| The Dow ended the week almost exactly where it began, while the S&P500 added 0.2%. The Utilities were unchanged, while the Transports dropped 1.6%. Earnings disappointments sent the Morgan Stanley Cyclical index to a 1.8% decline for the week. The Morgan Stanley Consumer index was unchanged. The broader market rally continued. The small cap Russell 2000 rose 1.3%, increasing y-t-d gains to 5.2%. The S&P400 Mid-cap index added 0.5%, with 2006 gains rising to 3.9%. The NASDAQ100 added 0.7% (up 6.2% y-t-d), and the Morgan Stanley High Tech index was little changed (up 5.8% y-t-d). The Semiconductors added 1.4%, increasing 2006 gains to 9.8%. The NASDAQ Telecommunications index gained 1.3%, with y-t-d gains of 8.7%. The Street.com Internet Index fell 1.8% (up 3.8% y-t-d). The Biotechs increased 0.7% (up 4.4%). Financial stocks were mixed. The Broker/Dealers gained 1.6%, while the Banks declined 0.4%. With Bullion up $17.40 to $557.40, the HUI index jumped 1.7%. For the week, two-year Treasury yields declined 2 bps to 4.33%. Five-year government yields fell 3 bps to 4.29%. Bellwether 10-year Treasury yields dipped 2 bps 4.35%. Long-bond yields declined 3 bps to 4.52%. The spread between 2 and 10-year government yields was unchanged at 2 bps. Benchmark Fannie Mae MBS yields fell 8 bps to a 12-week low of 5.58%, this week again outperforming Treasuries (spreads at 11-week lows). The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note narrowed 2 to 34, and the spread on Freddie’s 5% 2014 note narrowed 2.5 to 34.5. The 10-year dollar swap spread declined one to 50.5, an 11-week low. Investment-grade and junk bond spreads narrowed. The implied yield on 3-month December ’06 Eurodollars dipped 2 bps to 4.69% January 10 – Financial Times (Jennifer Hughes): “Investor demand for US Treasuries will be tested in the next month as investors face an unusually heavy supply of new bonds of record long duration. The Treasury yesterday announced a $13bn sale of five-year notes and $9bn in 10-year inflation-protected securities (Tips) this week - the first tranches of approximately $100bn in coupon-bearing notes due to be issued in the next month. It will be the biggest single month of supply since a similar period in 1996, according to Bank of America figures.” January 11 – Bloomberg (Al Yoon): “Mortgage bonds issued by companies such as Fannie Mae are having their best start to a year versus Treasuries since 2002 as interest-rate volatility falls and yields near their highest in two years attract buyers. The extra yield investors demand to hold mortgage-backed securities rather than Treasuries has narrowed by 10 basis points…to 125 basis points since Dec. 31.” January 13 – Bloomberg (Harris Rubinroit): “Georgia-Pacific Corp., the lumber company bought by Koch Industries Inc., led U.S. borrowers this week seeking more than $16.5 billion of loans for acquisitions amid record investor demand for the credits.” Corporate bond issuance jumped to a record $38 billion (from Bloomberg). For the week, investment grade issuers included Oracle $5.75 billion, Morgan Stanley $4.1 billion, Goldman Sachs $3.25 billion, HSBC $2.5 billion, Johnson Controls $2.5 billion, Mohawk Industries $1.4 billion, Virginia Electric & Power $1.0 billion, Deutsche Bank $800 million, Progress Energy $400 million, ERP Operating $400 million, Florida Power & Light $400 million, Nevada Power $210 million, Alabama Power $300 million, Waddell & Reed $200 million, and Entergy Mississippi $100 million. Junk bond funds saw outflows of $6.5 million (from AMG). Junk issuers included RH Donnelley $2.24 billion, Allis-Chalmers Energy $160 million, Westlake Chemical $250 million, and Inergy $200 million. Foreign dollar debt issuers included the European Investment Bank $3.0 billion, KFW $3.0 billion, Swedish Export Credit $1.0 billion, Brazil $1.0 billion, Ontario Province $1.0 billion, Landsbanki $600 million, Quebecor Media $525 million, Banco Brasil $500 million, and Excelcomindo $250 million. January 11 – Bloomberg (Caroline Salas): “The amount of defaulted corporate bonds increased by 75 percent worldwide last year to $28 billion… The increase pushed the speculative-grade default rate by dollar volume to 3.7 percent from 2.6 percent in 2004, according to…Moody’s…” Japanese 10-year JGB yields added one basis point this week to 1.45%. Brazil’s benchmark dollar bond yields rose 9 bps to 6.64%. Brazil’s Bovespa equity index rose 1.2%, with a y-t-d gain of 7.3%. The Mexican Bolsa added about 1%, increasing 2006 gains to 6.1%. Mexican govt. yields declined 2 bps to 5.31%. Russian 10-year dollar Eurobond yields jumped 8 bps to 6.48%. The Russian RTS index is up 10% y-t-d and has more than doubled in 52 weeks. Freddie Mac posted 30-year fixed mortgage rates declined 7 bps to 6.15%, an 11-week low but up 41 bps from one year ago. Fifteen-year fixed mortgage rates were down 5 bps to 5.71%, yet