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Mark's Market Blog

11-6-10: Bernanke Puts the Pedal to the Metal

By Mark Lawrence

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In spite of my predictions for a reversal, the market leap up on news that Bernanke was spending $75B to $100B per month with the express goal of pumping up the stock market. The markets are also allegedly very excited about the election results: apparently it's thought that a hung government is a good thing. This is a very sad commentary on the overall trust we have in our political process and the people we choose to run this country. For the first time this year, bank stocks went up faster than the market as a whole. This is especially noteworthy as BofA's troubles have intensified and their stock is tanking. In this financial crisis banks have and will continue to lead the market. On this basis I now project that the markets will trend upwards for at least the rest of the year.

S&P 500 May 9 2010 to November 5 2010

S&P 500 v. Financial Stocks 2010

In my last blog of 2009 I predicted the republicans would win the House but not the Senate. Last week I predicted republicans would win 245 seats in the House, 49 in the Senate, Harry Reid loses. The democrats did a surprisingly good job of beating the bushes to get their vote out, and Reid miraculously kept his job. The republicans took the house - the exact number is not finalized yet, but over 240. There will be recounts and likely some lawsuits, we won't know the final answer for a month or two. In the Senate it appears they will take 47 seats. So far they have 29 governor posts, with two yet to be determined. You'll be shocked, shocked to hear that Minnesota, which took a couple extra months to count their last Senator vote, hasn't finished counting their Governor vote.

Republicans are making noise about refusing to raise the debt ceiling. If they do this, then the treasury will be unable to issue new bonds to roll over our debt, and unless the Fed can engineer some brilliant new bailout, the US will quickly go into default. This would put the entire world on a cash only basis as the dollar, the world's trade currency, would have unknown value.

The jobs report for October came out, we "created" 150,000 new jobs. Keep in mind we need to create 125,000 just to keep up with population growth. At the same time other statistics seem to show that total employment hasn't changed, it would appear that what really happened is that 150,000 people quite looking for work. Anyway, even trusting the government's suspect numbers, getting back to pre-recession employment levels will take six to eight years on present trends.

Jobs in Recessions since 1945

Bank of America is now fighting for survival. Citi is most likely not far behind. The issue is bad disclosure on the mortgage backed securities they sold in the last five to eight years. It's more and more seeming that they will be forced to buy these back at a loss of perhaps as much as hundreds of billions of dollars. These cases will drag through the courts for several years - BofA will not die of a bullet through the heart, but rather "the death of 10,000 cuts." My take: it couldn't happen to a nicer group of guys. Years ago there was a bumper sticker in California that said, "Haven't had any sex lately? Try doing business with the Bank of America."

Last week the EU announced that after 2012 some countries would be allowed to default on their debt. Since then interest rates and CDS rates on Portugal, Ireland, and Greece have been skyrocketing, as investors come to grips with the idea that their poor judgement may result in their taking a loss instead of German taxpayers.

Ireland 10 year bond yield 2010

The Fed announces QE2 this week. QE, Quantitative Easing, is where the Fed basically buys junk bonds from banks, swapping them for treasury bonds. Banks love this, of course. QE1 bailed out the big banks and bumped up the stock market a bit, but did nothing for unemployment or the economy as a whole. Bernanke is no fool; although he's selling QE2 as a stimulus program, I believe what's really going on here is he sees the mortgage crisis returning, and he wants to be ready to bail out the banks - something it's clear the new congress will not do. Ask not for whom the bell tolls, it tolls for BofA, not you.

The Fed has announced that they want inflation running at about 2%. Why? Well, the Fed thinks they can stimulate the economy by lowering interest rates. This hasn't been working for the past two years, but. . . Anyway, the Fed cannot lower interest rates below zero - they can't pay us to take their money. But, if there's 2% inflation, then the current 1/2% short term rates are effectively negative interest. So, we can now understand the Fed: they're going to lower interest rates to raise inflation, because then lowering interest rates will have some effect. Get it? In physics, we have this idea we call Causality: if A caused B, then A must have happened before B. Like, if the nail caused your flat tire, the nail must have hit the tire before it was flat. In Fed Economics, apparently Causality is if A causes A, then A will cause more A and then everyone will get a job. But if A doesn't cause more A, then you need to do more A until A does cause A. In engineering, we call this "pushing on a string." I'm sorry, was that confusing? Don't worry, a few trillion dollars from now everything will be clear. Honestly, two years ago, before this crisis started, I didn't know what the Austrian school of economics was - the school that believes governments mostly only draw problems out and make them worse. Now I am one.

In the currency wars, the dollar continues to drop, raising prices on imports and lowering prices on exports. Most Asian currencies are tied to the dollar, so they haven't moved much compared to the dollar. The Euro, however, has gone through the roof. Why has the European Central Bank allowed this? A rising euro means that troubled European economies can't export their way back to solvency. Here's the problem: when the Fed prints dollars, the value of the dollar drops. When the ECB prints Euros, everyone thinks they are solving the PIIGS crisis and the Euro rises. If the ECB stops printing Euros, then people get scared of the PIIGS and the Euro drops - good for Germany, very bad for everyone else. The ECB finds themselves holding a steering wheel that's not connected to anything. Meanwhile, the Asian countries are getting scared of asset bubbles caused by the Fed flooding the world with money. More and more countries are putting on currency controls and buying dollars like mad to try to protect their economy. Why are they buying our more and more worthless dollars? We have the world's only consumer economy - the world economy is all about getting your people jobs to make crap to sell to Americans. Swedes, by comparison, have a per capita GDP that's almost the same as the US, but the average Swede lives in a 750 sq.ft. 3 room apartment without a garage. You just can't accumulate huge quantities of stuff in 750 sq.ft and no garage.

9.27% of mortgages are delinquent, and another 3.84% are in the foreclosure process for a total of 13.11%. Roughly 1 US home in 7 is in serious trouble.

State bailouts have already begun. Over 20% of California's debt issuance during 2009 and over 30% of its debt issuance in 2010 to date has been subsidized by the federal government in a program known as Build America Bonds. Under the program, the U.S. Treasury covers 35% of the interest paid by the bonds. Arguably, without this program the interest cost of bonds for some states would have reached prohibitive levels. California is not alone: Over 30% of Illinois's debt and over 40% of Nevada's debt issued since 2009 has also been subsidized with these bonds. This will be changing shortly - when California's democratic governor Jerry "Moonbeam" Brown and two democratic senators Feinstein and Boxer join Pelosi in lobbying the republican house for money for a California bailout, to prop up California's leftist unionized state, how far do you suppose that goes?

AIG sold off some more Asian subsidiaries, raising $37B. This money will be used to pay off loans from the Fed. The treasury will then most likely choose to change their stake from preferred shares to common shares, and start selling them off. If the price of AIG stock more or less holds up, the treasury stands to make a profit. I find this stunning, I would have bet money that AIG would wind up a $100B black hole. It turns out that the government will overall make a profit on TARP. Before you get all excited, it's worth remembering that Fannie Mae and Freddie Mac stand to cost the taxpayers something in the neighborhood of $400B - $500B.

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