Educate Yourself

Week in Review
For the week 4/21/2008 - 4/25/2008
Brian Trumbore
President/Editor, StocksandNews.com

Gloom, despair, and agony on me
Deep, dark depression, excessive misery
If it weren't for bad luck, I'd have no luck at all
Gloom, despair, and agony on me

There are a number of potentially titanic events this week. The Federal Reserve's Open Market Committee meets on Tuesday and Wednesday, at which point it is now expected they will lower the short-term funds rate another ?-point to 2.00%, and then issue language strongly hinting at a pause. There is also another key reading on home prices from S&P/Case-Shiller, Tuesday, and Friday's employment report for the month of April.

But to me the biggest figure will be released on Wednesday; the first look at gross domestic product for the first quarter. Have some of us been right in our gloom and doom for the economy? What if the number comes out positive, even if by a fraction, as some economists are now projecting? What does that do to forecasts for the rest of the year, or to sentiment; the latter being the key variable in any market environment? All I know is if GDP comes out with a '+' sign, I'll be spinning away with the best of them come my next review.

Of course I'll be shocked if the economy didn't take a negative turn in the quarter. It's become an environment where three things matter?housing, food and energy?and you can say that for just about anywhere in the world these days, particularly in the developed markets. You might be thinking, though, what about the global credit crisis? That's always been a subset of housing (and now increasingly commercial real estate). Without the bursting of the real estate bubble, obviously we have no credit crunch.

Food and energy prices, on the other hand, we all have to deal with, every darn place in the world. Gasoline futures, for example, finished the week over $3.00, meaning the day of $4.00 at the pump on a nationwide basis is just around the corner should the futures price rise another 20-30 cents from this level. Here in New Jersey, we've been somewhat sheltered thus far, unlike those of you in California, for example. We have the refineries that the rest of you like to crack jokes about, after all. Plus we skim it off our rivers, a right of passage for the little ones.

But what of this food bubble we're in, and if you don't think it's a bubble, take a glance at my "Wall Street History" piece on tulipmania that I dusted off. The price of rice tripling in a year? C'mon. That's just stupid. Don't panic and go rushing to hoard the stuff, at least here in America (recognizing I have international readers who may be in a little different predicament).

Energy is a different story, and an often told one. Inventories are low in some categories, you've had outages of one kind or another, and you have a key producer like the Saudis saying they don't need to increase their capacity (assuming they can in any big way) because there is enough oil already out on the market. So much for all those high-level meetings in Riyadh, at Camp David, or Crawford, Texas, over the years, asking the Saudis for their cooperation on supply.

But talk about gloom, despair, and agony, look no further than the airline industry as the cost of jet fuel soars beyond the heavens.

And what of housing? Existing home sales for the month of March were off 2%, about in line with expectations, though the median price rose slightly year over year, but then new home sales came in at their lowest level since 1991, with the median price down 13%. Plus inventories in both categories are still in the 10-11 month range, not good. You can't call a bottom in this market until much of it is worked off, plus as Mike Morgan, a real estate broker in Florida, wrote in Barron's, the inventory problem is migrating from builders to the lenders these days and the lenders are clueless as to how to best dispose of properties without making the problem worse. It also doesn't help matters that mortgage rates have been rising, even as the Federal Reserve has been lowering its own target rate, opposite of what the Fed hoped would happen. In this instance it's simply about much tighter lending standards and the bond market's fear of inflation, thus the rise in the 10-year Treasury off which conventional mortgages are pegged.

So you put it all together and it's no surprise defaults and foreclosures continue to rise. Jeff S. passed along a piece from the Arizona Republic that addressed the growing issue of people just walking away from their homes when the value falls below the amount left on the mortgage. In the Phoenix area in March alone, 2,365 homeowners pursued this path, quadruple the number a year ago.

But what's happening overseas, you might ask? More of the same. The Bank of England announced a plan to restore confidence in its financial system in an attempt to jumpstart a sliding housing market there, offering to take in assets of all kinds, including those exceedingly hard to trade these days, in return for government-backed bonds. U.K. banks have a year to repay the loans and in most cases could renew after that. This is what happens when mortgage approvals plummet 50% as they have in Britain in the past month.

