Senate proposes much higher phase-out threshold for the fiscal stimulus rebate

The House bill for the fiscal stimulus package had a fairly low threshold for phasing out the rebate ($75,000 to $87,000 for individual filers or $150,000 to $174,000 for joint filers), but now it turns out that the Senate is considering a much higher threshold:

Under the Chairman's modification, the amount of the credit (including both the basic credit and the qualifying child credit) is phased out at a rate of five percent of adjusted gross income above certain income levels. The beginning point of this phase-out range is $150,000 of adjusted gross income ($300,000 in the case of joint returns).

So, there is once again a chance that I could get a rebate.

OTOH, the "compromise" thresholds that will be negotiated in the conference committee could be... anybody's guess.

Just in case you are curious, here is exactly what the House bill said:

'(d) Limitation Based on Adjusted Gross Income- The amount of the credit allowed by subsection (a) (determined without regard to this subsection and subsection (f)) shall be reduced (but not below zero) by 5 percent of so much of the taxpayer's adjusted gross income as exceeds $75,000 ($150,000 in the case of a joint return).

-- Jack Krupansky

Disappointing day for economic data, but still no sign of recession

At least on the surface, the economic data was rather disappointing today. That said, it wasn't that bad and there are some bright spots in there as well.

The bad news was that consumer spending was weak in December. In fact, "real" (inflation-adjusted) consumer spending was actually down slightly, $900 million at an annualized rate which is was a mere $75 million. Yes, that was in fact a decline, which is what we look for in a recession, but it was way too slight to constitute the kind of "significant" decline characteristic of a recession. Nonetheless, it was a negative data point. To repeat, the good news is that there was not a significant decline in consumer spending.

The better good news was that real incomes rose modestly in December. The gain of 0.2% was modestly larger than the -0.2% decline in November. The bad news is that even after the gain in December, real income is still slightly less (-0.13%) that its peak in September. That is technically a decline from the peak, which is what we look for in recessions, but is still way too slight to constitute a "significant" decline that is needed to mark a recession.

The data was negative on the unemployment claims front, but not by much. Initial claims (375,000) rose, but are still well below the 400,000 threshold typical for a recession. In fact, the 4-week moving average of initial claims (325,750) is only modestly above the level a year ago (310,250) and still well below the 400,000 threshold typical for recessions. Continuing claims did tick up, but the 4-week moving average ticked down.

The weekly commercial paper report was fairly decent, continuing to grow after bottoming in the Fall. Overall, the commercial paper market is still fairly weak and there were decline in some sectors last week, but this incremental recovery is probably exactly what the financial markets need to rebuild a more solid foundation.

The Chicago PMI manufacturing report for January was rather negative, "at the verge of contraction", but at 51.3 is still modestly in the black. So, the bad news is that the manufacturing sector is quite sluggish, but the good news is that this is further evidence that the U.S. economy was not in recession in December or January. In theory, the Chicago PMI is a "harbinger" for the more-important ISM Manufacturing report that covers the entire U.S. rather than simply the Chicago region.

In short, we have yet another mixed bag, but still no sign of an imminent recession. Yes, the economy is "sputtering", but not in a way that suggests that it is really going to "conk out."

-- Jack Krupansky

Q4 GDP weak but not recessionary

Q4 real GDP growth certainly came in weak (0.6% annualized), but still wasn't indicative of a recession. The big caveat is that this is the "advance" report and subject to significant revision in each of the next two months, notably as the projected estimates for December solidify.

The calculation of that 0.6% included a positive 1.37% contribution from consumer spending (personal consumption expenditures) balanced by a negative -1.18% decline in residential investment.

Nominal GDP growth (annualized) came in at 3.2%.

Inflation consumed 2.6% of that (3.2% minus 2.6% equals 0.6%.)

Interestingly, growth in Q4 was in fact at the same rate as in Q1.

Ultimately, this report is far less interesting that the Personal Income and Outlays report next week which will give us a read on consumer spending in December. The upcoming ISM Manufacturing and Non-Manufacturing reports will give us a read on January. Note that the ISM Manufacturing index would have to come in at 41.9 or below to indicate that the overall economy was contracting (recession.) As the ISM puts it, "A PMI in excess of 41.9 percent, over a period of time, generally indicates an expansion of the overall economy." The PMI was 47.7 in December.

-- Jack Krupansky

Consumer confidence is mixed, but not all that bad

The headlines insist that consumer confudence declined since December (from 90.6 to 87.9), by the truth is a bit more complex. Yes, the "expectations" index declined (from 75.8 to 69.6), but the present conditions index actually rose, from 112.9 to 115.3.

This phenomenon happens a lot: consumer lose confidence in the future because they are bombarded by negative messages from the media, but in fact those same consumers have to admit that their current situation is not that bad.

Keep in mind that consumer sentiment reports are not reliable indicators of future consumer spending.

In truth, cash in your wallet and a steady paycheck are better indicators of future consumer spending. A rising present conditions index is actually a good sign that things are not as bad as the media reports suggest.

-- Jack Krupansky

What happens if the Senate approves a difference stimulus package?

Now that the House has passed the negotiated fiscal stimulus package and the Senate is talking about passing a different package, what happens if the Senate passes a significantly different package?

Simple: It all gets resolved "in conference." The party leadership, of both parties and from the House and the Senate meet to agree to assign representatives and senators to a conference committee. That conference committee then meets and "works out" a compromise package, which can be significantly different from either the House or Senate versions.

Although the conference committee will have wide latitude, subject to the "instructions" of the party leadership, they will have to be mindful that they do have to worry about the potential that the President may veto their conference legislation.

Get ready for some good old-fashioned back-room horse trading.

I am fairly confident that something close to the House package plus a few Senate items, including extended unisurance benefits, will get passed.

I also think that as part of the agreement by the Republicans to give the Democrats their goodies in conference, the Republicans will secure a Democratic leadership commitment to at least bring up the extension of the Bush tax cuts for consideration sometime during the year. In fact, the Republicans might even be willing to give the Democrats a fair amount of public spending in the package if they privately agree to support a vote for renewing the Bush tax cuts after the election.

-- Jack Krupansky

ARM mortgage resets seem to have peaked

Just for reference here is a commonly used chart of the expected schedule for ARM mortgages to reset their rates. Note that it appears that we are now past the peak. We have one coming month (April?) at a higher rate than this month, but otherwise the reset rate will be declining substantially from what was experienced this past Fall. Yes, there is a bulge out in 2010, but that is not an immediate concern and the peak rate of resets is below the recent levels.

It is quite possible that the combination of the big Fed rate cuts in conjunction with the talking down of the economy by the recession fear-mongerers may dampen the impact of the ARM resets (lower mortgage rates) to avoid the bulk of the worst-case scenarios.

-- Jack Krupansky

Moderate decline in chance for a half-point Fed rate cut

At this moment, February fed funds futures are priced at 96.9250 which corresponds to an implied fed funds target rate of 3.0750%, which implies a 100% chance of the Federal Reserve cutting the target rate by at least a quarter-point by the end of the month and a 70% chance of an additional quarter-point cut on top of that. In other words, a half-point cut is still likely, but no longer with as much "absolute" certainty as yesterday.

The increased skepticism about a half-point cut probably came as a result of the stronger-than expected durable goods orders report for December. People may be a bit less inclined to believe that a recession is a "slam-dunk", but they would like to see the extra Fed insurance nonetheless.

Fed funds futures are typically fairly reliable within 45 days of an FOMC meeting.The net here is that "the market" is predicting that the Federal Reserve will cut by a half-point at the FOMC meeting next week.

Please note that all of this is subject to change, literally at a moment's notice.

Update at 8:46 p.m. PT: Just in case you thought I was kidding about that caveat, now the February contract is priced at 96.9100, indicating a rate of 3.0900 which indicates only a 64% chance of a half-point Fed rate cut. I use 66% (2/3) as the breakpoint for indicating that an outcome is solidly more likely than not. So, technically a half-point cut is still likely, but not so likely as to be a reliably credible "bet." People are having some serious second thoughts even though they still feel than the Fed will probably go for more insurance than less.

Once again, I have to caution that all of this is seriously subject to chance at a moment's notice.

Oops! It changed again (really!)... the chance is now 68%, so... never mind! Aarrgghh!