were up 51 bps in a year. One-year adjustable rates slipped one basis point to 5.15%, with an increase of 105 bps from one year ago. The Mortgage Bankers Association Purchase Applications Index jumped 9.3% last week. Purchase Applications were down 8% from one year ago, with dollar volume down 6%. Refi applications jumped 9.9%. The average new Purchase mortgage rose to $220,600, while the average ARM fell to $318,200. The percentage of ARMs slipped to 28.1% of total applications. Broad money supply (M3) jumped $25.8 billion (week of Jan. 2) to a record $10.266 Trillion. Over the past 33 weeks, M3 has inflated $640.8 billion, or 10.5% annualized. Over 52 weeks, M3 has expanded 8.5%, with M3-less Money Funds up 9.0%. For the week, Currency added $1.9 billion. Demand & Checkable Deposits declined $3.2 billion. Savings Deposits gained $7.4 billion. Small Denominated Deposits rose $1.4 billion. Retail Money Fund deposits increased $6.2 billion, and Institutional Money Fund deposits surged $32.9 billion (up $63.0bn in 4 wks). In an interesting development, over the past 20 weeks, Retail Money Market Funds have expanded at 14.6% rate and Institutional Money Funds have expanded at a 23.2% pace. For the week, Large Denominated Deposits declined $8.0 billion. Over the past 52 weeks, Large Deposits were up $271 billion, or 24.8% annualized. For the week, Repurchase Agreements slipped $1.6 billion, and Eurodollar deposits dropped $11.3 billion. Bank Credit fell $19.1 billion last week to $7.489 Trillion. Over the past 52 weeks, Bank Credit has inflated $679 billion, or 10.0%. Securities Credit declined $4.5 billion during the week. Loans & Leases expanded 12.5% over the past 52 weeks, with Commercial & Industrial (C&I) Loans up 15.3%. For the week, C&I loans gained $4.5 billion, and Real Estate loans jumped $15.8 billion (up $39.6bn in 5 wks). Real Estate loans have expanded 14.3% during the past 52 weeks to a record $2.919 Trillion. For the week, Consumer loans added $0.6 billion, while Securities loans sank $26.8 billion. Other loans fell $8.6 billion. Total Commercial Paper jumped $40.9 billion last week to $1.702 Trillion. Total CP expanded $307.8 billion over the past 52 weeks, or 22.1%. Last week, Financial Sector CP borrowings surged $38.4 billion to $1.558 Trillion, with a 52-week gain of $298 billion, or 23.7%. Non-financial CP gained $2.5 billion to $144.2 billion, with a 52-week rise of 7.3%. Fed Foreign Holdings of Treasury, Agency Debt jumped $7.4 billion to a record $1.531 Trillion for the week ended January 11. “Custody” holdings were up $179.8 billion over the past 52-weeks, or 13.3%. Federal Reserve Credit dropped $16.9 billion to $815.9 billion. Fed Credit expanded 4.5% over the past 52 weeks. International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $507 billion, or 14.2%, over the past 12 months to a record $4.088 Trillion. Currency Watch: January 13 – Market News International (David Barwick): “The exchange rate of the U.S. dollar is bound to decrease eventually and could potentially do so in a way that destabilizes the global economy, William White, Head of the Monetary and Economic Department at the Bank for International Settlements, told Market News International. Policymakers’ persistent failure to respond appropriately to clearly unsustainable trends adds to concerns over future developments, White said… In a worst-case scenario, a sharp dollar fall could provoke a sell-off of American assets by foreign holders and an ensuing rise in U.S. interest and mortgage rates. This could hit consumption both in the U.S. and, via a negative wealth effect, in creditor countries with large dollar holdings. Compounding the difficulties is the current U.S. fiscal stance, which forces the Fed to carry the whole burden of adjustment and raise rates more than would otherwise be necessary. Although it is ‘impossible to give odds’ on the likelihood of a disorderly dollar fall, ‘the secular trend of the dollar has got to be weaker’ to remedy widening imbalances, White insisted… The specific cause for concern is that ‘for whatever reason, those holding dollars will tire of watching the value of their assets go down in terms of their own currency -- maybe because the value of assets in U.S. dollars is going down, maybe because the dollar is going down, or maybe because of a combination of the two -- and will say, ‘I’m out of here’ in volumes that lead to abrupt changes in exchange and interest rates’” The dollar index was about unchanged for the week. On the upside, the Indonesian rupiah rose 2.0%, the Romanian Leu 1.4%, the New Zealand dollar 1.0%, and the Russian ruble 0.9%. On the downside, the Norwegian krone declined 1.9%, the Chilean peso 0.7%, and the Swiss franc 0.5%. Commodities Watch: January 11 – Bloomberg (Tan Hwee Ann): “Zinc, used to galvanize steel to prevent corrosion, may average 41 percent more this