Meanwhile, business confidence in France and Germany is tumbling and Japan's inflation rate is suddenly running at its hottest rate in a decade.

Add it all up and it's not the best economic environment out there today. It's also no surprise that consumer sentiment, as measured by the Univ. of Michigan survey, is at a 26-year low, 73% in a USA Today/Gallup poll cite higher energy prices as a major concern, Whirlpool said it hasn't witnessed such a poor environment for selling appliances in decades, UPS reported a "dramatic slowing in the economy," and Starbuck's CEO Howard Schultz said "The current economic environment is the weakest in our company's history."

Nor is it any wonder, then, that exit polling in Pennsylvania on Tuesday showed the economy is the top concern of voters at 55%, followed by Iraq, 27%, and healthcare, 14%.

--But, recall my mantra around here. Gloom in the economy doesn't mean stocks totally crater. After their spectacular performance the week of 4/14, stocks edged higher again as earnings from the likes of Amazon, Apple, McDonald's, Microsoft, DuPont, and AT&T weren't that bad, though they weren't en fuego either. For the week the Dow Jones added 0.3% to 12891, while the S&P 500 advanced 0.5% and Nasdaq picked up 0.8%.

Yields continued to rise on inflation fears and the growing realization the Fed is about finished in cutting the funds rate. In just two weeks, the 2-year's yield has risen from 1.74% to 2.42%. It hasn't been a great stretch for bond funds, as you can imagine.

--Two weeks ago the Journal exposed a problem involving the London interbank offered rate, or Libor, one of the more important financial indicators in the world. Libor serves as the basis for interest rates on trillions of dollars in derivatives contracts and loans of all sorts, including subprime mortgages.

But as the Journal pointed out there has been a growing gap between Libor and other key rates and it called into question the process by which the rate is tabulated. Every morning, banks submit what it costs them to borrow money to Reuters, which then comes up with a rate that is dispatched globally.

The issue, though, is whether the banks have been manipulating the rate to prevent their own borrowing costs from escalating. Have they thus been hiding the actual rates they are paying for fear this would focus attention on their own cash needs? What has developed is a far larger than normal gap between rates reported by European and U.S. banks, though this is narrowing some. The British Bankers' Association is investigating.

Of course this means borrowing costs for all manner of players have risen and one sector that could be particularly hard hit is commercial real estate, where builders take out huge loans using floating-rate debt tied to Libor. More later as warranted.

--Bank of America set aside $3.3 billion in reserves for problem loans, such as for home equity lines, credit cards, and small business, all tied to the health of the consumer. National City, the nation's 10th-largest bank, raised $8 billion in capital, while Oppenheimer analyst Meredith Whitney said Citigroup's future earnings power is "seriously constrained" due to a broken model.

--If you'd like to find a secure job, assuming that's possible these days, forget state and municipal government work as tax revenues plummet, forcing severe budget cuts. California, which is facing a $16 billion shortfall over the next two years, has seen its unemployment rate rise to 6.2%.

--It appears Congress' prime fix for the housing crisis will focus on tax credits, though agreement on a final package is still a ways off.

--Ken Bensinger of the L.A. Times had a story on the growing number of folks who are setting fire to their homes or autos to collect on insurance if they are behind on their payments. A spokesman for Mercury Insurance said "We've seen a dramatic increase in this kind of fraud." The actual numbers may be small, but the percentage increase in suspected cases is soaring.

--Ford Motor Co. surprised the Street with a profit rather than an anticipated loss for the first quarter thanks to strong results from Europe and South America.

--Delta and Northwest reported a combined $10.5 billion in losses for the first quarter. However, a more accurate measure for Delta, excluding a $6.1 billion non-cash charge, is an operating loss of $274 million, due to a $585 million year- over-year increase in the cost of fuel. Separately, Continental and UAL are closer to a merger agreement.

--Under new rules announced by the Transportation Department, fuel economy standards would rise to 35.7 miles per gallon for cars and 28.6 mpg for trucks by 2015. Whoopty-damn-do.