My personal view at this stage is that there is enough rampant anxiety about the economy and outlook and the fiscal stimulus is still far enough down the road that the Fed is much more likely to go ahead with the "expected" half-point cut simply as "insurance", with the full knowledge that they could well reverse that cut within a month or two if the anxiety substantially dissipates in the face of economic improvement. In particular, the durable goods order report is just one additional data point and the Fed would almost never base a decision on one data point. Besides, I strongly suspect that the Fed decision was probably baked in the cake by the time the Fed officials went to bed Monday evening.

-- Jack Krupansky

Robert Scoble wants to know if we are in a recession

Uber-blogger Robert Scoble wants to know if "we" are in a recession. Sidestepping the issue of whether "we" is the entire world or simply the U.S., here is my response:

Technically, the U.S. economy is probably not in a formal recession per se, regardless of whether you use the popular two-quarter negative real GDP informal definition or the more robust NBER definition.

That said, clearly there are a lot of middle class families that are suffering from significant “economic distress.”

Unfortunately, no matter how short (or long) the formal “recession” lasts (if it occurs at all), the economic distress of the middle class will persist.

Even a moderate economic “slowdown”, which we are obviously in the middle of even if we are not in a formal recession, can cause significant economic distress for a significant fraction of the population. Not to mention the emotional stress of constantly being bombarded with messages of doom and gloom from the media even if your own situation is actually reasonably solid. The overall economic message coming from the media right now is that if you are not worrying about a recession, you should be worried.

So, there are two bottom lines here:

1) The economic distress of the middle class is not linked to whether a formal recession is underway.

2)”Fixing” the formal recession (if it even exists at all) will not fix the economic distress of the middle class.

Be clear, is your question about a formal recession per se, or simply whether there is enough of a slowdown in growth that significant numbers of people are feeling pain?

Health care “reform” (including care for chronic conditions such as you mention) obviously needs to be a key part of relieving the economic distress of the middle class. Debating whether we are or aren’t in a formal recession is orthogonal to addressing such social issues.

– Jack Krupansky

I continue to feel that there is only a 1 in 4 chance of us seeing a "formal" recession this year.

-- Jack Krupansky

Half-point Fed rate cut has 88% chance

At this moment, February fed funds futures are priced at 96.9700 which corresponds to an implied fed funds target rate of 3.0300%, which implies a 100% chance of the Federal Reserve cutting the target rate by at least a quarter-point by the end of the month and an 88% chance of an additional quarter-point cut on top of that. In other words, a half-point cut is very likely.

Fed funds futures are typically fairly reliable within 45 days of an FOMC meeting.The net here is that "the market" is predicting that the Federal Reserve will cut by a half-point at the FOMC meeting next week.

Please note that all of this is subject to change, literally at a moment's notice.

-- Jack Krupansky

Euro adrift in a narrow trading range

The euro continues to drift in a narrow trading range, and may be on the verge of making the U.S. dollar look "strong" again. March euro futures closed on Friday at $1.4657, up 0.39 cents from $1.4618 last week. And this is even in the face of the 0.75% Fed rate cut.

Far from being bullish on the euro, futures all the way out at June 2009 are priced only at $1.4448, which indicates the dollar gaining strength.

Although foreign exchange "strategists" do a lot of talking about "fundamentals" and how weak the dollar is, the truth is that it is all a giant shell game with speculation and short-term trading as its aim and nothing to do with long-term fundamentals.

Despite the "weakness" of the dollar, the euro, pound, and Canadian dollar have not made any headway against the dollar for over two months now.

-- Jack Krupansky

The mortgage refinancing boom

With all of the Fed easing before last week, the market for refinancing of mortgages has been booming in the past month. And that was before the latest 0.75% rate cut. The refinancing boom will have several positive effects:

1. Consumers will have more money to spend each month.
2. Existing mortgage-backed securities will be liquidated by early payment of existing mortgages, helping to clarify the value of these securities and to put cash in the hands of investors who then need to find a place to reinvest that money.
3. The mortgage-backed security market will be revitalized due to an influx in "clean" mortgages that are untainted by the subprime scandals.
4. We will likely see a modest reduction in the downwards pressure in the housing market

And all of this is before the upcoming fiscal stimulus bill dramatically raises the ceiling for conforming mortages that Fannie Mae and Freddie Mac can securitize. That is likely to happen by early March. This will help to revitalize the market for homes in the $425,000 to $625,000 range.

How it all plays out remains to be seen, but all is not dark clouds on the horizon.

-- Jack Krupansky

Role of proprietary trading at banks

The conspiracy mongers are having a field day with the tale of the rogue trader at Societe Generale, suggesting that the Federal Reserve was a gullible victim of his handiwork and should have somehow known better and even anticipated the event! Read about it in the article in The New York Times by Nelson Schwartz and Nicola Clark entitled "Societe Generale's Sales May Have Incited Market Plunge."

First of all, to be quite clear, the Fed is not chartered to manage asset prices, whether they be housing, commodities, bonds, or stocks. The Fed is also chartered to respond to events in the financial markets to assure stability and liquidity in the markets. As events were unfolding on Sunday, Monday, and Tuesday, there was a lot of disruption in the financial markets, including talk of markets reacting to economic conditions and outlook, which made the situation on Tuesday morning something the Federal Reserve needed to respond to.

One of Wall Street's so-called "professionals" who has irresponsibly helped to fuel the fantasies of the conspiracy theorists was Barry Ritholtz, someone who should know better. As The Times tells us:

"I have little doubt that Societe Generale's unwinding of those positions absolutely pressured indexes worldwide," said Barry L. Ritholtz, chief executive of FusionIQ, a New York-based investment research and money management firm. "And wouldn't it be embarrassing if the Fed had to make one of the biggest emergency rate cuts ever because of some rogue trader?"

Granted, fears of a recession in the United States and continuing worries about the spread of the subprime mortgage collapse were also responsible for the market downdraft in the last 10 days. But Mr. Ritholtz argued the rapid move by Societe Generale to close out tens of billions in futures positions might have been a major factor in pushing an already nervous market into an outright panic.

That last sentence is key. Whatever the rogue trader might have added to the panic, the market was already quite "nervous" well in advance of his actions. For Mr. Ritholtz to suggest or imply that the Federal Reserve was only responding to the actions of one trader is simply not supported by the facts.

As with most conspiracy-mongering, especially when it comes to the Federal Reserve, there was not a "lone conspiracy theorist." The Times tells us of at least one other:

Mr. Ritholtz is not alone in his suspicions. "I definitely think there is a link," said Byron R. Wien, chief investment strategist at Pequot Capital Management and a 40-year Wall Street veteran. "This precipitous unwinding created the negative momentum that spread around the world."

Mr. Wien also singled out the Federal Reserve chairman, Ben S. Bernanke, for criticism. "Bernanke has been reacting to events, rather than anticipating them," he said.

I see... Mr. Wien actually believes or wants us to believe that the Federal Reserve should have anticipated the actions of this rogue trader. That is a completely laughable proposition. Even as a general proposition it completely false, but this is why we hear such chattering on Wall Street about the Fed being "behind the curve." The Fed sees its charter as to respond to events (such as the collapse of an asset bubble), while a bunch of renegades on Wall Street feel that this charter is wrong and that the Fed is supposed to prevent market activity to try to force the markets to always adhere to principles that these renegades decide for themselves. The renegades think a recession is already baked in the cake and want the Fed to act as if that were fact. The Fed clearly believes that is not the case and has set policy accordingly. But, the Fed also has to cope with the potential economic impact of market events as well. Mr. Wien's criticism is completely off the mark. To be clear, his firm is in fact a hedge fund. Sane people should never look to hedge funds for reasonable assessments of Federal Reserve policy.

To be clear, the Federal Reserve is not responsible for assuring in advance that markets follow imagined rules that Wall Street "professionals" contrive, but rather the Federal Reserve works best to stay out of the markets in general and only intervene when a market disruption rises to the level of being a systemic threat to overall financial markets or the overall economy.

Enough on that aspect of this matter.

What really bothers me is that this episode demonstrates the folly of "banks" being able to trade for the house account, so-called proprietary trading or the operation of a so-called proprietary trading desk. Sure, proprietary trading is a great profit center for banks (accept at times such as this), but it is completely inconsistent with the charter of banks and financial institutions in general. If a bank wants to be a bank, it should stick to banking. If a so-called bank wants to engage in betting on market outcomes, then the so-called bank should change its designation to an investment fund, and notify shareholders of that fact.

What bothers me even more is that the proprietary trading desk is free to take positions that are counter to the interests of the bank's customers to whom the bank has a fiduciary duty to act as a rock-solid financial institution.