year than in 2005 because of shrinking stockpiles and rising demand in China for cars and buildings, Daiwa Securities SMBC said.” This week copper, zinc, and lead all traded to new record highs. Gold and platinum rose to 25-year highs and Aluminum to a 17-year high. February crude oil dipped 29 cents to $63.92. February Unleaded Gasoline fell 4.6% this week, while February Natural Gas sank 8.7%. For the week, the CRB index declined 0.8%, with y-t-d gain of 1.5% and a 52-week rise of 18.9%. The Goldman Sachs Commodities index fell 1% this week, with a y-t-d gain of 0.4% and a 52-week rise of 31.1%. China Watch: January 11 – Bloomberg (Meera Louis): “China may invest more of its $769 billion foreign reserves in other currencies, putting pressure on the U.S. dollar, the European Commission said. ‘There has been indications that China could begin to diversify foreign-exchange reserves away from U.S. dollar assets, something that could put downward pressure on the U.S. dollar,’ the commission said in an unpublished report to European governments that was obtained by Bloomberg News.” January 10 – Bloomberg (Nerys Avery): “China’s total trade climbed 23 percent last year to $1.42 trillion, the General Administration of Customs reported…” January 10 – Market News: “China’s trade surplus hit a record $102 bln last year as imports failed to keep pace with the 28.4% increase in exports, the General Administration of Customs said. China sold $762 bln in goods in 2005, compared with $660.12 bln in imports, up 17.6% over the previous year. “ January 11 – China Knowledge: “The bilateral trade volume between China and the E.U. is expected to reach a new high of US$200 billion for the year of 2005, as reported by the Information Office of China's Ministry of Commerce.” January 10 – Market News: “China’s exports of high-technology products rose 31.9% to $218.25 bln last year, accounting for 28.6% of total exports, the Commerce Ministry said…” January 10 – Bloomberg (Wing-Gar Cheng): “China, the world’s biggest electricity user after the U.S., consumed 13.5 percent more power last year because of increased energy demand, according to the China Electricity Council.” January 9 – Bloomberg (Nerys Avery): “China raised its estimate for 2004 gross domestic product growth to 10.1 percent from 9.5 percent following an economic census carried out last year, the National Bureau of Statistics said. The GDP growth rate for 2003 was raised to 10 percent from 9.5 percent…” January 11 – Bloomberg (Hanny Wan): “Rents for Hong Kong’s luxury residential properties will climb as much as 30 percent this year, driven by strong demand from expatriates moving to the city, real estate brokers Knight Frank said. The expected increase for properties of 100 square meters or more located in Hong Kong Island’s prime neighborhoods follows a 20 percent gain last year…” Asia Boom Watch: January 12 – Bloomberg (Kathleen Chu and Yoshimasa Yamaguchi): “Office vacancies in Tokyo fell last month to their lowest since December 2001, as demand continues to rise, according to a report by Miki Shoji Co., a closely held real estate broker. The vacancy rate in Tokyo’s five main business districts…declined to 4.22 percent…” January 9 – Bloomberg (Theresa Tang): “Taiwan’s export growth accelerated in December as a weaker currency and rising global demand for electronics fueled purchases of the island's personal computers and semiconductors. Overseas sales rose 15.4 percent from a year earlier to $17.2 billion after gaining 10.7 percent in November…” January 12 – Bloomberg (Meeyoung Song and Seyoon Kim): “South Korea’s jobless rate fell to 3.5 percent in December, adding to expectations that growth in Asia’s third-largest economy is picking up. The seasonally adjusted unemployment rate dropped from 3.6 percent in November… Low interest rates and tax cuts are encouraging Koreans to spend after credit-card debts forced households to tighten their purse strings in the past two years.” January 10 – Bloomberg (Anuchit Nguyen and Beth Jinks): “Thailand’s central bank plans to add to last year’s six benchmark interest rate increases to keep inflation in check, Deputy Governor Bandid Nijathaworn said. Thai bonds had the biggest drop since November.” Unbalanced Global Economy Watch: January 12 – CNW: “The country’s (Canada) housing market showed remarkable strength in the traditionally slower fourth quarter as sales activity in most major markets stimulated robust year-over-year increases in average prices (from Royal LePage Real Estate Services)... The highest average price appreciation occurred in detached bungalows, which rose to $269,810 (+9.1%), followed by standard condominiums, which increased to $190,123 (+7.0%), and standard two-storey properties, which rose to $327,269 (+7.0%). Homeowners in the energy-producing West saw the value of their properties appreciate at a much higher rate than