"Right now, the biofuel market is being grossly distorted by subsidies and trade barriers in the United States and the European Union. These make it rewarding to produce ethanol from corn or grains that are far less productive than sugarcane ethanol, divert land from food production (unlike sugarcane), and have dubious environmental credentials.

"What sense does it make to have a surplus of environmentally friendly Brazilian sugar-based ethanol with a yield eight times higher than U.S. corn ethanol and zero impact on food prices being kept from an American market by a tariff of 54 cents on a gallon while Iowan corn ethanol gets a subsidy?

" 'It would make a lot more sense to drop the tariff, drop the subsidy, and allow Brazilian ethanol into the United States,' said Philippe Reichstul, the chief executive of a biofuel company in Sao Paulo. 'Pressure on U.S. land will be slashed.'?

"The real scam lies in developed world protectionism and skewed subsidies, not the biofuel idea."

--The U.S. Food and Drug Administration says the contamination of the widely used blood thinner, heparin, is now "a world-wide problem." The FDA says it can link 81 deaths to the drug, manufactured by 12 companies in China.

--China now has 221 million Internet users, tying the U.S. for most people online. The percentage of Chinese online is 16 percent, below the world average of 19, though usage jumped 61 percent in just one year.

--I grow weary of the Microsoft / Yahoo potential deal. Yahoo reported better than expected earnings, saying in effect that Microsoft's hostile bid for the company was too low. Microsoft scoffed, but in issuing its own so-so earnings, offered that chances for a deal were diminished by Yahoo's intransigence.

--The number of class-action suits centering around the auction- rate securities market debacle continues to explode.

--According to various sources, including the Congressional Budget Office and the Bureau of Economic Analysis, the median household income, in 2006 dollars, has dropped from $49,447 in 2000 to $48,223 in '06. Separately, the personal savings rate was 7.3% in 1988 and is zero today.

--Wendy's agreed to a takeover by billionaire investor Nelson Peltz's Triarc, which owns the Arby's chain. Wendy's has been struggling, with revenues declining in the first quarter.

--Talk about a struggling company, look no further than Motorola, where handset sales plummeted 39% in Q1.

--My portfolio: Out of nowhere, my China biodiesel company stopped manufacturing biodiesel, as it turns out for a very good reason?.it isn't profitable with the government holding the line on diesel prices at a time when foodstuffs are rising. The stock didn't react well, as you might imagine, though the company reaffirmed earnings potential for 2009 when the new plant is fully operational. How, you might ask? By switching to specialty chemicals, which is where the company has its roots and is 74% of revenues today. Having seen the existing plant one year ago (it seems like five years), I know it's an easy transition. I would have bought more on Friday, actually, but I want to wait to see the new auditor's report on first quarter operations. I will keep you apprised of any future insight within reason, but I'm fully confident this one will work out and by this time next year I'll be back drinking premium beer.

--One year ago, the average money market fund yielded 4.70%. As Ronald Reagan said, 'Not bad, not bad at all.' Today, it's more like 2.50% and falling. Not good, not good at all, for those of us holding a substantial cash position.

Iraq: One day Moqtada al-Sadr threatened "open war" against the Iraqi government, and by extension the U.S., and then on Friday he was back to being conciliatory and urging calm. I got a kick out of Secretary of State Condoleezza Rice this week for ridiculing Sadr, even as some U.S. generals were calling for calm and lowering the rhetoric. My opinion was 'let sleeping dogs lie.'

Meanwhile, Gen. David Petraeus was promoted to lead U.S. Central Command, which means he oversees the wars in both Iraq and Afghanistan, though regarding the latter NATO still calls many of the shots. Petraeus' current right-hand man in Iraq, Lt. Gen. Odierno, moves up. President Bush, as many have commented, has finally gotten it right when it comes to his commanders.

Israel: There were a slew of reports that Israel was willing to negotiate away the Golan Heights if Syria would make a number of moves, including cessation of its alliance with Iran and cutting off support to terrorists, read Hamas and Hizbullah, in Lebanon and the Palestinian territories. Turkey has been acting as mediator between Israel and Syria.