Put simply, proprietary trading is an extreme distraction which requires a level of management attention that distracts from the bank's main business of... banking.

And as this episode illustrates, management of proprietary trading is fraught with risks. The last thing that banking customers need is for the management structure of the bank to be swiss-cheesed with managers whose specialty is something other than providing the highest quality banking services to its customers.

Now, if only I could figure out a way to get the media to shine a spotlight on the lunacy of allowing proprietary trading within banks.

Sigh.

-- Jack Krupansky

Intrade market indicates a 67% chance of recession in 2008

Trading on the Intrade Prediction Market indicates a 67.0% chance (down from 70.8% last week) of a U.S. recession in 2008. That is not a significant change, but does suggest that negative sentiment may have peaked in the face of a big Fed rate cut and progress on the fiscal stimulus plan.

People are not only quite worried that a recession is possible, but they consider it to solidly be the likely scenario. Nonetheless, conviction is still only "medium."

Personally, I do not feel any different about the chances of recession and put them down around 25% (1 in 4.) Actually, I think that any fiscal stimulus (any amount at any time) is likely to further reduce the chance of recession. It looks like the Fed rate cuts are stimulating a lot of mortgage refinancing which will stimulate some amount of consumer spending.

The so-called weakness in the economy is simply not profound enough to suggest an outright recession. For example, the weekly initial unemployment claims number has remained well below 400,000 even recently and even decline for the past four consecutive weeks, while traditionally that number tends to spike well above that 400,000 in recessionary times.

Nonetheless, the Intrade indication is probably a good proxy for overall market sentiment.

FWIW, Intrade trading currently (shortly after CNN projected Barack to win in the South Carolina primary) pegs Hillary at about 64% chance of being the Democratic presidential nominee (up from 57% last week) and Barack has a 36% chance (down from 41% last week.) OTOH, Intrade showed Barack having a 67% chance of winning going into the New Hampshire primary, so that just illustrates how tentative and subject to change these number really are. And I would suggest the same for the recession trading.

So, relax and try to think about creative ways to spend your rebate check and maybe even spend it before it arrives!

-- Jack Krupansky

ECRI Weekly Leading Index indicator falls sharply and still suggests a very sluggish outlook

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell sharply (-1.16% vs. +0.86% last week) but the six-month smoothed growth rate rose moderately (from -6.5 to -6.0) for a second consecutive week, but remains moderately below the flat line, suggesting that the economy will be somewhat sluggish in the months ahead.

According to ECRI, "Notwithstanding its recent uptick, WLI growth remains in the danger zone."

-- Jack Krupansky

Oops, now a half-point Fed rate cut is likely again

Illustrating how volatile the market sentiment about the economy is, at this moment, February fed funds futures are priced at 96.9350 which corresponds to an implied fed funds target rate of 3.0650%, which implies a 100% chance of the Federal Reserve cutting the target rate by at least a quarter-point by the end of the month and a 74% chance of an additional quarter-point cut on top of that. In other words, a half-point cut is once again likely.

Fed funds futures are typically fairly reliable within 45 days of an FOMC meeting.The net here is that "the market" is predicting that the Federal Reserve will cut by a half-point at the FOMC meeting next week.

The most profound wisdom I can offer is that all of this is subject to change at a moment's notice, as we have seen this morning.

-- Jack Krupansky

Half-point Fed rate cut is now unlikely

At this moment, February fed funds futures are priced at 96.8700 which corresponds to an implied target rate of 3.1300%, which implies a 100% chance of the Federal Reserve cutting the target rate by a quarter-point by the end of the month and only a 48% chance of an additional quarter-point cut on top of that. In other words, a half-point cut is now unlikely.

Fed funds futures are typically fairly reliable within 45 days of an FOMC meeting.

The net here is that "the market" is predicting that the Federal Reserve will only cut by a quarter-point at the FOMC meeting next week, but there are still a lot of people who are betting that there is still an outside chance of a half-point cut.

The most profound wisdom I can offer is that all of this is subject to change at a moment's notice.

-- Jack Krupansky

Gasoline back under $3

The AAA Daily Fuel Gauge Report shows the national average price for a gallon of regular unleaded gasoline has fallen to $2.998. This will put a small amount of additional money in the wallets of consumers and businesses.

The trend for both crude oil and wholesale gasoline is quite unclear at this point. Traders and speculators may push prices back up if they feel that stimulus is going to keep the economy afloat despite "recession" fears.

-- Jack Krupansky

Is a half-point cut still baked in the cake?

At this moment, February fed funds futures are priced at 96.930 which corresponds to an implied target rate of 3.0700%, which implies a 100% chance of the Fed cutting the target rate by a quarter-point by the end of the month and a 72% chance of an additional quarter-point cut on top of that.

Fed funds futures are typically fairly reliable within 45 days of an FOMC meeting.The net here is that "the market" is predicting that the Federal Reserve will still cut by another half-point at the FOMC meeting next week, but now a lot of people are having second thoughts as to whether the entire half-point cut is truly baked into the cake.

All of this is subject to change at a moment's notice.

The latest existing home sales report was negative, but not as terrible as it could have been. In fact home prices in some areas actually rose compared to November (and October) and the inventory of unsold homes shrank moderately for a second consecutive month. We are still not out of the woods, but this report did not make it feel as if we were getting deeper into trouble.

Weekly unemployment initial claims declined for a fourth week in a row. They are still elevated a bit compared to a year ago, but only modestly. This economic indicator is not signaling a recession.

-- Jack Krupansky

Poof! So much for my rebate

Good news and bad news.

The good news is that there is a report in The New York Times (actually an Associated Press report) that a deal has been reached for a fiscal stimulus package that includes rebates.

The bad news is that is is rumored that the rebates will have an income cap of $75,000 for individuals, so a lot of people (including myself) will not be getting any rebate.

The Times tells us that:

Under the tentative plan, families with children would receive an additional $300 per child, subject to an overall cap of perhaps $1,200, according to a senior House aide who outlined the deal on condition of anonymity in advance of formal adoption of the whole package. Rebates would go to people earning below a certain income cap, likely individuals earning $75,000 or less and couples with incomes of $150,000 or less.

Of course, none of this is final yet.

More importantly, the idea is that we all benefit from stimulating the overall economy, especially those of us owning stocks.

So, overall it is good news.

Update 4:19 p.m. PT: From The Washington Post:

Full rebates would be sent to single taxpayers who earned up to $75,000 and couples with incomes of as much as $150,000. The value of the payments would decline after that and phase out entirely at incomes of roughly $87,000 for individuals and $174,000 for joint filers.

That is a little better than the initial report, but I will still not be getting any rebate. Sigh. OTOH, I personally do not need it as much as a lot of people do.

-- Jack Krupansky

CBO does not expect current slowdown to register as a recession

The Congressional Budget Office (CBO) is about as close as you are going to get to an independent, impartial, non-partisan, fair, calm, truthful, sensible opinion in Washington, D.C., not to mention very thorough. They nominally work for Congress but operate independently, and they are certainly independent of the White House and the Federal Reserve and the U.S. Treasury. CBO is concerned about the recent slowdown, but they still insist that a recession is not the slam-dunk that many people are chattering about. In their testimony before Congress today they said:

The state of the economy is particularly uncertain at the moment. The pace of economic growth slowed in 2007, and there are strong indications that it will slacken further in 2008. In CBO’s view, the ongoing problems in the housing and financial markets and the high price of oil will curb spending by households and businesses this year and trim the growth of GDP. Although recent data suggest that the probability of a recession in 2008 has increased, CBO does not expect the slowdown in economic growth to be large enough to register as a recession. Economic performance worse than that suggested in CBO’s forecast could significantly decrease projected revenues and increase projected spending. Furthermore, policy changes intended to mitigate the economic slowdown would, by design, tend to increase the budget deficit in the short term.

CBO expects the economy to rebound after 2008, as the negative effects of the turmoil in the housing and financial markets fade.

As far as defining "recession", CBO notes:

The National Bureau of Economic Research, which by convention is responsible for dating the peaks and troughs of the business cycle, defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real [inflation-adjusted] GDP, real income, employment, industrial production, and wholesale-retail sales."

Note, that even if there were some modest decline in those metrics, that would not be sufficient to mark a recession. There needs to be a "significant" decline and it needs to last "more than a few months."

