruna 0.8%, and the Canadian dollar 0.7%. On the downside, New Zealand dollar fell 2.8%, the Polish zloty 1.0%, the Chilean peso 1.0%, and the Australian dollar 1.0%.
Commodities Watch:
January 17 – Bloomberg (Stephen Voss): “World oil demand will accelerate throughout 2006 as China’s imports grow and U.S. consumption picks up from late last year, when hurricanes and mild winter weather curtailed use, the International Energy Agency said. Demand will grow 1.6 percent in the first quarter from the year-earlier period, before rising to a 3 percent increase in the fourth… Consumption will advance 2.2 percent this year on average to 85.1 million barrels a day, after gaining 1.3 percent last year.”
January 20 – Bloomberg (Samantha Shields and Hannah Gardner): “RAO Unified Energy System, Russia’s national power grid, deepened cuts to non-essential users and Finland as a deadly cold snap continued to push domestic electricity consumption to new highs. A Siberian cold front blew west earlier this week, sending temperatures in Moscow, Europe’s biggest city, plunging to minus 30 degrees Celsius (minus 22 Fahrenheit), the lowest in half a century.”
January 19 – Bloomberg (Helen Yuan): “China’s iron ore imports may rise 16 percent this year to 320 million metric tons as steelmakers such as Anben Iron & Steel Group boost production capacity, the China Metallurgical and Mining Association said. The imports may account for 55 percent of China’s demand for the steelmaking ingredient…”
This week zinc and lead traded to new record highs. Sugar prices rose to the highest level since 1981. March crude oil surged $3.90 to $68.48. March Unleaded Gasoline jumped 5.5% this week, and March Natural Gas rose 5.7%. For the week, the CRB index added 2.5%, increasing y-t-d gains to 4.0%. The Goldman Sachs Commodities index jumped 4.9% this week, with a y-t-d gain of 5.3%.
China Watch:
January 17 – Bloomberg (Yanping Li and Nerys Avery): “China’s economy expanded by about 9.8 percent last year in real terms, the nation's tax commissioner Xie Xuren said. The economy expanded by between 13 and 14 percent in nominal terms… China overtook Italy to become the world’s sixth-largest economy in 2004 after the government last month revised up output by 16.8 percent to nearly $2 trillion. The National Bureau of Statistics last week raised its preliminary estimate for China’s 2004 GDP growth to 10.1 percent from a previous 9.5 percent.”
January 19 – Kyodo: “China’s trade surplus with the United States rose to 114.17 billion in 2005, up from $80.2 billion in 2004, according to official statistics… China’s exports to the United States rose 30 percent against a 9 percent increase in imports in 2005, according to the General Administration of Customs.”
January 20 – Bloomberg (Jianguo Jiang): “China’s retail sales reached 6.2 trillion yuan ($768 billion) last year, Vice Premier Wu Yi said… Retail sales, one of the engines driving the country’s economic expansion, rose 13.3 percent…”
January 19 – Bloomberg (Wing-Gar Cheng): “China, the biggest energy consumer after the U.S., paid 41 percent more for its crude oil imports last year as global prices surged. China’s oil import bill climbed to $47.7 billion last year…”
Asia Boom Watch:
January 20 – Bloomberg (Lily Nonomiya): “Japan, the world’s second-largest economy, is expanding faster than the Bank of Japan's October prediction, the central bank said. ‘Japan’s economy is expected to deviate slightly above the outlook’ in October as Domestic and external demand increase steadily, the bank said…”
January 19 – Bloomberg (Patricia Kuo): “Michael Malone, the head of Bank of America Corp.’s gaming finance unit, first visited Macau on a Wednesday afternoon in April as horizontal rain pelted the city. Inside the Sands Macao, every table was packed with gamblers from mainland China. Minimum bets were eight times Las Vegas levels. Within three weeks of returning to the U.S., Malone signed off on Bank of America’s first loan to a casino in Macau, a $1.1 billion project from Las Vegas-based Wynn Resorts Ltd. ‘Everyone will walk out of the rooms converted, if not already a believer in the demand for gaming in Macau,’ says Malone… Bank of America is competing with lenders such as Goldman Sachs Group Inc. and Deutsche Bank AG to finance Asia’s casino boom.”