Egypt continues to mediate between Hamas and Israel and a potential ceasefire, though Hamas says it must be extended to the West Bank while Israel says no. At the same time, Israeli Prime Minister Ehud Olmert is claiming a letter from President Bush to then-Israeli Prime Minister Ariel Sharon four years ago gave Israel permission to expand West Bank settlements that it hoped to then retain in a final peace deal, even as Bush's roadmap for peace calls for a freeze on settlement construction, which has turned out to be a joke.

Separately, a New Jersey resident was charged with espionage for passing on nuclear secrets to Israel in the 1980s (1979 to 1985, at least).

As for former president Jimmy Carter and his trip to the region, including two days of talks with exiled Hamas leader Khaled Meshaal in Damascus, he claims he had tacit approval from the State Department, which of course counters he's nuts if he believes that. Carter says Hamas now offers it could "live as a neighbor next door in peace" with Israel, provided Palestinians get their independent state on all the territories seized by Israel in the 1967 six-day war. At the same time, 2/3s of Israelis say that if there is ever to be a peace deal, Hamas has to be part of it.

"The problem is not that (Carter) is, or is not, talking to the Syrians - everyone does it to some degree. It isn't that he went to Damascus to meet with the exiled head of Hamas - everyone, including the Israelis, will one day have to do that too, in accordance with that old rule which says that in the end it is with your enemies not your friends that you have to come to an understanding and make peace.

"The problem is the spectacular and useless embrace he exchanged with the senior Hamas dignitary, Nasser Shaer, in Ramallah.

"The problem is the wreath he laid piously at the grave of Yasser Arafat, who, as Mr. Carter knows better than anyone else, was a real obstacle to peace.

"It is that, in Cairo, if we are to believe another Hamas leader, Mahmoud Zahar, whose statement has so far not been denied, Mr. Carter apparently described Hamas as a 'national liberation movement' - this party which has made a cult of death, a mythology of blood and race, and an anti-Semitism along the lines of the Protocols of the Elders of Zion into the linchpin of its ideology.

"The problem is also the formidable nose thumbing he got from?Khaled Meshaal, who, at the very moment he was receiving Mr. Carter, also triggered the first car bombing in several months?on the Gaza strip - and that this event elicited from poor Mr. Carter, all tangled up in his small-time mediator calculations, not one disapproving or empathetic word?.

"All hypotheses are permitted. Whatever the reason, Mr. Carter has demonstrated an unusual capacity to transform a political error into a disastrous moral mistake."

Iran: The U.S. is vehemently opposed to a potential gas pipeline between India and Iran. India said it didn't need our advice, but the pipeline definitely imperils current U.S.-India negotiations over a comprehensive nuclear technology deal.

[The incident in the Gulf between a U.S. ship and Iranian gunboats does not appear to have been a big deal.]

Pakistan: A top Taliban commander, who allegedly ordered the hit on Benazir Bhutto, has told his followers to cease all attacks in the country (though there was one on Friday). Pakistan's new government had earlier announced it would deal with the militants through dialogue, much to the chagrin of the U.S. It obviously just gives the Taliban a safe haven to plan and launch further attacks in Afghanistan, as well as providing a base for al Qaeda. Such a move on behalf of the Pakistani government is tantamount to disaster.

North Korea: The White House and CIA presented evidence to Congress that supposedly shows Syria building a nuclear reactor, with Pyongyang's help, that was not intended for "peaceful purposes." This is the same facility taken out by Israel seven months ago, so even some congressional Republicans complained that if this was truly the case, why didn't the White House come forward earlier? The administration counters that the public acknowledgement of North Korea's complicity in the plant will pressure the North into living up to its previous six- party agreement to fully declare its nuclear weapons program, per the Dec. 31, 2007, deadline.

Once again, this is pitiful. Earlier, President Bush, who met with new South Korean President Lee, said of the state of talks with North Korea, "Why don't we just wait and see what they say before people go out there and start giving their opinions."

Meanwhile, you still have Iran defying the United Nations in failing to stop enriching uranium. North Korea and Iran, two members of the Axis of Evil, continue to just toy with the West and this administration. [By the way, because of the preceding, any talk of Condi Rice being McCain's running mate is outrageous.]