-- Jack Krupansky

No change in chance of a recession, still 70%

Trading on the Intrade Prediction Market is still indicating about a 70% chance of a recession in 2008. In other words, no big leap since last Saturday. Even after all the turmoil in the financial markets. Even with all of the media chatter.

70% indicates people betting that there is a strong likelihood of a recession, but it still means that there is a significant amount of skepticism.

Usually I use 66% (2 out of 3) as the threshold for judging likelihood, but when the chances get stuck right near that threshold for some time, you have to wonder.

Incidentally, trading on Intrade rates Hillary as having a 67% chance of capturing the Democratic nomination and Barack as having only a 33% chance. I would note that people on Intrade gave Barack a 67% chance for winning New Hampshire on the eve of that primary and we saw how that movie ended.

In short, we still aren't seeing the kind of "data" that would push people to the 85% or 90% level of belief in the inevitability of a recession.

Recession is still more of a media fiction than a reality. But stay tuned.

-- Jack Krupansky

Lower interest rates great for U.S. federal government balance sheet

BTW, lower interest rates are a really good deal for the balance sheet of the U.S. federal government. The U.S. Treasury just auctioned 3-month T-bills this morning for 2.424% and even 6-month T-bills fetched only 2.47%. That really sucks if you are buying T-bills, but is really great for the U.S. Treasury and taxpayers since it effectively allows Uncle Sam to refinance its short-term debt at a significantly lower rate. This means that the interest portion of the U.S. federal government budget will shrink a bit.

It also means that financing of new issues for longer-term U.S. Treasury debt (2-year, 5-year, 10-year, 30-year) will be at cheaper interest rates as well. That of course will also suck if you are a buyer of Treasury notes and bonds, but will be great for the U.S. federal government budget since interest payments will become smaller as debt is incremnetally rolled over as it matures (e.g., 10-year notes issued 10 years ago.)

Finally, it means that the upcoming fiscal stimulus will be financed at really cheap rates.

Nice to see that there are some silver linings in all those dark clouds.

-- Jack Krupansky

Will the Fed cut by another half-point or more?

At this moment, February fed funds futures are priced at 97.1100 which corresponds to an implied target rate of 2.8900%, which implies a 100% chance of the Fed cutting the target rate by another 50 basis points by the end of the month and a 44% chance of a quarter-point cut on top of that. Fed funds futures are typically fairly reliable within 45 days of an FOMC meeting.

The net here is that "the market" is predicting that the Federal Reserve will cut by another half-point at the FOMC meeting next week.

Although the market is also saying that there is a slightly less than coin-flip chance that the Fed will give us a 0.75% cut by the end of the month rther than just a 0.50% cut, this could be more of a speculative bet or insurance hedge by various market participants. I wouldn't say this extra cut is baked into the cake until the chance goes above 66% (2 out of 3.)

All of this is subject to change at a moment's notice.

-- Jack Krupansky

Trader! Trader! Trader!

I couldn't resist. I have been doing such a great job focusing on long-term investing, but... the blind irrationality of the market today just sucked me in. It was a combination of prices looking cheap and anticipation of the "pain" of lower interest income on idle money. I had a relatively small amount of cash sitting in a couple of old accounts left over from the dot-com boom. Earning 5% income had been a great incentive not to do anything with the cash, but the confluence of so many factors today just made it a no-brainer to put that small amount of cash to work.

I bought July 35 call options on Microsoft. The stock was sitting at $32.133 and had traded above $35 a couple of times in the past six months and the company has only been getting stronger over the past year, so it seemed like a relatively low-risk bet. I bought a batch of call option contracts in an old Roth IRA account and then a second batch in a taxable account a few minutes later at a lower price. The price for the first batch was $1.51 or $151 per contract (100 shares) -- hardly more expensive than buying a "lottery ticket." Stock prices were quite volatile, so I was able to get the second batch at $1.41 or $141 per contract.

My expectation is to hold the options for two to four months and be sure to dump them at least six weeks before they would expire in July. At least that is my intention. OTOH, I would probably dump them immediately if the stock ever gets above $40.

Just to be clear, it is important to treat stock options as "lost money" and mentally pretend that 100% of the "investment" is completely gone and that the "value" only goes above $0.00 when you finally sell the options. As I suggested, think of call options as lottery tickets.

It is okay to do this kind of thing once in a while and be sure to not make it a habit and to be sure to do it only with a small amount of free cash that you are 100% prepared to lose, but the confluence of irrationality today really was one of those "black swan" moments (the Fed cutting by 0.75% inter-meeting??!!) that does not present itself on a frequent basis.

BTW, it is sounding as if the fiscal stimulus package will be even biigger than the 1% of GDP that was being proposed.

Now, back to contemplating the pain of a measly 3% interest on money market funds. Sigh.

-- Jack Krupansky

Did a recession start in 2007?

Some people insist that the U.S. economy was already in recession at the close of 2007. My conclusion is that it is fairly unlikely. The latest Federal Reserve Beige Book that covers the period from mid-November through December tells us that:

Reports from the twelve Federal Reserve Districts suggest that economic activity increased modestly during the survey period of mid-November through December, but at a slower pace compared with the previous survey period. Among Districts, seven reported a slight increase in activity, two reported mixed conditions, and activity in three Districts was described as slowing.

That strongly suggests that the U.S. economy was not in recession at the close of 2007.

There seems to be some consensus that Q4 real GDP will come in around 1.5%, but I continue to believe that it will come in somewhere between 2.5% and 3.5%. Even if you believe that December was somewhat weaker, October and November were fairly decent. Hence, no recession in Q4.

We will not get the consumer spending report (Personal Income and Outlays) for December until the day after the upcoming FOMC meeting (Thursday, January 31, 2008). We already know that the December employment report was slightly positive (subject to significant revision of course) and that Industrial Output was flat (also subject to revision.) So, unless the revisions head south, it already appears that the U.S. economy was not in recession even on a monthly basis in December.

-- Jack Krupansky

Commercial paper market showing some signs of life

A significant amount of market commentary talks about the so-called "credit crunch" as if nobody could borrow any money, but the reality is that even the commercial paper market is showing signs of life again. An article on Bloomberg by Bryan Keogh entitled "U.S. Asset-Backed Commercial Paper Expands Third Week" informs us that not only is the overall commercial paper market rising again, but even asset-backed commercial paper (ABCP) is coming back. As the article tells it:

Debt backed by mortgages, credit-card loans and other assets expanded for a third straight week, boosting optimism that the freeze in short-term credit markets that started last year may be abating.

U.S. asset-backed commercial paper outstanding rose $26.3 billion, or 3.4 percent, to a seasonally adjusted $805 billion for the week ended Jan. 16, the Federal Reserve in Washington said today. It was the second-biggest increase in at least seven years.

I follow the Fed's commercial paper report every week and had noticed the trend myself. After trending straight down since the middle of August, it was a shock to see ABCP rise up from the dead two weeks ago with not even a mention in the media.

Three consecutive weeks is still not enough to establish a durable trend, but it is quite promising.

And, it continues to confirm that the general media and even most of the financial media does a very poor job of enlightening people about the true state of the financial markets.

-- Jack Krupansky

What will the Fed do?

I have written before about how some of the key inputs to the FOMC decision-making process are the behind the scenes personal conversations that Fed officials have with banking and business leaders in the final days before the FOMC meeting. Dallas Federal Reserve Bank president Richard Fisher explicitly mentioned that process in his recent speech entitled Challenges for Monetary Policy in a Globalized Economy before the Global Interdependence Center in Philadelphia:

In the course of preparing for each FOMC meeting, I regularly consult directly with some 30-plus CEOs to develop a sense of future business activity, including cost and pricing developments. I have found this rigorous exercise to be extremely helpful in placing our staff's econometric analysis in context as I have prepared for FOMC meetings in the past, and I will be listening especially carefully to these business operators' reports on inflation-related developments as I prepare for upcoming FOMC meetings.

The media never refers to this key element of FOMC preparation. But it is a key process that helps to assure that the FOMC participants are as up to speed on the real economy as is humanly possible.

As far as the coming FOMC meeting, I will continue to note that Fed funds futures prices are usually a fairly reliable indicator within 45 days of an FOMC meeting. As of the close on Friday, February fed funds futures (at 96.43) were indicating a 100% chance of a half-point cut plus a 72% chance of an additional quarter-point cut. Part of this betting is that some people believe that the Fed may be forced to cut before the FOMC meeting as well as at the meeting. Either way, a lot of people are expecting that the Fed will cut its target rate by 0.75% once the FOMC meeting completes. A 0.50% cut at the meeting now appears to be a "slam-dunk", but the additional quarter-point to still a bit speculative. Some of this may depend on how certain $150 billion of fiscal stimulus becomes before the FOMC meeting.

