Friday, September 28, 2012

Friday, September 28, 2012 - Eat Cake

Eat Cake
by Sinclair Noe

DOW – 48 = 13,437
SPX – 6 = 1440
NAS – 20 = 3116
10 YR YLD un = 1.64%
OIL + .25 = 92.10
GOLD – 6.50 = 1772.10
SILV - .17 = 34.59
PLAT + 13.00 = 1669.00

There are bad things and they are bad. There are good things and they are good, even though the bad things are bad.

Let me give you an example; You probably know I'm not a fan of the Federal Reserve. I believe there are better ways to conduct monetary policy. This does not mean the Fed's monetary policy doesn't work. You've heard the old adage, “don't fight the Fed”. In case you haven't noticed, the stock market has doubled in the past 3 1/2 years. That's good, even though the bad things about the Fed remain bad.

And the stock market has been performing much better than seems possible. As the third quarter comes to an end you might think about the problems in Europe and the slowdown in China; you might think about the slowdown in the US with the economy growing at an anemic 1.3% pace, the seemingly never ending housing recovery, the interminably high unemployment; and you might think of the looming fiscal cliff and the dysfunctional political bickering as corrosive elements sucking the life blood out of the economy; and you might think the best investment opportunities are in freeze dried foods and concrete bunkers – but no. The stock market has been sweet.

The S&P 500 Index has gained more than 5.8% in the current quarter and 15% since January. The Dow Jones Industrial Average is up nearly 4.3% in the past three months and 10.4% year-to-date. September is always a scary month in the markets; it is the month most likely to wipe out a portfolio. Seasonally speaking the stock market avoided a September surprise with a 2.4% gain. Next Monday we move into the fourth quarter, the best three-month span for returns over a 20-year, 50-year, and even 100-year period. According to the Stock Trader's Almanac, stocks have advanced in every fourth quarter since World War II (excluding 1948) when an incumbent president wins the election. No guarantees. The second scariest month in the stock market is October. The fourth quarter has some potentially big market moving events that will not tolerate complacency. The third-quarter earnings reporting season kicks off in October and it might be the weakest earnings season in the past 3 years.

Still, you look over a chart of the S&P 500 for the past 3 ½ years and you are looking at a massive bull market. It is a little bit amazing when you think about everything: the Flash Crash (make that crashes), Euro double dip, Euro riots, BRIC slowdown, debt ceiling debacle, oil spikes, unemployment, etc., etc., etc.. Just goes to show you. Even though the bad things are bad, there are good things, and they are good.

And that brings us to today's edition of Banks Behaving Badly. Bank of America says it has agreed to pay $2.4 billion to settle a class-action lawsuit related to its acquisition of Merrill Lynch. Shareholders alleged that Bank of America and some of its officers made false or misleading statements about both companies' financial health.

The lawsuit was filed on behalf of investors who bought or held Bank of America stock when the company announced its plans to buy Merrill Lynch in a $20 billion deal back in 2008; you may recall it was the same weekend that Lehman Brothers collapsed. Bank of America didn't tell investors all the details about the huge losses that were occurring in Merrill's fourth quarter. There was general reference to losses, but never was the magnitude of those losses disclosed. The transaction came into question later after Bank of America disclosed that Merrill would post $27.6 billion in losses that year. BofA ended up taking about $45 billion in bailouts.

The Securities and Exchange Commission won a $150 million settlement from Bank of America in 2009 to resolve charges that it misled shareholders when it acquired Merrill; but this was different; they failed to disclose to shareholders before they voted on the Merrill deal that it had authorized Merrill to pay as much as $5.8 billion in bonuses to its employees in 2008 even though the investment firm lost $27.6 billion that year. And a major civil fraud suit against Bank of America and former CEO Kenneth Lewis remains pending from New York state.

So, BofA will pay $2.4 billion to settle the case but they are not admitting any wrongdoing. Makes you want to holler; throw up both your hands.