elsewhere in Canada…” January 10 – Bloomberg (Alexandre Deslongchamps): “Canadian housing starts unexpectedly increased in December, supporting the central bank’s view that interest rates must be raised further to cool the economy.” January 12 – Bloomberg (Michael Rothschild): “Sales of collateralized-loan obligations in Europe rose 33 percent last year to a record 10 billion euros ($12 billion) as the quality of the credits they package deteriorated, Standard & Poor’s said… Sales of leveraged loans, credits rated below investment grade, doubled last year to $125 billion…” January 11 – Bloomberg (Craig Stirling): “Britain’s trade deficit widened to a record in November as exports to countries outside the European Union fell, a sign that economic growth may struggle to pick up this year. The trade gap widened to 6 billion pounds ($10.6 billion)…” January 11 – Bloomberg (Joao Lima): “Spanish mortgage growth may slow this year as interest rates rise, the Spanish mortgage association said. Mortgage loans may rise between 18 percent and 20 percent compared with growth of more than 25 percent 2005, the association said…” January 12 – Bloomberg (Jonas Bergman): “Swedish apartment prices had record gains last year after the central bank cut benchmark interest rates to a record low in June to stoke growth. Apartment prices rose 22 percent nationwide, led by a 28 percent gain in the province of Oestergoetland…” January 12 – Bloomberg (Michael Teagarden and Bradley Cook): “OAO Gazprom, the world’s biggest natural-gas producer, overtook Wal-Mart Stores Inc. and Procter & Gamble Co. to join the world’s 10 largest companies by market value after its shares surged in London and Moscow. The state-controlled Russian company’s London-traded American depositary receipts advanced 8.7 percent to $91.60, valuing the company at $217 billion.” January 12 – Bloomberg (Maher Chmaytelli): “Egyptian stocks had their biggest advance in almost nine months after state media reported economic growth this year will be better than 2005, boosted by tourism and exports… The CASE 30 Index rose 6.1 percent to 7354.05 at the close… Egypt’s economy will grow by 6 percent in 2006, thanks to a projected increase in revenue from tourism and petroleum exports…” Latin America Watch: January 11 – Bloomberg (Adriana Arai): “Mexican Finance Minister Francisco Gil Diaz said the country's economy this year will grow 3.7 percent… Economic growth will accelerate from about 3 percent in 2005…” January 11 – Associated Press: “For the second straight year, Brazilian automakers set new production and export records in 2005, the Brazilian Motor Vehicle Manufacturers Association said… Output came to a record of nearly 2.5 million vehicles in 2005, a gain of 10.7 percent on the previous production record set in 2004…” January 10 – Bloomberg (Peter Wilson): “Venezuelan vehicle sales soared 70 percent last year to a record high as increased government spending fueled consumer demand and the economy expanded 9.4 percent.” January 13 – Bloomberg (Alex Kennedy): “Venezuelan President Hugo Chavez said he plans to increase salaries for government workers by as much as 80 percent this year.” January 11 – Bloomberg (Andrea Jaramillo): “Colombia’s exports rose 15.5 percent in November, the statistics agency said… Colombia’s imports rose 21.4 percent in November from a year earlier, boosted by purchases of electronic appliances and cereals.” January 6 – Bloomberg (Alex Emery): “Peru’s trade surplus rose to a record $4.75 billion last year on surging sales of gold, copper and fishmeal. The trade surplus jumped 70.1 percent as exports increased one-third to a record $16.85 billion…” Bubble Economy Watch: At $64.2 billion, the November Trade Deficit was lower-than-expected. Goods Imports were up 11% from a year ago to $146.2 billion. Goods Exports jumped 13% to a record $77.4 billion. Import Prices were up 7.9% y-o-y. December’s Producer Price reading was up 5.4% from December 2004. December Retail Sales were up 6.4% y-o-y, with Sales ex-autos up 8.0%. January 13 – Bloomberg (Cotten Timberlake): “U.S. retailers’ sales rose a better-than-expected 6.4 percent in November and December, led by gains in clothing and electronics, the National Retail Federation said. It was the industry’s third-best holiday season in 10 years.” January 12 – Bloomberg (Kevin Orland): “Equity Office Properties Trust Chairman Sam Zell comments on the…U.S. labor market: ‘Anybody who’s out there hiring people today, or is trying to, I’m sure are quite aware of what is really a blistering employment market that I believe is going to contribute to some wage inflation.’” January 12 – Bloomberg (Lisa Kassenaar): “Sharon Dolin dialed the Jewish Community Center on Manhattan’s Upper West Side last month to enroll her 7-year-old son in summer day camp. No such luck. ‘It’s insane,’ says Dolin, 49, who turned down a place on the