Please note that changes to the fed funds target rate impact the real economy with a significant lag, on the order of months to a year or more, so it would be incorrect to presume that any recent economic weakness was an indication that Fed monetary policy was not working. Actually, mortgage applications were up sharply again last week, so there is at least some evidence that there has been some positive effect to date.

-- Jack Krupansky

Strong capital inflows from abroad help to keep the U.S. economy afloat

An article in The New York Times by Peter Goodman and Louise Story entitled "Overseas Investors Buy Aggressively in U.S." helps to illustrate two points: 1) capital inflows from abroad are doing a great job of compensating for the credit crunch, and 2) continued investment in U.S. companies is helping to keep the U.S. economy afloat at a time when people are worried about a possible recession.

Funny, you never hear the recession promoters talk about these capital inflows. Mostly that is because they have some sort of vested interest in promoting despair.

-- Jack Krupansky

Euro still lost in the weeds

The euro is looking awfully lifeless of late, and may be on the verge of making the U.S. dollar look "strong" again. March euro futures closed on Friday at $1.4618, down 1.62 cents from $1.4780 last week.

Far from being bullish on the euro, futures all the way out at June 2009 are priced only at $1.4433, which indicates the dollar gaining strength.

Although foreign exchange "strategists" do a lot of talking about "fundamentals" and how weak the dollar is, the truth is that it is all a giant shell game with speculation and short-term trading as its aim and nothing to do with long-term fundamentals.

Despite the "weakness" of the dollar, the euro, pound, and Canadian dollar have not made any headway against the dollar for two months now.

-- Jack Krupansky

How to spend my rebate

It sounds as if it is almost a done deal that we will all get $800 rebates as part of the anti-recession fiscal stimulus package that is being developed. Some cynics are chattering that we might not see the money until the summer, but I suspect it will be in the March timeframe. Besides, there is no need to wait; simply spend the money using your credit card and then pay it off when the rebate actually arrives.

The bigger question is what to spend it on. My options for what to do with my rebate:

1. Long weekend trip to San Francisco. Maybe even stay at the Hyatt Regency Embarcadero for the first time since 1993.
2. Buy one of those cool new Apple iPod Touch devices that has Wi-Fi browsing and now maps, weather, stocks, news, etc. The 16GB version costs $399, so that only covers half of my rebate.
3. Budget for some steak dinners (at about $75 to $85 each) in the coming few months.
4. Pay down some of my back taxes. In other words, take some of the money that the U.S. Treasury will be giving me and give it back to... the U.S. Treasury (IRS).
5. Buy carbon credits so that I can be carbon neutral for a few years.
6. Simply save it. Not very attractive since I already have my rainy day fund fully funded and may not be eligible to contribute more to my retirement accounts this year. Besides, we are supposed to spend this money.
7. None of the above. Something creative. Maybe even socially responsible.

I may simply opt for #1, but I would prefer to go with #7 and come up with something that will add some significant value to my life and maybe even be socially responsible. I could simply go with #5 and then feel that I have been socially responsible.

-- Jack Krupansky

Intrade market indicates a 70% chance of recession in 2008

Trading on the Intrade Prediction Market indicates a 70.8% chance (up from 60% last week) of a U.S. recession in 2008.

In other words, people are not only quite worried that a recession is possible, but that they consider it to solidly be the likely scenario. Conviction is still "medium", but has been growing strongly on a weely basis. Oh, and this is in the face of all the chatter about a $150 billion fiscal stimulus.

Personally, I do not feel any different about the chances of recession and put them down around 25% (1 in 4.) Actually, I think that any fiscal stimulus (any amount at any time) is likely to further reduce the chance of recession.

The so-called weakness in the economy is simply not profound enough to suggest an outright recession. For example, the weekly initial unemployment claims number has remained well below 400,000 even recently and even decline for the past three consecutive weeks, while traditionally that number tends to spike well above that 400,000 in recessionary times.

Nonetheless, the Intrade indication is probably a good proxy for overall market sentiment.

OTOH, if I were to try to synthesize the chance of recession from the overall tone of commentary, it would be a near 100% chance of recession in 2008 and in fact indicate that the U.S. was probably in recession back in December. In other words, much of the commentary that attracts the interest of the press grossly misleads people about what the actual overall data suggests.

FWIW, Intrade trading current pegs Hillary at about 57% chance of being the Democratic presidential nominee (down from 60% last week) and Barack has a 41% chance (up from 40.8 last week.) OTOH, Intrade showed Barack having a 67% chance of winning going into the New Hampshire primary, so that just illustrates how tentative and subject to change these number really are. And I would suggest the same for the recession trading.

So, relax and try to think about creative ways to spend your rebate check and maybe even spend it before it arrives!

-- Jack Krupansky

ECRI Weekly Leading Index indicator rises moderately sharply again but still suggests a very sluggish outlook

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose moderately sharply (+0.88% vs. +1.18% last week) and the six-month smoothed growth rate rose moderately (from -7.1 to -6.5), but is moderately below the flat line, suggesting that the economy will be somewhat sluggish in the months ahead.

It is too soon to say that the WLI has turned the corner, but it has risen for three consecutive weeks.

The WLI does indicate the economic outlook is still rather weak, but not so weak as to suggest that a recession is absolutely imminent.

According to ECRI, "Despite its latest uptick, WLI growth remains near its worst readings since the 2001 recession, underscoring the economy's heightened vulnerability." Last week they said "It is still possible for prompt policy action to help avert a recession." Two weeks ago they said "WLI growth is now at its worst reading since the 2001 recession. However, the WLI's recent decline is not based on pervasive weakness among its components, suggesting that a recession could still be averted."

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner. It presently indicates "cloudy weather" for the next few months, but is still not forshadowing major storms in the real economy, even if financial markets and some sectors of the economy may continue to struggle.

-- Jack Krupansky

5.25% APY CDs at Countrywide Bank going, going, soon

Last week you could have picked up an FDIC-insured 6-month CD from Countrywide Bank at 5.45% APY. This week they are down to 5.25%. And no telling how soon they will fall down into the 4% range now that Bank of America has agreed to buy Countrywide.

Countrywide Bank is part of Countrywide Financial which has all of these mortgage problems, but it is a bank and bank deposits up to $100,000 are insured by the FDIC.

Personally, I do not have enough free cash that the difference in rate would make a big annual difference and be worth the hassle of having some of my cash off in a bank they I am not doing any other business with.

-- Jack Krupansky

Fiscal stimulus probably on the way

Although there has been some degree of chatter about the possibility of fiscal economic stimulus for some time now, it finally looks to be likely, varying only in the amount and form. An article in The New York Times by Steven Weisman and David Herszenhorn entitled "Bush and Congress Seen Pushing for Stimulus Plan" summarizes the situation. It sounds as if the plan will be announced within the next couple of weeks. $100 billion is a commonly discussed size. The form might be some combination of individual tax rebates, business investment credits, extended unemployment benefits, and a couple of other goodies designed to appeal in an election year.

Mind you, I personally do not think any of this fiscal relief is needed since I truly believe that the economy is stronger than the pundits give it credit for being, but it does appear to be headed our way in any case.

The real point is that the presumed "recession" is getting increasingly unlikely. I predict that six months from now we will be in the midst of Fed rate hikes and collectively scratching our heads and wondering why we were so worried about economic weakness when the core economy has been so strong.

-- Jack Krupansky

What will the Fed do?

It was quite amazing and amusing to see the reactions to Federal Reserve Chairman Bernanke's speech on Thursday. Sure, he allowed that the Fed could and is willing to act aggressively, but somehow that got stretched into a slam dunk certainty that the Fed will act, which is not what Bernanke said at all. In truth there will be more than enough new economic data, including the latest Fed Beige Book, plus candid, private discussions between FOMC participants and banking and business leaders in the days immediately before the FOMC meeting, so that there will be plenty of room for the Fed to evolve to a significantly different position than what people seemed to be misguidedly assuming after they distorted Bernanke's speech.

OTOH, enough people were already talking about a half-point cut as being a done deal before Bernanke's speech, as well as being indicated by fed funds futures prices, that this was Bernanke's opportunity to disavow that presumption and he most certainly did not.