"So: Israel had to risk war with Syria to destroy a nuclear facility built with the help of lying North Koreans. But no worries, the U.S. says it can still trust North Korea to tell the truth about its current programs. This makes us wonder if the unofficial U.S. nonproliferation policy is to have Israel bomb every plutonium facility that the North Koreans decide to sell.

"If a Democratic president were pursuing the Bush administration's North Korean diplomacy, Republicans would hoot him out of town. Mr. Bush should beware of diplomats dangling 'legacies' before him. Otherwise, his real legacy on North Korea may be turning nuclear nonproliferation into a global farce."

China: The government appears to have tamped down a backlash against the West over the Tibet protests. Retailers such as France's Carrefour were being targeted in generally peaceful demonstrations. At the same time, China has said it will meet with representatives of the Dalai Lama.

Zimbabwe: As I go to post, there are stories of yet another severe crackdown on opposition forces, this as a Chinese ship, loaded with weapons for Zimbabwe, was denied the ability to offload its cargo in South Africa though is now reportedly docking in Angola. South African leader Jacob Zuma, who will eventually take over for current President Thabo Mbeki, said the violence in Zimbabwe was unacceptable, but he refused to criticize Mbeki for his meager response to Robert Mugabe's rein of terror.

[As an aside, recall that Zuma is a polygamist with at least 18 children by five women who was also acquitted of raping an HIV-positive young woman with whom he had unprotected sex. A terrific role model for young South African males.]

Russia: Georgia accused Russia of shooting down an unmanned reconnaissance plane as it flew over the breakaway republic of Abkhazia. Moscow said the claim was "nonsense," but Georgia produced video evidence of the downing over Georgian territory. Previously, President Putin ordered his government to establish closer ties with the separatists in Abkhazia and South Ossetia.

"In 1937, Hitler agitated for the rights of the Sudeten Germans in Czechoslovakia; in 1938, he annexed Sudetenland into the Reich, purging it of non-Germans. In Abkhazia, most Georgians, Armenians, Estonians, Greeks and Russians - perhaps 500,000 in all - are already gone. The Kremlin recognizes Georgia's international boundaries, but its actions belie its words?

"Meanwhile, the West appears deaf and dumb to Georgian President Mikhail Saakashvili's offer on March 28 of unprecedented autonomy for Abkhazia. Georgia's proposal of a new negotiating format for South Ossetia fares no better. Western political autism is irresponsible. The West must awake and unite - not to oppose Russia or support Georgia, but to stand up for its ideals?.

" 'The belief that security can be obtained by throwing a small state to the wolves is a fatal delusion,' said Winston Churchill just before Munich. We should have learned the lesson 70 years ago."

Paraguay: A populist Roman Catholic Bishop, Fernando Lugo, won the election for the presidency here, ending over 60 years of rule by the Colorado Party. Back in 2006, Lugo resigned the priesthood when he helped organize protests, but the Vatican refused to accept the resignation, saying Lugo had a "freely accepted lifetime commitment" to continue serving. Canon Law prohibits priests from participating in political parties or labor unions, according to the Cardinal overseeing Latin America at that time. So now it's up to the pope to formally defrock him.

Lugo, a leftist, is best known for his advocacy of land reform. Said the current president, Nicanor Duarte, "For the first time in our history, one party will transfer power to another without a coup, without bloodshed and without fighting among brothers."

Mexico: Following up on my comment last week about the soaring violence in the border town of Juarez, across from El Paso, Josh P. passed along some local articles and comments. In Tijuana, for example, doctors staged a walkout to protest rampant kidnappings; one doctor a week for ransom, according to the doctors' leader.

Americans in large numbers have been reconsidering trips to Mexico. The U.S. State Department issued its own Travel Alert update on April 14.

"Violent criminal activity fueled by a war between criminal organizations struggling for control of the lucrative narcotics trade continues along the U.S.-Mexico border. Attacks are aimed primarily at members of drug trafficking organizations, Mexican police forces, criminal justice officials, and journalists. However, foreign visitors and residents, including Americans, have been among the victims of homicides and kidnappings in the border region."

Dow Jones +0.3% [12891]
S&P 500 +0.5% [1397]
S&P MidCap +1.1%
Russell 2000 +0.1%
Nasdaq +0.8% [2422]

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