October, Tuesday 18, 2011

DOW + 180 = 11,577
SPX + 24 = 1,225
NAS + 42 = 2657
10 YR YLD - = 2.15%
OIL +.39 = 86.77
GOLD – 15.60 = 1656.10
SILV +.24 = 32.14
PLAT – 19.00 = 1535.00

Sometimes I wonder if I should even read the closing numbers – does it really matter that the Dow Industrials dropped a couple hundred points yesterday or that it bounced this morning? No; probably not. Maybe the daily scoreboard gives you some feel for the rhythm of the market, for the prevailing sentiment; then again, maybe not. Over the years, I’ve talked about trends in the market. One of my favorite phrases is that a trend in place is more likely to remain in place than it is to change – until it changes. Trends are not infinite. No pattern is perpetual. The greater the expectation, the more you should question the premise. And I’m reminded of the Mark Twain quote – History doesn’t repeat but it does rhyme.

There’s a reason for this – it’s because we’re human and we have imperfect and selective memories. History rhymes because we put our unique human imprint on it, just enough to make minor alterations on the trajectory through time. You may remember a long ago wound, but a recent cut still stings and because it stings, it moves to the front of your thoughts and it colors your thinking; it might make you skittish; it might make you cautious; it might freeze you in your tracks; or maybe the sting emboldens you and motivates you.

For many investors, 2008 is the recent wound that colors your outlook. It certainly seems we are looking at some sort of historic rhyme playing out. So, what did you learn from your history?

Well, one thing is to make sure you’ve got a plan that allows you to look past the noise and clutter, be sure to enjoy your achievements as well as your plans; and don’t pay too much attention to the daily scoreboard.

So, that’s a long way to go to get us to the first story of the day:

During a speech today in Boston, Bernanke said the steps the Fed took during the 2008 crisis proved to be successful. The Fed lowered short-term interest rates to record lows and expanded its portfolio of Treasury and mortgage-backed securities to push long-term rates lower.

Bernanke said the Fed helped calm markets by being more explicit about its interest rate policy. He said it's a trend that will increase in the future.

Bernanke did not address the current state of the economy or possible future moves on interest rates; he also did not take questions from the audience. He used an entrance to the building that was not near an Occupy Boston protest group that has been camped in Dewey Square, across the street from the Boston Fed.

I’m not quite sure how, but somehow this confirms that the universe is unfolding as it should.

Maybe.

Goldman Sachs posted a third-quarter loss, which was driven by markdowns on the value of the firm’s own investments, was $393 million, or 84 cents a share. The third-quarter loss, which compared with a year-earlier profit of $1.9 billion, was the second time that Goldman Sachs failed to post a profit since it became a public company in 1999. In both cases the loss was caused by reductions in the value of Goldman Sachs’s investments in companies, private- equity funds and loans.

Bank earnings statements have been unusually messy in the third quarter, largely because of an accounting quirk known as Debit Valuation Adjustments. DVA means when the value of a bank’s outstanding bonds and other debt shrivels, a bank posts a gain. If the market value of a bank’s debt shrinks, and it’s only trading at 80 cents on the dollar, in theory a bank could buy back the debt at a much lower cost. That’s why banks book a gain when the value of their debt goes down. It’s counterintuitive, yes.

Bank of America’s third-quarter numbers may have taken the record for messiness. BofA posted a headline profit in the third quarter of $6.2 billion, or 56 cents a share, but then it gets confusing. There’s $1.7 billion gain on DVA;  $4.5 billion in gains on adjustments to fair value on structured liabilities. O.K. my head hurts to think about it – Bank of America either earned $6.2 billion or they lost a few billion. Really – I don’t think anyone really knows for certain.

But just when your head feels like it might pound out of your skull – the pain goes away, only to be replaced by a sick, really sick feeling in the pit of your stomach.  Bank of America is actually multiple companies – including a holding company and a retail bank. The retail side is where customers make deposits in checking and savings accounts, and the FDIC insures those deposits. The holding company is the part that makes trades – that’s the casino. And some of the gambling involves derivatives. We don’t know how much BofA holds in derivatives because they don’t want to say and they are too powerful to be forced into saying anything they don’t want to say. Moody’s downgraded the credit rating of the holding company from A2 to its third lowest rating. Meanwhile, the retail bank side still had a rating of Aa3. Now the traders in the casino weren’t happy about the junk-like rating on the holding company and they demanded BofA do something to shore up the counterparty risk in the derivatives. Bof A looked around and saw the retail banking business, and realized they could back-stop the risk with the $1trillion dollars in customers deposits, which are insured by the FDIC. So BofA transferred up to $53 trillion in derivatives from the holding company over to the retail bank. We still don’t know the exact amount, but $53 trillion is a good guess. The FDIC, which is the entity backstopping the deposits in a worst-case scenario, is not happy with this move for obvious reasons; worst case scenario is that the derivatives lose 2% of their value and wipes out the $1 trillion in deposits. So the FDIC went to the Federal Reserve to try to stop the transfer and the Federal Reserve said, no – no problem. So, now, the FDIC is forced into being the back-stop for BofA’s derivatives gambling operation; the FDIC is back-stopped by the full faith and credit of the United States Government – downgraded credit but still; and of course that means that you and me and everybody else is on the hook.

Did you ever hear the story of Sir Walter Raleigh? In today’s drama, Sir Walter Raleigh is played by the Federal Reserve; Queen Elizabeth is portrayed by Bank of America, and the cape that gets laid over the puddle of mud and trampled on is, of course the American Taxpayer.