Fed funds futures prices are usually a fairly reliable indicator within 45 days of an FOMC meeting. As of the close on Friday, February fed funds futures were indicating a 100% chance of a half-point cut plus a 40% chance of an additional quarter-point cut. Part of this betting is that some people believe that the Fed may be forced to cut before the FOMC meeting as well as at the meeting.

The economic data of late has been mixed enough that there is no need for the Fed to cut its target rate before the scheduled FOMC meeting. I do believe that a quarter-point cut is a slam-dunk and that a half-point is a distinct possibility if we see significant deterioration over the next two weeks. The weekly data, such as chain store sales, unemployment claims, mortgage applications, and commercial paper issuance, will give the Fed some hard data to consider. As important, a wide variety of banking and business leaders will privately tell Fed officials what they really think is needed.

Please note that changes to the fed funds target rate impact the real economy with a significant lag, on the order of months to a year or more, so it would be incorrect to presume that any recent economic weakness was an indication that Fed monetary policy was not working. Actually, mortgage applications were up sharply last week, so there is at least some evidence that there has been some positive effect to date.

-- Jack Krupansky

Euro continues to stagnate

Even with all the chatter about the possibility that the Federal Reserve will cut its target rate by half a point at the end of the month, which would in theory put downwards pressure on the dollar, the euro hardly responded, with the March futures closing on Friday at $1.4780, up only very slightly from $1.4777 last week.

Far from being bullish on the euro, futures all the way out at June 2009 are priced only at $1.4586, which indicates the dollar gaining strength.

Although foreign exchange "strategists" do a lot of talking about "fundamentals" and how weak the dollar is, the truth is that it is all a giant shell game with speculation and short-term trading as its aim and nothing to do with long-term fundamentals.

Despite the "weakness" of the dollar, the euro, pound, and Canadian dollar have not made any headway against the dollar for two months now.

-- Jack Krupansky

Intrade market indicates a 60% chance of recession in 2008

Trading on the Intrade Prediction Market indicates a 60% chance (up from 55% last week) of a U.S. recession in 2008.

In other words, people are quite worried that a recession is possible and consider it (just barely) likely, but without strong conviction.

Personally, I would still put the chances down around 25% (1 in 4.) The so-called weakness in the economy is simply not profound enough to suggest an outright recession. For example, the weekly initial unemployment claims number has remained well below 400,000 even recently, while traditionally that number tends to spike well above that 400,000 in recessionary times.

Nonetheless, the Intrade indication is probably a good proxy for overall market sentiment.

OTOH, if I were to try to synthesize the chance of recession from the overall tone of commentary, it would be about a 99% chance of recession in 2008. In other words, much of the commentary that attracts the interest of the press grossly misleads people about what the actual data suggests.

FWIW, Intrade trading current pegs Hillary at the same 60% chance of being the Democratic presidential nominee and Barack has a 40.8% chance. OTOH, Intrade showed Barack having a 67% chance of winning going into the New Hampshire election, so that just illustrates how tentative and subject to change these number really are.

-- Jack Krupansky

Is the asset-backed commercial paper market poised for a comeback?

For two consecutive weeks the Federal Reserve Commercial Paper Outstanding report has shown an increase in outstanding asset-backed commercial paper (ABCP), for the first time since August. Two weeks is not enough to establish a new trend yet, but it is notable against the backdrop of a steep decline of ABCP over the past five months.

There will continue to be a string of bad news for the asset-backed securities markets over the coming weeks and months, but we are also likely to see a rising tide of positive news and data as well.

-- Jack Krupansky

Are mortgage markets poised for a comeback?

There is an interesting article in The Wall Street Journal by James Hagerty entitled "Mortgage Markets Get a Hand - BofA Purchase Is Vote Of Confidence in Revival Of Housing Industry" which strongly suggests that the buyout of Countrywide by Bank of America may mark a real turning point for the mortgage markets and the housing markets.

Granted, there are plenty of open issues, including legal liabilities related to "bad" subprime mortgages, but there does seem to be plenty of upside potential on virtually all sides.

In any case, at least this is a solid piece of good news relative to the endless stream of bad news for the housing and mortgage markets.

-- Jack Krupansky

ECRI Weekly Leading Index indicator rises sharply but still suggests a very sluggish outlook

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose sharply (+1.12% vs. +0.06% last week) but the six-month smoothed growth rate fell moderately (from -6.3 to -6.7, a 6-year low), moderately below the flat line, suggesting that the economy will be somewhat sluggish in the months ahead.

The WLI does indicate the economic outlook is rather weak, but not so weak as to suggest that a recession is imminent.

According to ECRI, "It is still possible for prompt policy action to help avert a recession." Last week they said "WLI growth is now at its worst reading since the 2001 recession. However, the WLI's recent decline is not based on pervasive weakness among its components, suggesting that a recession could still be averted."

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner. It presently indicates "cloudy weather" for the next few months, but is still not forshadowing major storms in the real economy, even if financial markets and some sectors of the economy may continue to struggle.

-- Jack Krupansky

Bloomberg's John Berry on why a recession is unlikely in 2008

Bloomberg columnist John Berry has a piece entitled "A Recession Shouldn't Be in Your 2008 Forecast" which presents one case for why a recession is unlikely this year. He says:

Some analysts were predicting a recession would hit the U.S. economy in the fourth quarter as consumers, hurt by falling house prices and the high cost of gasoline, cut spending.

It didn't happen, and there's no reason to think it's going to this year either.

Economic growth will be slow in the first half of 2008, and the unemployment rate, which was still a low 4.7 percent in November, is likely to rise. Housing sales and construction will continue to be a drag for months to come.

On the other hand, economic growth should accelerate in the second half of the year as financial-market conditions and the U.S. trade deficit improve, the housing drag lessens and the effect of the 100-basis-point cut in the Federal Reserve's overnight lending-rate target in recent months begins to kick in.

Some optimistic analysts believe growth might rebound to a 3 percent rate in the second half.

Given the turmoil in financial markets, the risk of a recession is hardly zero. Nevertheless, the current state of the economy simply doesn't show the signs usually associated with one.

He also notes that:

Many of the forecasts calling for a recession are based on an assumption that large losses associated with subprime mortgages and the securities backed by them will force banks to reduce lending big time. The resulting credit crunch will undermine business investment and consumer spending, the forecasters say.

There are scant signs of that happening.

The summary of the most recent survey of economic conditions conducted by the National Federation of Independent Business and released on Dec. 11 said, ``There is no `credit crunch.'

``Only three percent of the owners cited the cost and availability of credit as their number one business problem,'' the summary said. ``Thirty four percent reported all their credit needs met compared to 4 percent who reported problems obtaining desired financing, typical of readings for the past few years.'' 

Part of John's case is based on a forecast released last week by Mickey D. Levy, chief economist at Banc of America Securities, who I happen to know from personal experience is extremely sharp and on top of both economics and banking. John quotes Mickey as saying that:

``Large banks have adjusted their portfolios, but they haven't reduced their regular lending,'' he said. They have cut back the leverage and lines of credit to hedge funds, venture capital funds, mortgage brokers and the housing sector.

``But to the rest of the non-financial sector they are making all the good loans they can while applying their existing lending standards more rigorously,'' Levy said. ``And as far as I can tell, the 8,000 or so other banks are largely unaffected by this.''

-- Jack Krupansky

Euro stagnating again?

Even though the mixed and weak economic reports last week raised the odds of Fed rate cuts which would in theory put downwards pressure on the dollar, the euro hardly responded, with the March futures closing on Friday at $1.4777.

Far from being bullish on the euro, futures all the way out at June 2009 are priced only at $1.4638, which indicates the dollar gaining strength.

Although foreign exchange "strategists" do a lot of talking about "fundamentals" and how weak the dollar is, the truth is that it is all a giant shell game with speculation and short-term trading as its aim and nothing to do with long-term fundamentals.

