Procerity

After the Stress Tests

admin — Mon, 04 May 2009 12:41:28 +0000

Some 19 banks holding approximately two-thirds of all US bank assets are being “stress tested”. One cannot be blamed for wondering why those banks, including Citigroup Inc, Bank of America Corp, JPMorgan Chase & Co, Wells Fargo & Co and Goldman Sachs, have not always had their assets under scrutiny by the regulatory authorities. What was being done before the stress tests were invented? It seems that instead of having ongoing supervision of the financial institutions, we are resorting to intermittent inspections.

Procerity’s Prognosis: Expect a sudden realignment in relative valuation of bank shares this week as the stress test results become known.

Who Pays for the Financial Crisis?

admin — Wed, 22 Apr 2009 14:42:57 +0000

Two groups of people are going to end up paying for the financial crisis: savers and taxpayers. The government’s decision to expand the money supply to offset short-term deflationary pressure does not come without a price. The price will be in the form of vigorous inflation, and the cost will be born by those who hold cash or debt, especially long-term debt. Taxpayers are also on the hook. Government funded backstops (TARP, debt guarantees, overpayment for toxic assets, for example) are ultimately funded by the taxpayer. Taxpayers who are also savers will be paying twice, once through taxes and again through the loss of purchasing power. While taxes may be difficult to avoid paying, there is still time to shed cash and fixed income assets.

Procerity’s Prognosis: 30-year US government bonds, currently yielding 3.8%, are going to appear extraordinarily expensive in retrospect.

A Bankruptcy Opportunity

admin — Wed, 08 Apr 2009 13:22:10 +0000

The latest news reports suggest that General Motors is urgently preparing for eventual bankruptcy. This, after billions of dollars of US taxpayer wealth has been transferred to bailout GM as well as Chrysler - money that is not very likely to ever be repaid. Meanwhile Germany is extending its subsidy to scrap dilapidated vehicles and encourage the purchase of newer technology transportation. While one country transfers funds from taxpayers to a sunset industry, the other distributes it to its consumers. Regardless of which government action is more effective, almost five months ago, Procerity predicted that, “Any aid dispensed to the automakers will only delay the inevitable” That forewarning appears to be coming true.

Procerity’s Prognosis: Expect markets to provide little upside opportunity until a major automaker bankruptcy occurs.

What if Every Central Bank Quantitatively Eased?

admin — Tue, 31 Mar 2009 15:36:18 +0000

The OECD is recommending that the European Central Bank (ECB) commit to more quantitative easing and that the Bank of Canada consider expanding its money supply as well. This, despite the OECD’s wavering about the effectiveness of the Bank of England’s adventure into quantitative easing. Meanwhile, China is becoming justifiably worried about the extent of quantitative easing being undertaken by the US Fed. Quantitative easing is after all simply a euphemism for ‘printing money’. If the money supply is expanded faster than the real economy, prices will rise, even though the value of non-currency assets may be stagnant or even declining. Any central bank that engages in excessive expansion of its money supply simply watches its currency become devalued. But, if every central bank simultaneously undertakes quantitative easing, at least exchange rates will appear stable, and perhaps that will provide the illusion that no currency devaluation has taken place.

Procerity’s Prognosis: Expect continued pressure for quantitative easing around the world from those who have already committed to expanding their own money supply.

Soros Validates Procerity’s Prognostication

admin — Mon, 19 Jan 2009 22:58:42 +0000

On November 22nd, 2008, Procerity’s Prognosis was, “Expect deflation to take hold in the near future followed by a period of overshooting inflation.” This prediction now has the weight of George Soro’s insights behind it. According to the billionaire hedge fund manager, the monetary squeezing (reversal of the monetary easing) will be even more difficult to accomplish than the injections of liquidity. Draining the excess money from the economy will be politically unpopular because it will need to occur prior to the resumption of full employment.

According to Soros, the government will have to be very quick to reverse the flow of money it is currently pumping into the economy. Not only must the Fed act almost instantaneously, it must also be able to accurately pinpoint the juncture at which to change direction. Given the pace at which politically unpleasant decisions are made and the difficulty of timely diagnosing the state of the economy, Procerity’s earlier prognosis still stands.

Procerity’s Prognosis: “Expect deflation to take hold in the near future followed by a period of overshooting inflation.”