waiting list. After putting off applications until March or April in previous years… A surge of New York children under age 13 and parents accustomed to battling for slots in exclusive preschools are pushing the limits of summer day camps. Two- to eight-week sessions that cost $150 a day or more are filling faster than ever, camp directors say. Consultants are charging $300 for an initial chat on choosing the right camp and gaining admission. At Fieldston Outdoors in the Riverdale section of the Bronx, the phone started ringing at 12:01 a.m. on Dec. 1, the first chance to get an application. The 92nd Street Y on the Upper East Side, with 12 programs for 1,500 children, sold out its $4,975 camp for 3- and 4-year-olds on one November day…” January 10 – UPI (Todd Zwillich): “Overall U.S. expenditures for healthcare slowed to their lowest rate of growth since 2000 last year, but analysts warned that the nation’s medical spending is still outstripping its long-term ability to pay. According to a federal report released Tuesday, $1.88 trillion was spent on healthcare for Americans in 2004, up 7.9 percent from the year before.” Fiscal Deficit Watch: January 12 – Bloomberg (Brendan Murray): “The U.S. budget deficit will rise to more than $400 billion this fiscal year as spending increases for the reconstruction of the Gulf Coast region devastated by Hurricanes Katrina and Rita, a White House aide said. The preliminary estimate…was made during a conference call with reporters in Washington and is higher than the $341 billion projection the Bush administration made in July. The deficit in fiscal 2005, which ended Sept. 30, was $319 billion.” Three months into fiscal year 2006, federal government Total Receipts are running 8.8% above comparable levels from 2005 at $487.2 billion. Individual Income Tax Receipts are 7.7% ahead of year ago levels, with y-t-d Corporate Income Tax Receipts up 25.4%. Total Spending is 7.2% ahead of last year at $605.3 billion. Financial Sphere Bubble Watch: January 12 – New York Times (Jenny Anderson): “Ferrari dealers, get ready. Wall Street bonuses are in and they are big. Alan G. Hevesi, the New York State comptroller, announced yesterday that Wall Street bonuses were estimated to hit a record $21.5 billion for 2005, surpassing the previous record of $19.5 billion, set in 2000… The Street’s munificence will be felt throughout New York: Mr. Hevesi estimated that New York State would collect $1.5 billion in tax revenue from those bonuses, and New York City about $500 million. ‘Wall Street continues to be critically important to the economies of both the city and the state,’ he said… Revenue at Wall Street firms grew by 44.5 percent through the first three quarters of 2005, reaching the highest levels since the stock market peaked in 2000.” “Project Energy” Watch: January 11 – Financial Times (Carola Hoyos): “The oil revenues of the Organisation of the Petroleum Exporting Countries, the cartel that controls 40 per cent of the world’s oil supplies, will increase by 10 per cent to a record $522bn this year, the US Department of Energy forecasts. Opec’s increased wealth, driven by continuing high oil prices and an increase this year in the group’s production, should help keep interest rates low if members of the group continue to spend their increasing wealth in the US bond market, economists said. The yield of the 10-year bond has remained nearly flat since mid-2004 in spite of the Federal Reserve increasing official interest rates by 3.25 percentage points during that period.” January 11 – Bloomberg (Dan Lonkevich): “Amerada Hess Corp., the fifth-biggest U.S. oil producer, said it will increase capital spending to $4 billion this year as the company develops offshore fields around the globe to boost output. Excluding acquisitions and costs for returning to the company’s oil concession in Libya, spending will climb 28 percent…” January 12 – Bloomberg (Greg Chang): “California regulators approved a $2.5 billion solar-power subsidy, the largest ever in the U.S., offering more business to solar-panel makers such as SunPower Corp. and Evergreen Solar Inc. that already are struggling to meet demand.” January 10 – Bloomberg (Margot Habiby and Danielle Sessa): “Boone Pickens, the legendary Dallas oilman and hedge fund manager, donated $165 million today to the Oklahoma State University athletic program in what the school called the largest-ever single gift to U.S. college athletics. Pickens’ gift will partially fund a $300 million project to build an athletic village on the university’s main Stillwater, Oklahoma, campus, Oklahoma State said in a statement… Projects include rebuilding the west end zone at Boone Pickens Stadium…and constructing a multipurpose indoor practice complex; facilities for soccer, track and tennis; an equestrian center; and a baseball stadium and outdoor practice fields.” January 11 – Bloomberg (Jeb Blount and Romina Nicaretta): “Petroleo Brasileiro SA, Brazil’s state-controlled oil company, said it will lead an $18 billion effort to expand oil and gas production in a bid to increase electricity generation and cut dependence on foreign natural gas.” January 6 – Bloomberg (Eduard Gismatullin): “President Vladimir Putin urged the Russian government to accelerate development of natural-gas projects in eastern Siberia and the Far East, to increase supplies to domestic customers and exports to the Asia-Pacific region.” Mortgage Finance Bubble Watch: Countrywide Financial reported an impressive December. Total Fundings were up 28% from December 2004 to $44.5 billion. The Mortgage Loan Pipeline was up 25% to $59.6 billion. Purchase Fundings were up 28% from the year ago period, Non-purchase/refi 27%, and ARM fundings 21%. ARM fundings were 50% of Total Fundings during December. Home Equity Fundings ($4.0bn) were the strongest since record fundings posted last August. Subprime Fundings of $4.4 billion were the second-strongest on record. Countrywide’s Bank saw assets balloon 78% over the past year to $73.1 billion. January 11 – Bloomberg (Danny King): “Home Depot Inc., the world’s largest home-improvement retailer, and IndyMac Bancorp Inc. will begin lending as much as $2 million to individual home contractors and developers to boost revenue from the homebuilding industry. Under the new SPEC Construction Loan program, builders can borrow as much as $2 million for as long as 18 months, Atlanta-based Home Depot said… Builders will also get 5 percent rebates on Home Depot products, the company said. ‘SPEC’ refers to speculative homes built before they are sold to a consumer.” January 10 – Dow Jones: “Warning of growing risks for some lenders, U.S. regulators on Tuesday proposed guidance for banks and thrifts that lend largely for office buildings, rental apartment buildings and other commercial real estate ventures. In a joint proposal, regulators said some banks and thrifts have ‘high and increasing concentrations of commercial real estate loans on their balance sheets,’ which may make them more vulnerable to commercial real estate market downturns.” Anecdotes of Excess Begetting Excess: As I noted again last week, it is a central tenet of Credit Bubble Analysis that if an expanding Financial Sphere provides Easy Credit Availability and Abundant Marketplace Liquidity (prospective purchasing power), the Economic Sphere will undoubtedly conceive of ways to spend it. It is also critical to appreciate that a rapidly expanding Financial Sphere creates its own reinforcing (cheap) liquidity. And it is the nature of evolving Bubbles to circumvent processes that would typically marshal adjustment and self-correction. For the past several years, Mortgage Finance Bubble excesses have fostered massive Current Account Deficits that have been easily recycled back to booming U.S. debt securities markets. This has engendered only easier Credit Availability and General Liquidity Over-abundance. Credit Bubble Dynamics dictate that, if accommodated, Credit Inflation Manifestations will strengthen and broaden. Excess feeds and is fed by Credit excess until the unavoidable bust. These are fundamental analytical constructs to guide us as we look forward. Contemporary Wall Street Finance’s 1990s maiden foray into Global Credit Bubble Dynamics ended in spectacular disaster. Yet, here at home, the Fed and GSE’s post-Russia/LTCM reliquefication both emboldened the leveraged risk-takers and provided excess (“King Dollar”) liquidity for which to fuel the fateful technology Bubble. The bursting of the tech/telecom debt boom gave rise to an historic collapse in short-term interest rates and Bernanke’s Manifestos on “government printing presses,” “helicopter money,” “non-conventional” inflating measures and a “global savings glut.” Importantly, Greenspan’s reflationary policies and Bernanke’s extraordinary rhetoric sanctioned Wall Street “structured finance” as a primary source of system liquidity, along with stoking the fledgling Mortgage Finance Bubble, the mushrooming derivatives markets, and the empowered global leveraged speculator community to unprecedented excesses. The Fed was compelled to guarantee perpetually liquid financial markets; there would be absolutely no turning back and no middle ground in managing the boom. The unfolding Global Liquidity Glut and the faltering dollar spurred a massive worldwide inflation in commodities, energy, real estate and securities markets. This unusual strain of inflation is currently in a rage, inflamed by the rampant inflation of dollar claims and the robust expansion of the vast majority of Credit systems internationally. As I see it, the U.S. system will soon face a significant test. The optimistic view has it that housing markets are slowing; that this will engender a moderating impact on consumption; and