-- Jack Krupansky

Byron Wien's top 10 surprises for 2008

Byron Wien, formerly of Morgan Stanley, offers his list of top 10 surprises at the beginning of each year. Duff McDonald over on Portfolio.com reproduces Byron's 2008 list in a post entitled "Byron Wien's 10 Surprises Coming in 2008." Read the details there, but I'll simply list the surprises concisely here:

1. Recession
2. 10% stock market correction but recovery during the summer
3. Dollar bounces around as low as $1.35 and above $1.50, foreigners continue to buy cheap U.S. assets
4. Inflation rises above 5%, 10-year U.S. Treasury yield rises to 5%, lots of talk about stagflation
5. Oil bounces between $80 and $115
6. Agricultural commodities are strong, gold hits $1,000
7. Chinese economy slows due to U.S. recession, Chinese stock market declines sharply
8. Russia asserts itself politically, Brazil and Russia stock markets do better than India and China stock markets
9. Infrastructure improvement as an election theme causes construction and engineering stocks to rally, global water problems cause desalination stocks to soar
10. Barack Obama wins, Democrats get a clear majority in Congress

Wien's approach is to pick surprises that people generally feel have only a 1 in 3 chance but he believes have a 50% chance of happening in the year. It is not uncommon for half of his surprises to (sort of) come true.

-- Jack Krupansky

The Coming Oil Crash

I do not have a high level of confidence about what crude oil prices will do in 2008, although I do expect them to pull back dramatically at some point even if they do push somewhat higher above $100. For an interesting perspective, check out the article on Portfolio.com by John Cassidy entitled "The Coming Oil Crash" which argues that the price of crude oil is likely to come back down to earth, although he is careful not predict a date for that "inevitability."

-- Jack Krupansky

Credit card offers

I finally got around to cleaning out my files for 2007 and packing them away in a file storage box and counted the credit card offers I had received during 2007 as I threw them away. A grand total of 65, and I did not respond to even one of them. I have three credit cards right now and that seems to cover my credit needs, even to take a two week trip to New York City.

I do think I will apply for at least one or two this year, just as a backup. I think I do want to get the Fidelity credit card and probably one that has a cash back or points.

-- Jack Krupansky

What will the Fed do?

Although the Federal Reserve has made it clear that they will be driven by incoming data, the data is in fact quite mixed (despite the views of some commentators.) Sure, some people are chattering that the "rising unemployment" in the latest employment report is an indicator that we are most likely falling into recession if not already there, the truth is that it simply is not so simple as that. It may have been so simple back in the days when we had a manufacturing-driven economy, but the U.S. economy has evolved dramatically since then. Most people acknowledge that the U.S. is now a service-driven economy, but somehow there are still quite a few people who are even to this day unable to accept that.

So, what will determine the Fed's actions at the upcoming FOMC meeting at the end of the month?

Although there will be incrementally more "hard" data, the primary determinant of the Fed actions will be the general tone of the feedback that they get when they have last minute conversations before the meeting with business execuives and their contacts at financial institutions around the country and in particular in the twelve regional Fed districts. Even last minute data reports give a lagged view of the economy, so the Fed governors and the Fed presidents are crucially dependent on on the up-to-the-minute, raw, unadulterated views that that receive in the final days before the FOMC meeting. Yes, the data matters too, but in an economy that is evolving rapidly and may or may not be on the "verge" of a recession, the Fed actually does do a good job of keeping a finger to the wind and an ear to the ground.

We will get the Fed Beige book soon, but even that will be somewhat dated compared to thos crucual last-minute conversations immediately before the FOMC meeting. Also note that the Beige book attempts to describe the current situation and does not attempt to look forward or recommend what Fed action may be required going forward. But, to be sure, if the economy is in recession, as some commentators insist, it would show up in the Beige book as a profound weakness across many sectors and regions of the economy.

The three critical economic reports from this past week paint a clearly "mixed" economic situation. The ISM Manufacturing report was clearly weak, the ISM Non-Manufacturing report was modestly strong, and the December employment report was mixed to weak. Nobody doubts that the Fed would be justified in cutting their target rate in the face of such data. The debate is over how aggressively the Fed should act.

A minimum of a quarter-point cut is a "slam dunk." Although quite a few people feel that a half-point cut is clearly requried, there is not widespread agreement on that point, especially with high energy prices, so a half-point cut is not a "slam dunk." Fed futures indicate a 66% chance of a half-point cut, which suggests that a half-point cut is almost but not quite likely.

My personal view is that the Fed will go ahead with another quarter-point cut for "insurance", but that the data simply doesn't warrant a more aggressive level of "accommodation." Despite the chatter of many commentaters, the overal real economy simply is not on the verge of falling of a cliff.

Also please keep in mind that there is an ongoing and necessary "adjustment" going on in the housing sector and the Fed need to avoid interfering with that adjustment and asset repricing process even as the Fed needs to strive to prevent that adjustment from infecting the rest of the economy. I know there is a lot of debate about all of that, but the simply truth is that the Fed is navigating that process about as competently as any government entity could possibly hope to do.

As a minor side note, this being a new year, the voting composition of the FOMC changes. Some Fed presidents will no longer have a vote and some who hadn't been voting in 2007 will begin voting in 2008. Note, that all twelve Fed presidents do participate equally in the FOMC meeting discussions, even if they do not get to vote.

-- Jack Krupansky

Intrade indicates a 55% chance of recession in 2008

Trading on the Intrade Prediction Market indicates a 55% chance (up from 47% last week) of a U.S. recession in 2008.

In other words, people are quite worried that a recession is possible and consider it (just barely) likely, but without very much conviction.

Personally, I would still put the chances down around 25% (1 in 4.) The ISM Non-Manufacturing report on Friday was still too strong to indicate an imminent recession and the rising employment component in the ISM report effectively counters the weakness of the December employment report. And, we simply are not seeing any dramatic rise in weekly unemployment insurance claims.

Nonetheless, the Intrade indication is probably a good proxy for overall market sentiment.

OTOH, if I were to try to synthesize the chance of recession from the overall tone of commentary, it would be about a 99% chance of recession in 2008. In other words, much of the commentary that attracts the interest of the press grossly misleads people about what the actual data suggests.

-- Jack Krupansky

ECRI Weekly Leading Index indicator rises slightly but still suggests a very sluggish outlook

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose slightly (+0.05% vs. -0.84% last week) but the six-month smoothed growth rate fell sharply (from -5.2 to -6.2, its lowest since the week of November 16, 2001), moderately below the flat line, suggesting that the economy will be somewhat sluggish in the months ahead, neither booming nor busting.

The WLI does indicate the economic outlook is rather weak, but not so weak as to suggest that a recession is imminent. The WLI growth rate has been this low before without being followed by a recession.

According to ECRI, "WLI growth is now at its worst reading since the 2001 recession. However, the WLI's recent decline is not based on pervasive weakness among its components, suggesting that a recession could still be averted."

A WLI growth rate of zero (0.0) would indicate an economy that is likely to run at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to forecast a relatively stable "Goldilocks" economy.

The current reading for the smoothed growth rate is still too close to zero to discern with any great confidence whether the economy is really trending downwards or upwards. We may need another month or even two before the trend becomes clear.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner. It presently indicates "cloudy weather" for the next few months, but is still not forshadowing major storms in the real economy, even if financial markets and some sectors of the economy may continue to struggle.

-- Jack Krupansky

ISM Manufacturing report not as bad as it seemed

The ISM Manufacturing Report on Business for December was somewhat of a disappointment, showing a contraction fo the manufacturing sector in December, but it was not as bad as it first seemed. Yes, it showed a contraction of the manufacturing sector, but not by enough to indicate a contraction of the overall economy. In fact, according to the report, "if the PMI for December (47.7 percent) is annualized, it corresponds to a 1.8 percent increase in real GDP annually." That is in fact a higher rate of GDP growth than many forecasters are suggesting for Q4, and that would be if October and November has been at December's low PMI, while in fact those two months were significantly better.

The ISM Non-Manufacturing Report on Business on Friday will tell us how the services sector was doing in December.

In summary, as weak as the ISM report seemed, it probably indicates that Q4 GDP will come in at 3.0% or better.

Incidentally, according to ISM, the manufacturing PMI would have to fall below 41.9 before a contraction of the overall economy would be indicated.

Still, the relative weakness of the ISM Manufacturing report would suggest that the Fed will be a little more likely to cut its target rate again at the end of the month. We'll have to see how the ISM Non-Manufacturing report and the monthly employment report do on Friday. My forecast: mixed.

Incidentally, the construction spending report for November showed a gain despite a continued decline in residential construction. Nonresidential construction continued to grow faster than residential construction spending is declining. But, that was for November and it will be another month before we get the construction spending report for December.

-- Jack Krupansky

Your 'safe' money really is safe

Jon Markman has usually been a very credible and competent financial journalist, but somehow he has managed to slip off the track and into the journalistic equivalent of a ditch with his piece on MSN Money entitled "Your 'safe' money isn't so safe" which misguidedly attempts to argue that most retail money market mutual funds may be entering a "danger zone." He says:

Investors are fleeing the volatility of the stock market at the year-end, according to industry data, and stashing the proceeds in supposedly nice, safe money market funds at the scorching rate of $18 billion per week.