MBS Mop Up

admin — Wed, 31 Dec 2008 12:54:22 +0000

The Fed plans to soak up a half trillion dollars of mortgage-backed securities (MBS) in the first six months of 2009. The aim is to drive down mortgage rates and lower the cost of home financing. Making mortgages cheaper should stabilize house prices. But the price of anything is a relative measure. So, if the price of housing is still “too high” relative to other assets in the economy, one solution is to raise the price of the other assets. The MBS mop up will be doing just that. By suddenly injecting $500 billion dollars into the economy, the Fed is essentially raising the price of everything.

Procerity’s Prognosis: Expect inflation to halt the drop in house prices.

Automaker Bankruptcy Delayed

admin — Sat, 20 Dec 2008 14:37:55 +0000

The $17.5 billion dollars of TARP funding extended to General Motors and Chrysler requires the companies to extract concessions from bondholders, employees, and retirees. Bondholders will have to accept equity in exchange for the money they have lent. Employees will have to sacrifice their “jobs bank” and take a pay cut. And retirees will have to accept company stock as funding for their health care trust. Under normal circumstances, such concessions would be decided by a court through a Chapter 11 bankruptcy proceeding. The current automaker bailout, however, is relying on negotiations instead of court imposed discipline.

Procerity’s Prognosis: Expect the negotiations to drag on until bankruptcy becomes unavoidable.

Orderly Bankruptcy for Automakers

admin — Thu, 18 Dec 2008 17:48:49 +0000

According to a report from Reuters, President Bush is “worried about a disorderly bankruptcy”. This concern was expressed after Chrysler had announced it’s plants would be closed for an entire month. Given the Administration’s beating around the bush (pun intended) with respect to bailing out the automakers, it is probably safe to expect that nothing more will be forthcoming other than additional expressions of dismay. The hope apparently is for an orderly bankruptcy.

Procerity’s Prognosis: The markets may present a buying opportunity when the expectation of an automaker bankruptcy finally becomes a reality.

Madoff Made off with Billions?

admin — Mon, 15 Dec 2008 18:46:05 +0000

When stock markets are booming, it is easier to hide malfeasance than when investors are liquidating their portfolios. Bernard L. Madoff was arrested for allegedly running a $50 billion Ponzi scheme. A Ponzi scheme is a fraudulent investment operation that pays out unrealistically high “profits” to early investors from the money put into the organization by later investors, rather than from any real business returns. The illegal investment vehicle is named after Carlo Ponzi, who, although not the first to invent such a scheme, is also obviously not the last. Until the recent market meltdown, Madoff appeared to be doing well - in retrospect, too well.

What is very interesting about the Madoff affair is the stature of the victims involved (estimated losses in brackets). Santander of ($3.1 billion), HSBC Holdings Plc ($1 to 1.5 billion), Royal Bank of Scotland ($600 million), Natixis ($600 million), BNP Paribas ($480 million), Nomura Holdings Inc ($300 million) are just some of the largest financial institutions that have been duped. Perhaps the halo effect of surrounding the former chairman of the NASDAQ blinded the banks to the underlying “business” of Bernard L. Madoff Investment Securities LLC.

Procerity’s Prognosis: Expect more skeletons to come out of the closet in the new market environment.

Helicopters Dropping Cash

admin — Sat, 22 Nov 2008 15:46:30 +0000

Evidence that deflation is becoming a problem is mounting. In the U.K. in October, the inflation rate dropped by 0.7% - the largest one-month drop ever recorded. Raw material costs in the U.K. plummeted at the highest rate in 22 years. The Bank of England is forecasting a contracting economy for most of 2009.

In Canada, the consumer price index experienced the largest one-month drop since June 1959. The annual inflation rate shrunk from 3.4% in September to 2.6%.

From September to October, U.S. inflation fell by the largest amount since record-keeping began in 1947, one full percent. And core inflation also fell by 0.1%, when economists had expected it to increase by that amount.

The apparent cause of looming deflation is a massive drop in global aggregate demand. Consumers have maxed out their credit and banks are hoarding cash - ingredients for prolonging a recession or even creating an economic depression. One extreme solution offered to counter the deflationary threat is to simply “print” money and deliver it directly to consumers to spend (sending out the helicopters to drop cash, as Milton Friedman is claimed to have said).

Of course this raises the spectre of rampant inflation. The situation is very delicate. Not enough “monetary easing”, and deflation threatens - too much “monetary easing” and excessive inflation is generated. With a relatively long duration between implementation and the impact of any action, the chance of erring on either side is quite high. Besides the risk of monetary easing being either too little or too much, there is the additional risk that its effectiveness will be limited because the population will remain skeptical (effectively shooting the helicopters of cash out of the sky).

Procerity’s Prognosis: Expect deflation to take hold in the near future followed by a period of overshooting inflation.