January 16 – Bloomberg (Kartik Goyal and Cherian Thomas): “India’s exports of textiles, gems and other products rose 16.2 percent in December, after suffering the first decline in almost four years in the previous month, the government said. Overseas sales rose to $8.28 billion last month... Imports rose 8.4 percent to $11 billion in December, narrowing the trade deficit to $2.7 billion from $3 billion a year ago, the ministry said… India, Asia’s fourth-biggest economy, needs faster exports to accelerate industrial growth to the 10 percent pace that Prime Minister Manmohan Singh’s government says is required to sustain an economic growth rate of over 7 percent.”
January 17 – Bloomberg (Kartik Goyal): “India’s economy is expected to expand 7 percent to 7.5 percent in the fiscal year ending March 31, in line with the central bank’s forecast, Finance Minister P. Chidambaram said. ‘All available projections for the current fiscal year point to the possibility of recording an eventual growth rate of between 7 to 7.5%,’ Chidambaram said… The economy grew 6.9 percent in the last fiscal year. India is seeking to accelerate economic reforms to attract more overseas investment and keep the economy growing at 7 percent or more for the next 10 years.”
January 17 – Bloomberg (Kim Kyoungwha): “Spending by South Korean companies will jump this year, led by flat screen makers such as Samsung Electronics Co., as consumer demand at home and abroad improves, the commerce ministry said today. Investment in plants and facilities is forecast to rise 16 percent to 50.2 trillion won ($50 billion) in 2006, the ministry said in a statement, citing a survey of top 200 companies.”
January 18 – Bloomberg (Beth Jinks and Laurent Malespine): “Thailand’s central bank raised its benchmark interest rate for the tenth time in 17 months to curb inflation and boost savings. The Bank of Thailand increased its 14-day bond repurchase rate by a quarter-point to 4.25 percent…”
January 18 – Bloomberg (Laurent Malespine): “Thailand’s government will boost its spending for fiscal 2007 by 8.5 percent, similar to the increase in fiscal 2006, as the country’s economy expands and tax revenue climb.”
January 20 – Bloomberg (Wahyudi Soeriaatmadja): “Indonesia produced 5.11 million motorcycles in 2005, 31 percent more than a year earlier…”
January 16 – Bloomberg (Jason Folkmanis): “Vietnam’s exports to the U.S. rose by a quarter through the first 11 months of last year, paced by surging footwear, furniture and crude oil shipments. Shipments to the U.S. rose 25 percent through November 2005 to $5.97 billion, from $4.76 billion a year earlier… Vietnamese exports to the U.S. have jumped from just over $1 billion in 2001.”
Unbalanced Global Economy Watch:
January 20 – Bloomberg (Laura Humble): “U.K. mortgage lending rose the most in 18 months in December, a banking group said, adding to signs Britain's $6 trillion property market is regaining momentum.”
January 19 – Bloomberg (John Fraher): “Producer-price inflation in Germany, Europe’s largest economy, rose the most in more than two decades in December after a surge in the price of oil. Prices for goods such as plastics and newsprint were 5.2 percent higher in December from a year earlier… That was the biggest gain since July 1982…”
January 16 – Bloomberg (John Fraher): “Inflation in Germany, Europe’s largest economy, accelerated to the fastest pace in four years in 2005, led by a surge in energy costs. Consumer prices rose 2 percent last year after 1.6 percent in 2004…”
January 19 – Bloomberg (Tasneem Brogger): “Danish mortgage borrowing reached an all-time high last year as homeowners took advantage of record-low interest rates to lock into cheap loans. Gross mortgage borrowing rose 71 percent to 748 billion kroner ($121 billion) in 2005…”
January 20 – Bloomberg (Jonas Bergman): “Sweden’s central bank raised its key interest rate by a quarter of a percentage point to 1.75 percent, the first increase since 2002, to keep a lid on inflation as growth accelerates in the largest Nordic economy.”