Yet investors might only be exiting one danger zone and entering another, as a close look at money market funds at major U.S. brokerages reveals that most are invested in the same sort of dubious paper that has rocked the financial world in the past six months.

Although many money market funds have the word "cash" in their names -- leading investors to think that they are no more risky than a handful of paper money -- many are thinly veiled bets on the deteriorating mortgage market, a bet that has gone very bad for Wall Street, to the tune of hundreds of billions of dollars. The question now is how bad it could get for these supposedly safe funds.

Talk about the-sky-is-falling fear-mongering and yellow journalism. Yes, Jon does start with a number of specific and correct reports, but then he misleadingly represents that they are relevant to retail investors, which is simply not the case. And then he proceeds to do the financial and jouranlistic equivalent of making a federal case out of what is at most a minor parking violation.

Let me be very clear: Contrary to the overall tone that Markman takes, investment in retail money market funds is extremely safe.

I (and others) have written about this before (see "Enhanced cash funds vs. money market funds"), and I can assure you beyond all shadow of a doubt that no retail money market fund investors are at risk of losing a single dime. Sure, some institutional funds and some "cash management vehicles" and "investment pools" that sound  as if they are money market funds but are not have had some issues, but none of those difficulties in any way indicates that retail money market funds might be at risk.

Yes, there have been a few cases where the parent money management firm or bank has felt the need to acquire or guarantee some of the assets held in money market funds, but these situations have been dealt with in an orderly manner and at no point was even one dime of retail money market fund money at risk. Not one single dime. There is simple no "danger zone" as Markman suggests.

I have in fact looked at the asset holdings lists for several popular money market funds and although there is a lot of commercial paper, little of it has any exposure to mortgages. Even when it does, it is all short term by definition (and required by SEC regulation). In general, the assets held in retail money market funds mature in less than 90 days, so that the vast bulk of any exposure to subprime debt that may have been acquired by the fund before the crisis in August would have already matured before the end of November. You can be sure that the managers of retail money market funds would not have rolled over any of that maturing commercial paper into any new paper which is now considered risky. By SEC regulation, they are not allowed to. Sure, money market fund managers will continue to invest in quality commercial paper and in some cases that may even be asset-backed or even mortgage-backed, but you can be absolutely sure that your money market fund holdings will not be bets on the future of subprime mortgages.

To be crystal clear, no retail money market fund is as Markman insists "thinly veiled bets on the deteriorating mortgage market." Not even close. He couldn't be further off the mark. He has no evidence to back up this assertion, it is simply his shoot-from-the-hip opinion and misguided characterization. He should be ashamed of himself.

Markman makes the following false assertion:

4.5%-plus annual yields on money market funds... have been generated by a relatively new brand of mortgage-focused investment companies called special investment vehicles, or SIVs...

The correct characterization is that the higher yields come from commercial paper and repurchase agreements. Very little of the commercial paper in retail money market funds is "mortgage-focused." Yes, a fair amount of the repurchase agreements may be "mortgage-related", but are very short term (usually a few days or a couple of weeks) and very low risk and usually have already matured by the time even the monthly holdings report comes out. To be very clear, a repurchase agreement or "repo" is not the same as an investment in the asset for which the agreement is written. The implication that repurchase agreements may be bets or risky is completely groundless.

Markman makes the following false assertion:

If you are among the tens of thousands of Charles Schwab customers who keep cash in the Schwab Value Advantage Money Fund (SWVXX), for instance, then you have had a subprime time bomb ticking away in your brokerage account. Likewise if you are a Smith Barney customer who keeps cash in that brokerage's gigantic Western Asset Money Market Fund (SBCXX). Sadly, these funds are just two among many.

You will be happy to know that there are no ticking time bombs in even those funds. A ticking time bomb implies that you could lose your entire investment, and that is simply not the case. In fact, in these cases there is no significant risk of losing any of your money. The manager of the Western funds has decided to use corporate funds to finance the purchase of the questionable commercial paper that was in the funds. At no point was even a single dime of retail money market fund money at risk, not a sigle dime. Labelling the situation a ticking time bomb is grossly misleading. I do not know what Markman's ultimate motives are, but fear-mongering is never a reasonable approach by a journalist, although it is a key and defining characteristic of yellow journalism.

As far as Schwab, you can read a December 5, 2007 MarketWatch article by Murray Coleman entitled "Analyst sees Schwab unwinding SIVs in money markets - But no threat to credit risk of its money markets seen" which explains Schwab's situation in more detail, but as the title suggests, does not back up Markman's false claim of the risk of loss of investor principal via some purported ticking time bomb. And this is a story that was available several weeks ago.

Markman must have read that or similar articles because he goes on to say that "Brokerages have pledged to shrink their exposure to SIVs and tacitly pledged to support money market funds' values in the event that the mortgage-backed securities in which they are invested go belly-up." But that is once again trying to mislead readers into believing that a retail money market fund might be invested in "mortgage-backed securities", when the most they are exposed to is short-term commercial paper or repurchase agreements, neither of which is even close to being the same as investing in mortgage-backed securities which are by definition long-term and not even permited in retail money market funds which by SEC regulations limit duration of debt to 397 days and also require the avaerage duration to be under 90 days.

Things get a little murkier when Markman brings up SunTrust. It is true that SunTrust bought or was planning to buy SIV-issued debt from two of its money market funds, but one was institutional, so it is not possible to sense how much of the retail fund was at risk. But ultimately no retail investor money was at risk at all since SunTrust bought the questionable assets at full price plus accrued interest. So, once again, not a single retail investor dime was at risk. No "danger zone" and no ticking time bomb. In short, Markman is completely wrong when he uses SunTrust as an example of "It's only getting worse." The SunTrust story is a great example of things getting better, not worse. Maybe things might get worse for SunTrust shareholders, I couldn't say, but that is not relevant to an assessement of retail money market funds.

Markman mentions BlackRock Cash Strategies Fund, but once again that is not relevant to retail money market fund investors. Markman conveniently neglected to inform his readers that a "cash strategies fund" is not a money market fund.

Markman says that "Bank of America closed an 'enhanced' institutional money market fund at its Columbia unit", but once this has no relevance to retail money market funds.

Markman says that "Over in Europe, Rabobank Groep said it would bail out its own SIV, Tango Finance, by taking responsibility for its $7.6 billion in fast-diminishing assets", but a) that is not relevant to retail money market fund investors, and b) is an example of things getting better, not worse.

Deep within his "your money isn't safe" article Markman finally tells us that "Only one U.S. money market fund has ever 'broken the buck,' or failed to return a dollar for every dollar invested, and that was more than a decade ago." Only one. Ever. He has essentially no firm basis for the central thesis of his article.

Also hidden deep in his article he tells us the good news about Schwab:

Schwab spokeswoman Sarah Bulgatz said her company is "very comfortable" with its money market holdings and their underlying credit strength. She said all of the company's funds "maintain the highest short-term and long-term ratings available" and that none has been downgraded. Bulgatz says that as the commercial paper in question matures and rolls out of Schwab's funds, it is not being replaced, and that the percentage of the funds in SIVs has declined sharply.

But then strangely Markman goes off the deep end again by groundlessly asserting that:

Yet other institutions may not have been as proactive as Schwab, so no one really knows whether any bank will find itself forced to rip off its cash customers over the next year.

He clearly either didn't read or didn't take to heart the part about commercial paper maturing repidly and the fact that it is short-term. And on what basis is he concluding that retail money market fund investors should worry that their "bank will find itself forced to rip off its cash customers over the next year"? Did I say fear-mongering?

Let me say this clearly: You as a retail investor do not need to worry that your bank might be "forced to rip off its cash customers over the next year" -- other than the fact that banks charge higher fees and pay lower yields (in general) than investment firms such as Fidelity and Vanguard.

MSN Money can do better. This abysmal performance by Markman is unacceptable. It is time for him to go.

Oh, and by the way, did you know you can get 5.30% APY for an FDIC-protected savings account (not a money market mutual fund) from Countrywide Bank? Yes, it is with Countrywide, but it is FDIC-protected. Countrywide bank also offers a 5.50% APY 6-month CD that is also FDIC-protected. Why couldn't Markman have told us about some of this good news? What exactly is his agenda?

-- Jack Krupansky