GM sold shares to the public last week some of which were previously owned by….the public. Anyone lucky or well connected enough to be allocated shares in the IPO was able to book a near 10% profit almost immediately while the less fortunate previous owners – that would be you and me – took a loss that rightfully belonged to GM bondholders and the auto unions. To add insult to injury, small investors who were mostly locked out of the IPO shares and bought in the aftermarket near the peak were sitting on an additional loss of nearly 5% by week end. Just in case that wasn’t enough to cause a spontaneous Tea Party rally, the Chinese government raised reserve requirements for their banks last week which seems unlikely to help GM’s bottom line, a considerable portion of which is derived from its sales in the Middle Kingdom financed at least partially by said Chinese banks.
Just to add to the ironic nature of the week, China had to raise those reserve requirements because their inflation is heating up thanks to the easy money policies of…wait for it…our very own Federal Reserve. Ben Bernanke spent an entire speech Friday doing his level best to find a way to blame our troubles on anyone but ourselves and certainly not himself. You see, according to Ben, it is the fault of those mean emerging markets who insist on growing faster than he wants them to by daring to manage their own currencies as they see fit for their benefit rather than ours. It is their fault for buying our Treasury bills, notes and bonds and allowing – heck, forcing – us to spend beyond our means.
Frankly, Bernanke’s justifications for QE II are getting so confusing, I’m not sure Bernanke even knows why he’s doing it anymore. A gaggle of Fed luminaries spent part of the last two weeks assuring one and all that the Fed’s goal wasn’t to weaken the dollar and then Bernanke spent most of that really long speech Friday in Germany whining that emerging countries were hurting the world economy by not allowing their currencies to appreciate. So while QE II is meant to help the US economy, it isn’t meant to hurt the dollar but if emerging market currencies were allowed to rise it would help the world and presumably the US economy. Maybe the Fed’s goal is to give everyone a headache and stimulate the sale of aspirin. Wouldn’t it have been easier for them to just buy Johnson and Johnson stock? Don’t laugh; it makes as much sense as what they are actually doing.
In addition to the Chinese reserve requirement changes, the GM IPO and the Fed’s ongoing implementation of what Bernanke insists shouldn’t be called quantitative easing because it only has the side effect of increasing bank reserves, the market also had to deal with the ongoing unraveling of the Irish banking sector which resembles more than anything the situation that evolved in Iceland a couple years back. The big difference is that Iceland’s government told the banking sector to pound sand and forced the European banks that lent to them to take the loss rather than the public. The Iceland economy imploded but banking resumed on a healthier basis and the economy now has a chance at decent recovery since it isn’t burdened with the bank’s debts.
Ireland, on the other hand, backed their banks completely which means their economy imploded anyway just like Iceland but now they have to go to the EU on bended knee with their low corporate tax rates offered as tribute in exchange for a bailout so they can pay off the Continental banks who took the risk of lending to Irish banks. And their economy will likely face years of sub par growth burdened by excessive debt. Systemic risk turns out to mean, as I always suspected, that the failure of one badly run bank means the failure of other badly run banks. Why that is a bad thing is apparently beyond the comprehension of mere mortals and non Federal Reserve employees.
Even with all that chaos, the stock market managed to end the week just about where it started. The bond market wasn’t so lucky despite repeated buying on the part of the NY Fed. Despite what Bernanke wants, the Fed may just not be a big enough player to bend the bond market to its will. Last week’s economic data was once again better than expected and the bond market appears to be sending the Fed a message that further easing just isn’t warranted. Not that they are listening. There were still some bad reports last week – primarily in housing again – but overall it was another good week for data.
Retail sales were better than expected in October rising 1.2% led by a surge in auto sales. Strength was widespread though with sales ex-autos rising 0.4%. Inventories rose once again but it was matched by the rise in sales so the inventory to sales ratio remained constant at a low 1.27. Industrial production was flat in October but that was entirely due to a drop in utility output. Based on the reports I’m getting from my daughter in Chicago that is due to a pretty mild winter so far. Manufacturing was up a healthy 0.5% with or without autos with most of the gain on the durables side (although non durables were up too) which would seem to indicate some confidence in the economic outlook.
We did get contradictory reports on manufacturing from the Empire State and Philly Fed surveys. The former was incredibly weak while the latter blew the doors off expectations. How two districts so close together can produce such starkly different outlooks is a just one of the mysteries of this recovery for which I have no answer. The Empire survey showed big drops in new orders, unfilled orders, shipments and workweek. Delivery times improved somewhat but remains negative. Even with all those negatives the employment component remained positive. The Philly survey was a near mirror image of its NY cousin with almost every component rising. Again, I don’t know for sure why the reports were so different. The recovery is obviously still tentative and uneven. I don’t see anything that makes me think that is about to change.
The weakest reports of the week were housing related. The builders index was flat at a still low 16 and housing starts reflected that coming in at a rate of just 519k. The only good news I could find in that report is that it was mostly due to a drop in multifamily starts which are notoriously volatile. Permits were up slightly so the market doesn’t look like it is headed off a cliff but it still isn’t what I would call healthy. Mortgage applications fell after a rise in rates which I can’t help but point out is the opposite of what the Fed told us to expect from QE II.
The inflation reports last week supported the case for QE II if you are inclined to believe the fiction that is the government’s inflation measures. Headline PPI and CPI both showed rises of 0.4 and 0.2 respectively. Core prices fell 0.6% at the wholesale level and were flat at the consumer level. The PPI showed more stress underneath the surface with intermediate and crude goods rising much more rapidly than finished goods which probably isn’t a good thing for profit margins. The CPI report was also interesting as much for what it didn’t show as what it did. Basically the only part of CPI deflating is housing which makes up the largest portion of the index. Thus the crux of the Fed’s argument for QE II is that it was okay to ignore housing prices when they were rising rapidly but now that they are falling it is an emergency requiring drastic action. One can’t help but note the inflationary bias in that choice.
Jobless claims came in at 439k last week which is not bad but still not all that good either. The one thing Bernanke said in his speech Friday with which I agree completely is that having millions of unemployed for years to come is an outcome we as a society should and do find unacceptable. Obviously I disagree with Bernanke’s efforts to change that dynamic through monetary means but at least his heart – if not his brain – is in the right place.
As I said above, stock markets were basically flat last week despite some increased volatility. Bulls in the AAII poll dropped from 57.6% to 40% and while it is good news that a little correction can cause such a quick turn in opinion, it isn’t enough to convince me to use my cash. The strangely euphoric reception of the GM IPO was just a little too exuberant for my taste. This is a company with deep troubles and a continued government involvement that values politically correct car designs over ones that attract, you know, actual customers. That such a poorly managed company can command a premium price speaks volumes about the attitude of investors.
Since the Fed started actually implementing QE II the markets have not responded as everyone expected and to me that is a cause for caution. Bond yields are up, stock and commodity prices are down and emerging markets, particularly China, are taking it the worst. The unintended consequences of QE II are as yet unknown but I suspect they will be considerable. Keeping more cash than usual on hand until trends become clearer only seems prudent.
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