January 18 – Bloomberg (Halia Pavliva): “Russia said its 2005 budget surplus was the highest since 2000 as the world's second-biggest oil supplier benefited from record prices for the fuel. The surplus more than doubled in the year to 1.5 trillion rubles ($54 billion), said Finance Ministry spokeswoman Irina…”
January 17 – Bloomberg (James Cordahi): “The United Arab Emirates economy, the second-largest amongst Arab countries, surged 17 percent last year, driven by oil, finance and construction, the Arab News reported… Oil and gas, which accounted for 40 percent of the country’s gross domestic product, grew by 43 percent…”
January 17 – Bloomberg (Mahmoud Kassem): “Egypt wants to attract small investors to place money in the stock market through a fund available at the post office, the state-run Al-Ahram newspaper said today, citing Investment Minister Mahmoud Mohieldin.”
Latin America Watch:
January 19 – Bloomberg (Katia Cortes and Andrew J. Barden): “Brazil will spend a third more this year on infrastructure projects such as power plants, roads and seaports, said Carlito Merss, the lower house lawmaker steering the 2006 budget through congress.”
January 17 – Bloomberg (Matthew Walter): “Chile’s economy will grow at least 6 percent this year, faster than the government forecast in its 2006 budget, on rising consumption and investment, President Ricardo Lagos said.”
Bubble Economy Watch:
January 15 – Market News International (Claudia Hirsch): “The U.S. residential rental market is strengthening in major urban centers, boosted by prohibitively high home purchase prices and the lack of rental supply the housing boom left in its wake, according to apartment brokers. Rising mortgage rates are also driving rental interest, as potential buyers hang back and hope that purchase prices drop, real estate agents said. In historic brownstone Brooklyn, New York, which is close to Manhattan's financial district, rental demand is high following years of astronomical sales price increases in both boroughs, according to a local rental agent. ‘We have a very strong market for rentals right now," said Joan Natale, of Joan Natale Real Estate in Brooklyn… ‘It’s completely turned around from last year.’”
January 18 – Reuters: “U.S. wage growth will likely accelerate moderately in the coming months, according to data released on Wednesday. BNA, a Washington-based news publisher, said its Wage Trend Indicator rose to 100.02 in the fourth quarter from 99.75 in the third quarter. It was the first reading above 100 since 2001, the company said.”
January 19 – The Wall Street Journal (Anne Marie Chaker): “States have put more money into higher education this fiscal year in what amounts to the biggest increase in appropriations for colleges and universities since 2001. And as many state governors head toward elections, some are promising even better prospects next year for tuition-paying families. Budgets for higher education have increased an average of 6% for the year ending June 30, up from the 3.8% increase for fiscal 2005…”
January 20 – Bloomberg (Heather Burke): “In Manhattan, where three out of four families don’t have a car, the other 25 percent now pay as much for parking as many people in other parts of the U.S. spend on rent. Central Parking, the world’s largest parking-lot owner, raised rates at its garage on Second Avenue and East 65th Street to $350 a month from $325 in October… Keeping a car at Time Warner Center across from Central Park runs about $550 to $600 a month.”
California Watch:
January 18 – Bloomberg (Daniel Taub): “Southern California home sales in December fell to the lowest level in four years for that month as price increases slowed, indicating the region’s housing boom ended, DataQuick…said.. A total of 28,952 homes were sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties, down from 30,317 a year earlier… The count was he lowest for a December since 24,913 homes were sold in December 2001. As home sales fell, prices rose at half the record 27 percent pace set in May 2004, meaning ‘the boom phase of this cycle is behind us,’ DataQuick analyst John Karevoll said… ‘The big question here is, ‘Are prices going to go into decline, or are they just going to level off here?’”
January 19 – Bloomberg (Daniel Taub): “Home sales in the San Francisco Bay Area fell for the ninth month in a row in December, and prices dropped from a record, indicating the region's housing market is leveling off, (said) DataQuick… A total of 9,347 new and resale houses and condominiums were sold in the nine-county region, a 15.5 percent decline from a year earlier… The median home price was $609,000, a 2.6 percent decline from November’s all-time high of $625,000 and a 14.3 percent increase from $533,000 a year earlier.”