that this unfolding “mid-cycle” Goldilocks economic environment will prosper for at least the next several years. This, however, flies in the face of the Credit Bubble thesis that Excess Begets Excess. Which will it be? Has the cuddly little bond bear already passed, or has the Big Bad Bear Market not yet even arrived? For at least the past two years, any indication of economic weakening immediately induced a rapid decline in bond yields. The upshot was a rapid boost to mortgage finance, housing, consumption and Credit creation generally (heralded as economic resiliency). To be sure, the over-liquefied U.S. bond market has proved powerfully resilient and self-reinforcing. Until proven otherwise, analytical discipline forces me to give this robust Inflationary Bias the benefit of the doubt. Indeed, it appears that signs of cooling in some key housing markets have mortgage yields, once again, in retreat. This should lend support to housing and consumption. The key issue today is whether recent historic mortgage Credit excesses can be sustained, even at somewhat reduced levels. At current rates and considering the backdrop, I don’t see why not. However, when it comes to Excess Begetting Excess, a one-dimensional focus on real estate markets would today leave us at a distinct analytical disadvantage. In particular, Inflationary Manifestations are in full bloom throughout the global economy. “Emerging” markets/economies are in the midst of an historic run. Additionally, we are in the initial stage of what has all the potential to progress into an unprecedented global energy and energy-conservation spending boom. Outside of energy, surging global commodities markets are driving stepped-up investment. Global M&A remains robust. It is also becoming increasingly clear that global technology/telecom industries are poised – markets willing - for another bout of spectacular spending excess. Excess Begets Excess, and we must these days ensure that our analysis expands beyond the U.S. consumer. It is a most fascinating environment. The U.S. bond market – the epicenter of global liquidity excess – is today fixated on housing and “core” inflation data. This narrow focus is dictated by the reasonable presumption that these are two of the Fed’s key indicators. The marketplace expects that sanguine readings on both will allow chairman Bernanke to err on the side of continued accommodation. Ironically, however, housing and “core” inflation will almost certainly this year prove especially poor indicators of heightened inflationary pressures and loose financial conditions. Inflationary Manifestations are clearly broadening from home prices (especially after the explosive growth in the home construction industry and a major build up in inventories). Meanwhile, rising (non-core) energy and commodities prices will provide the most intense cost pressures (and drag on industrial profits!). For now, we should assume that current low market yields and liquidity over-abundance will sustain the Mortgage Finance Bubble, while stoking other bubbling excesses. The Fed will feel the heat. This week provided a flurry of interesting anecdotes and data supporting the Expanding Bubble Thesis. From Sam Zell (see Bubble Economy Watch): “Anybody who’s out there hiring people today, or is trying to, I’m sure are quite aware of what is really a blistering employment market that I believe is going to contribute to some wage inflation.” As for this week’s data, the Producer Price Index was up 5.4% from last December (despite the dollar’s rally). December Goods Exports were up 13% from a year ago to a new record. December Retail Sales Ex-autos were up 8% y-o-y. The NASDAQ Telecommunications index is up almost 9% y-t-d already. The small caps, mid caps, and broker/dealer indices all traded to new all-time record highs. Global equity markets continue to boom. Mortgage spreads have narrowed significantly, supporting the view that myriad other Inflation Manifestations and Bubbles will for now help sustain the Mortgage Finance Bubble. When it comes to Excess Begetting Excess, few manifestations are more conspicuous than those emanating from our federal government’s finances. Massive mortgage and Treasury Credit creation run unabated, in the process inflating asset prices and generating enormous corporate cash flows/profits (along with global liquidity). Three months into fiscal 2006, total federal government receipts are running almost 9% above 2005 levels (that were up 14.6% from 2004!). Yet the White House now projects that the 2006 deficit will surge to $400 billion. Total expenditures have thus far expanded 7.3% above comparable 2005 levels (that were up 7.9% from 2004). Spending on hurricane recovery is one factor, but expenditures (including interest payments!) are rising generally, which induces greater levels of borrowing, more spending, higher costs and additional