While it might be a challenging third quarter earnings reporting season for many industries, there is one sector that is expected to do well – the big banks. And the biggest banks are likely to profit from the same thing that got them into trouble five years ago: mortgages. The fees generated from making mortgages will be a big profit center. There has been a small boom in refinancing activity and that is likely to last for the next year or so. Banks benefit from the fees they get from closing loans, but also from the fact that investors want more mortgages than lenders can easily make. When a bank makes a new loan, it can quickly sell it off to investors at a relatively high price.

Over the past year, with the Fed acting as a backstop, the interest rates have dropped but the spread, the difference between what the banks charge the home-buyer and they amount they sell the mortgage-backed security to investors – that spread has doubled. If the spread was the same as it was one year ago, the mortgage rate on a 30-year fixed would be about 2.8%. Yesterday, Freddie Mac said the average rate for a 30-year home loan fell to a record low of 3.4 percent. That difference or spread is just profit for the big banks.

So, next week Wells Fargo and JPMorgan Chase are both expected to post more than $4.5 billion in profits for the third quarter, an increase of more than 15 percent from last year. Fixed-income trading revenue will likely rise at the investment banks, thanks in part to more trading in mortgage-backed securities.

The University of Michigan-Thomson Reuters consumer-sentiment gauge rose to a final September reading of 78.3 — the highest since May — from 74.3 in August.

The Commerce Department reports consumer spending rose by 0.5% in August; that's the fastest rate since February. Personal income inched up 0.1% last month on a seasonally adjusted basis. After-tax incomes adjusted for inflation, meanwhile, actually fell 0.3% last month. This may sound obvious, but it is worth noting; consumers cannot keep spending faster than their incomes grow, especially since their savings rate is already on the low side.

I ran across a guide published by Fidelity Investment, and it looks at how much you should have saved at various points in your life in order to be on track for retirement. Obviously, the best thing is to start saving money at an early age and let the power of compounding help. Here's how much you should have saved at different ages in order to have a retirement paycheck that matches your working paycheck:

Start at age 15, and you need to save 8% of annual income for life.
Start at age 20, and you need to save 11.1% of annual income for life.
At age 25 you need to save 15.4%.
At age 30 you need to save 21.4%.
At age 35 you need to save 30.1%.
At age 40 you need to save 43.2%.

At age 50, you need to save 100%. If you earn $100k at age 50, and you only save $50k, then your saving strategy will only allow you to retire on a $50k lifestyle. So, you need to lower your expectations, or maybe buy a lottery ticket.

Spain’s bank stress tests came and went Friday evening in Madrid. Of 14 Spanish banks subjected to the tests, seven will need an additional $76 billion in capital, which was widely expected. There are still bigger problems in Spain. This week, Spain announced budget and economic reforms, and there was social unrest and protests. Spain's richest region, Catalonia, is calling for independence, part of the mounting political fallout from an economic crisis that is far from resolution. So far, Spain's Prime Minister Mariano Rajoy has resisted going to the ECB for a bailout that would include submitting to the humiliation of internationally imposed austerity measures to qualify for the rescue.

Riot police fired tear gas at an angry mob throwing gasoline bombs during a general strike in Athens today, a day after Spanish police shot rubber bullets at leftist protesters attempting to storm parliament, where lawmakers were mulling more austerity. Days after it seemed European policymakers may have finally launched a drive to save the continent's single currency, the euro zone's battlefield is spreading from trading floors to the streets. Last week, a march by half a million Portuguese forced the government to climb down over planned cuts to workers' take-home pay. Portugal is a small country; only about 10 million people. A half-million Portuguese taking to the streets is significant; it's like the entire capitol city of Lisbon was protesting in the streets. About a week ago, 1-and-a-half million people marched in protest through Madrid.

I see almost nothing about these protests on the nightly network news. A couple of weeks ago, ECB President Mario Draghi promised to do whatever it takes and then the European Central bank promised to buy the bonds of troubled governments if necessary. And all the debtor nations had to do was was agree to more and more austerity. The markets were downright giddy with the prospect of open-ended quantitative easing from the ECB. Then the Greeks and Spaniards and Portuguese had strikes and huge, massive demonstrations. It turns out that austerity has already gone too far. The people on the street don't give a damn about bailing out the banks and the bondholders.

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