“Project Energy” Watch:
January 17 – Bloomberg (Daryna Krasnolutska and Torrey Clark): “NAK Naftogaz Ukrainy, Ukraine’s state gas company, will build a $3 billion liquid natural gas terminal on the Black Sea to import the fuel from Libya and Egypt, as the country tries to reduce its dependence on Russia for supplies...”
Mortgage Finance Bubble Watch:
January 18 – Reuters: “More than four in 10 first-time U.S. homebuyers put no money down on their purchases last year, a trade group said on Tuesday in a report that highlighted Americans’ reliance on the nontraditional financing economists worry has stretched consumers too far. The National Association of Realtors, in a survey of homebuyers, said 43 percent of first-time buyers financed 100 percent of their purchase while another 50 percent financed between 71 percent and 99 percent of their home. The group’s president, Tom Stevens, said he was not concerned about the percentage of people putting no money down on their home purchases. ‘I think that’s just a reflection of what we’ve been seeing in terms of the options that first-time homebuyers have,’ Stevens said…”
January 18 – American Banker (Jody Shenn): “For the first time since the adjustable-rate mortgage boom began, monthly payments on a significant number loans are expected to rise sharply this year – and give lenders both credit-quality worries and refinancing opportunities. Merrill Lynch & Co. says the rates on about $400 billion of mortgages will reset for the fist time this year...”
Financial Sphere Earnings Watch:
Citigroup reported (convoluted) 2005 Net Income of $24.59 billion, up 44% from 2004. Earnings for the quarter were up 30% y-o-y to $6.93 brillion, disappointing the street. Total Revenues for the quarter were up only 3% y-o-y to $20.8 billion. U.S. Q4 Consumer Revenues were down 10% from comparable 2004. International Q4 Revenues were up 13% to $8.998 billion (International Cards up 19%). Revenues in Japan were up 41% y-o-y for the quarter. In Latin America, “Consumer results included double-digit receivable growth in cards, consumer finance, and retail banking.” Fourth quarter Corporate and Investment Banking Revenues were up14% y-o-y to $6.236 billion. “Fixed income markets revenues decreased 9%, reflecting lower results in commodities and structured corporate finance. Equity markets revenues increased 39%, driven by improved performance and growth in cash trading, derivatives, and structured products.” The company repurchased 93 million shares during 2005. Total Assets were little changed for the year at $1.494 Trillion. Consumer Loans were up 4% y-o-y to $455 billion, and Commercial Loans jumped 16% to $132 billion. On the Liability side, Deposits were up 5% y-o-y to $593 billion, Fed funds & Repos increased 16% to $242 billion, and Brokerage Payables were up 41% to $71 billion.
Wells Fargo reported record 2005 Net Income of $7.7 billion, up 9 percent. The company originated $366 billion of mortgage loans during the year (second highest). Total Assets expanded at a 25% annualized rate during the quarter to $481.7 billion. Average Loans grew at a 14% rate during the quarter, the strongest pace of expansion since Q2 2004. And while mortgage revenues actually declined during the quarter, “Commercial loan growth was broad based across virtually all of our businesses, including small business direct, middle market, commercial real estate, leasing, trade finance and asset-based.” “Average commercial and commercial real estate loans were up 13%.” On the Liability side, Interest-bearing Deposits increased 17% y-o-y to $226.7 billion.
Merrill Lynch 2005 earnings were up 18% to $5.218 billion, its third consecutive year of record earnings. Fourth quarter earnings were a record $1.495 billion, up 25% from comparable 2004. Global Markets and Investment Banking 2005 Revenues were up 25% to a record $13.9 billion. Fourth quarter Principal Transactions Revenue more than doubled from the year ago period to $715 million. The company repurchased 10.9 million shares of stock during the fourth quarter and 63.1 million shares throughout the year.