borrowing. And when it comes to the Credit system monetizing surging energy and healthcare costs, it is helpful to think in terms of the federal government simply inflating the quantity of Treasury bills in the global economy to pay for inflating expenditures. December Hourly Earnings were up 3.1% from the year ago period, the strongest y-o-y increase since March 2003. I expect both wages and personal income growth to surprise on the upside until the Bubble bursts. Corporate America was well-positioned to provide generous year-end bonuses. Is the recent surge in M3 and, more specifically, money market fund assets, indicative of unusually large bonus payments? Clearly, Wall Street’s $21.5 billion year-end bonus pool will stimulate income gains for real estate agents, luxury goods salespersons, and summer camp operators in the Northeast and elsewhere. There are as well indications that the market for technology employees has tightened significantly over the past year, and we will have to wait and see how much the bubbling energy sector - facing a dwindling-to-non-existent talent pool - is willing to pay up. The paucity of trained truck drivers, nurses and accountants has not been rectified, and there is evidence of skills shortages throughout services industries. As for this week’s anecdotes of Excess Begetting Excess, it is certainly worth noting Boone Pickens’ “largest-ever single gift to U.S. college athletics.” His $165 million donation will set in motion a $300 million upgrade to athletic facilities at Oklahoma State University. Asset inflation, including higher prices of crude oil, energy stocks and securities (at home and abroad) generally, continues to provide a quite favorable backdrop for higher education spending across the nation. And from Dow Jones’ ace financial journalist, Christine Richard: “When the Pilgrim Rest Baptist Church in Phoenix, Arizona looked to fund a facility for its members with on-site fitness equipment, a gymnasium, a spa and Jacuzzi, a beauty salon and a culinary studio, it didn’t just pass the plate. Much of the church’s $10 million expansion plan, which includes a ‘wellness center,’ an education center and an expansion of the church, was funded by selling bonds through the Phoenix Industrial Authority. ‘Bond financing enabled us to complete a project that otherwise wouldn’t have been possible,’ said Richard Yarbough, administrator for the 3,500-member church. The church sold $2.1 million in taxable bonds, which are backed by church revenues, and $6.8 million in tax-exempt bonds, backed by proceeds from the non-religious activities at the new facilities. And, they’re not alone in turning to the bond market to finance increasingly ambitious expansion and building plans.” Again, if overheated markets are keen to provide liquidity, it will be spent. This week saw a record $38 billion of corporate debt issuance. To this point, the bond market has shrugged off what will be ongoing record corporate and Treasury issuance. One would think that the marketplace would have some concern with supply or perhaps even fear of an overheated economy. There is little fear and lots of greed. And this market dynamic is, indeed, the greatest Anecdote of Excess Begetting Excess. You see, the greater the excesses – mortgage finance, commodities, global equity markets, Credit derivatives, leveraged lending, leveraged speculation, and so on – the more the markets anticipate bursting Bubbles and a zealous Bernanke “reflation.” Appreciating that Dr. Bernanke scorns “Bubble Poppers,” there is today every incentive to play myriad Bubbles for all their worth. After all, wealth is there for the taking and fortunes for the making. Everyone should be rich. And, at this manic phase of systemic liquidity excess, the more fragile and vulnerable the system becomes to Bursting Bubbles, the more timid the policymaker and the greater the bias for bond yields to decline - Begetting only greater excesses. Moreover, when circumstances now develop that pose potential systemic risk – the Iranian nuclear issue, for example, knee-jerk bond rallies work only to stoke speculative impulses and buttress Bubbles. Years of incredibly rewarding Credit and speculative excess, recurring Bubbles, and repeated central bank marketplace interventions have irreparably distorted risk perceptions and marketplace dynamics. And here we are - we can now clearly assay the serious flaw in Dr. Bernanke’s aversion to Bubble popping: It really boils down to policymakers coming to possess only two options, both unattractive. Option one is to act decisively and pop the Bubbles. Option two is to accommodate the Bubbles, watch them further intensify and multiply, and allow the manic crowd to get only more manic. There reaches a point where the middle ground has been lost. Act decisively and take the pain or cowardly and watch Excess Beget Precarious Excess. |
Pages
▼