So, what exactly was the Rumor of the Day the lifted the markets to triple digit gains? Let’s look at Europe. France and Germany have agreed to boost the EFSF, that’s the eruoland bailout fund, boost it to $2.7 trillion dollars. Britain’s Guardian newspaper reports they will present the plan at this Sunday’s euro crisis summit. The paper said confidence that the plan would be approved at the summit was on the rise after Moody's warned it might put France's top AAA credit rating on review, citing the cost of bailing out troubled banks or other members of the EU. Then Reuters reported the story and they found a source that said – no, it ain’t necessarily so.

So, we have a new pattern developing – rumor, disappointment, rumor, disappointment. And remember what we talked about – Patterns are not perpetual – which is to say I would not feel comfortable being long over the weekend.

Late in the trading day, which makes this a potential market mover for tomorrow: Moody’s cut Spain’s rating two notches to A1. In making the cut, Moody’s said: Since placing the ratings under review in late July 2011, no credible resolution of the current sovereign debt crisis has emerged and it will in any event take time for confidence in the area's political cohesion and growth prospects to be fully restored.

And lest you think there is an actual solution to the problems in Euroland; within the next few hours, Greece will be closed. It will remain closed for two days. Greek newspapers are calling it the mother of all strikes. The Greeks are protesting increased taxes and austerity cuts – I think that rhymes with something – and so Greece will be closed

Occupy Wall Street is now Occupy Everywhere. It is Occupy 70 countries. It’s even Occupy Phoenix. The movement has attracted widespread support as it marks its one-month anniversary. So far, my vote for the most unexpected supporter of the movement goes to Mohammed El Erian, he heads the world’s largest bond fund, PIMCO. He writes, “A peaceful drive for greater social justice can unify people from diverse cultural backgrounds, political affiliations, religions, and social classes…Through constructive collaboration, the movement’s energy and intensity can – and hopefully will — be combined with other influences to formulate forward-looking solutions for an America that must desperately regain its economic vigor, provide more jobs, and deliver better on its traditional commitment to social fairness and equal opportunities.”

PIMCO seems like the personification of the Wall Street caricature. So, what would motivate El-Erian to take up the cause? Well, PIMCO has its own grievances with the banking establishment. PIMCO is currently in a legal battle with another major fund company, BlackRock, against Bank of America over its mortgage backed securities losses in 2008.

The headline of the day comes form the Chronicle of Higher Education: “Intellectual Roots of Wall St. Protest Lie in Academe.” So on the one hand, Occupiers are accused of being uninformed while on the other hand they are accused of garnering advice from people who have expertise in particular fields.

Obama is continuing his campaign-style effort to promote his jobs package in appearances in North Carolina on Monday. And he appears to be voicing sympathy for the Occupy Wall Street Movement.

What do you call someone who jumps out in front of a mob and tries to turn them into a parade? (a politician)

One thing we are learning is that the protesters are not uneducated – they are increasingly showing they are quite bright, quite clever

Can tax cuts “pay for themselves” – inducing so much additional economic growth that government revenue actually increases, rather than decreases? I’ve heard the arguments of the Laffer Curve. I’ve interviewed Art Laffer, and frankly he can’t get his formula off the cocktail napkin it was drawn on. The question comes up because “Dynamic scoring,” has apparently surfaced in the supercommittee charged with deficit reduction – the joint congressional committee with 12 members. Dynamic scoring sounds technical or perhaps even scientific, but here the argument means simply that any pro-growth effect of tax cuts should be stressed when assessing potential policy changes (e.g., reforming the tax code).  Even if we allow that there is a positive benefit, I still can’t figure this next news article:

Accord­ing to the Asso­ci­ated Press, Sen. John McCain (R-AZ) sent a let­ter to the bipar­ti­san bud­get super­com­mit­tee in which he indi­cated he is open to cost-saving steps in mil­i­tary ben­e­fits.

The AP reports that McCain indi­cated his sup­port for Pres­i­dent Obama’s pro­posal to start charg­ing older mil­i­tary retirees a $200 annual enroll­ment fee for TRICARE for Life. In addi­tion, McCain urged the super­com­mit­tee to con­sider restrict­ing working-age mil­i­tary retirees and their depen­dents from enrolling in TRICARE Prime. McCain pointed out that the Con­gres­sional Bud­get Office has esti­mated that such a move would save $111 bil­lion over 10 years.

McCain also said he sup­ports the administration’s pro­posal for a com­mis­sion to review pos­si­ble changes to the 20 year mil­i­tary retire­ment sys­tem and the cur­rent mil­i­tary pay and com­pen­sa­tion model.

As of October 1, 2006, 413 retired Members of Congress were receiving federal pensions based fully or in part on their congressional service.  Of this number, 290 had retired under CSRS and were receiving an average annual pension of $60,972. And a Senator is eligible for the pension after only 5 years of service.

I guess the idea is to take way any positive economic benefit that might come to veterans having affordable health care and passing that benefit to the health care company running Tricare.

This next story is just a follow-up on a story I first told you about three weeks ago. I mentioned the CPI-W inflation gauge and how it should result in an increase in Social Security payments. Now it’s official. Some 55 million Americans can expect their first increase in Social Security benefits in three years. The increase in benefits, which is likely to end up around 3.5%, will first show up in government checks sent out in January 2012. The exact size of the increase will be determined Wednesday when the Labor Department releases the consumer price index for September. Annual adjustments are based on changes in the so-called CPI-W gauge during the U.S. government’s fiscal year, which runs from October to September.

The average Social Security recipient now receives about $1,175 or month, or $271 a week, according to the Social Security Administration. The average benefit could climb by $350 a year, or $35 a month. Now for the downside – higher Medicare premiums will likely eat up most of the higher income.