JPMorganChase earned $2.698 billion during Q4, up 7% sequentially and 62% y-o-y. Weak trading results pushed Fixed Income market revenues ($1.1 billion) down 55% from the third quarter. At $1.2 billion, Investment Banking fees were up 18% from the third quarter to the highest level since Q1 2000. Commercial Bank Operating Earnings were up 14% from the prior year to $289 million, as “…Mid-Corporate Banking growth of 15%, and Real Estate growth of 9% drove the improvement…” The company repurchased $1 billion worth of stock during the fourth quarter (26.3 million shares), double the third quarter’s buyback. “As of December 31, 2005, a total of $4.1 billion, or 112.8 million shares, have been purchased under the $6.0 billion share purchase program.” Total Assets were little changed during the quarter at $1.199 Trillion.
Washington Mutual’s fourth quarter Net Income was up (a disappointing) 29% from the year ago period to $865 million (results include the Providian acquisition). “Revenue from sales and servicing of home mortgage loans, including the results of all MSR (mortgage servicing rights) risk management instruments, was $264 million in the fourth quarter…compared to $497 million in the third quarter…and $384 million in the fourth quarter of 2004.” Total Assets expanded at an 11% rate during the quarter to $343 billion. “Average Assets were up 15 percent for all of 2005…”
Welcome to 2006:
Welcome to 2006. Liquidity overabundance, intense global speculative excess, increasing volatility across the spectrum of markets, geopolitical ambiguities, corporate earnings uncertainties, and energy susceptibility – and we’re only three weeks into the new year! Indeed, it has taken little time at all for an extraordinary global backdrop to show its hand: The Global Liquidity Glut is matched against Acute Energy Market Vulnerability and Geopolitical Uncertainty. Highly speculative markets are being pushed to more unstable extremes, although the seasoned players are keeping one eye fixated on the exit. The intensity of speculative impulses is matched by the frailty of Bubble underpinnings, and volatility has become the order of the day.
Revelations of fraud and serious marketplace infrastructure shortcomings were blamed for an abrupt 8% spill in the highflying Japanese equity markets, before a rally reduced losses somewhat. Here at home, the tug-of-war between liquidity excess and a series of high-profile earnings shortfalls this week provided quite a grudge match. Consistent with liquidity-driven markets, nothing seems to matter until it abruptly does. And it is the nature of liquidity-driven markets to create their own inflated expectations. Rising stock prices provoke optimistic forecasts and enthusiastic earnings revisions. For awhile, companies and management teams can make good. For awhile. Hopefully, this week provided a much needed wake-up call.
There will be those that continue to trumpet total S&P500 earnings growth, but the bottom line is that individual company earnings predictability is becoming much more uncertain. When it comes to profits, I believe we have likely reached an important inflection point. The nature of this aged inflationary boom now ensures atypical price divergences and generally disparate inflationary pressures throughout the economy. That’s why I refer to it as “Monetary Disorder.” Ballooning Trade Deficits are an increasing drain on domestic company revenues, a long-festering issue that has become pressing with the surge in energy prices. As we have been witnessing, an enormous amount of purchasing power (potential cash-flow and “profits”) is now diverted to the energy companies and oil-producing economies, on the top line providing formidable competition for spending dollars and towards the bottom inflicting some real pain with rising expenses. I will also suggest that over-liquefied Bubble Economies face the inevitable dilemma of an expanding pool of discretionary spending and proliferating avenues in which to spend it. On many dimensions, the flow of finance/spending power throughout the economy has become highly unstable/uncertain, with the nature of cost inflation increasingly incalculable.
As much as the initial stages of an inflationary boom are notable for their rather generous dispersion of business revenues (and profits), the late phase proves unsacrificing on the cost/expense side. From a P&L perspective, extrapolating early-stage (inflated) profits portends some rather nasty disappointments. Some companies and industries do get hit early (airlines and autos, for example), as they lack the means to generate revenues to meet their surging costs (jet fuel and healthcare). The fortunate, positioned to enjoy the spending boom, initially prosper mightily, although they will typically be exposed to significant uncertainty with respect to both revenues and expenses as the boom matures. Wage gains generally lag but can really surprise on the upside. Highly uneven Bubble Economy spending patterns ensure sector skills shortages. Late-stage liquidity excess guarantees an onslaught of investment and competition – a.k.a. Price and Profit Instability and Destruction – throughout the hot areas.
For the economy as whole, some aspects of the Credit Bubble Profits Dilemma can be postponed by continued rampant system-wide Credit expansion. This we have certainly experienced over the past year. The flaw in the bullish analysis, however, is that heady aggregate U.S. profit growth is sustainable this year without some rather remarkable consequences. There are today two powerful Inflationary Manifestations that do not garner the serious analytical attention they deserve: surging global energy prices and the Unwieldy Pool of Global Speculative Finance. Not unexpectedly, both are out of the blocks quickly for 2006, and both appear poised to add great uncertainty to the general outlook.
There is today great uncertainty with respect to energy and commodities prices and, at some point, supply availability. Less obvious, there is as well unusual uncertainty associated with the reality that speculative liquidity has come to be the driving force behind myriad market Bubbles and a key source fueling myriad Bubble economies. The backdrop is one of classic boom and bust dynamics, but on an unprecedented global markets and economies scale. Sustaining the U.S. Credit (and aggregate profits) Bubble comes at a high cost of great uncertainty with regard to the soundness of global markets generally – debt, equity, energy, commodities, and currencies. Don’t be surprised if currency markets turn frenzied.
The Credit Bubble is only sustained through the continued rapid expansion of the U.S. financial sector. Sector profits, then, become a key analytical focus. Financial profits are – as they should be at this Manic Bubble Stage – (seductively) enormous. But they are also almost certainly peaking, with funding costs rising, lending margins shrinking, competitive pressures intensifying and Credit losses lurking. Nonetheless, this is an analytically tricky juncture. We are in the Bubble phase where a weakened profit outlook will for awhile likely continue to incite only more aggressive lending and trading. A move on the margin by some away from mortgages to commercial lending will support continued job and income growth. Stock prices remain an overriding focus and growth an overriding management objective. And, having repurchased enormous quantities of their shares (injecting significant liquidity into the equity market), bank and broker managements have every incentive today to push the risk envelope to achieve expected results (that become only more inflated as liquidity excess fuels share and market gains).
Undeniably, however, earnings visibility is turning murky throughout the financial arena (from JPMorganChase to Citigroup to GE). The easy profits bonanza days of abundant cheap finance and a steep yield curve are winding down. Mortgage profits have peaked. And there is the unavoidable dilemma associated with great Financial Sphere inflations: windfall sector “profits” nurture intense competition for lending, speculating and deal-making. Booming securities markets impinge on the traditional lending business. For some time, the additional Financial Sphere capacity is self-reinforcing. Easier Credit Availability, lending and speculating excess, and heightened general marketplace liquidity fuel asset inflation and Bubbles. But there is no escaping the Late-Stage Bubble Reality: Competitive pressures progressively impinge profits, while measures to sustain elevated earnings create surreptitious dependency on the resulting Bubbles.
Today, the Financial Sphere must expand aggressively – “inflate or die” - to sustain vulnerable industry profits (and stock and asset prices). Inflated (and susceptible) system profits and asset prices are dependent on continued extreme Credit expansion. To sustain profitability in an increasingly challenging environment, the Financial Sphere is compelled to direct its focus to financing and tending to (prospering) asset market speculators (global real estate, debt, equity, M&A, commodities, currencies, etc.). At the same time, faltering lending margins impel an increased focus on trading – trading, of course, on the long side of the same inflated markets as their leveraged speculator clients. The problem is there is no climbing off of the treadmill. Sustaining industry and system profits comes at the great cost of linking the Inflating Financial Sphere both directly and indirectly to progressively more speculative and dangerous asset markets – at home and abroad! When markets are going up, it’s almost, I would say, “magical.” When they go down, well, it can look scary in a hurry.
The Global Credit Bubble has left no room for error – and certainly no room for a geopolitical crisis. It is boom or bust, volatility, and uncertainty. It’s going to be quite a year.
