February 10th Working Capital Newsletter

February 10th Working Capital Newsletter

Liquid Capital Blog

Feb 24, 2012 | Hadaf Zubi

Hadaf Zubi
Liquid Capital™
Canadian Head Office
Toronto, ON


LCC's Weekly Economic Update – Week ending February 10th, 2012

Hadaf Zubi

(All figures collected Friday, 4pm EST)

Complicating the Recovery


The big news story this week, other than the Euro testing resistance at $1.32 and dropping due to yet another failed Greek 'resolution', is the $25 Billion mortgage agreement signed between five big US banks and the Attorneys General of 49 states. The deal consists of $20B in mortgage adjustments and $5B in cash fines, with Bank of America paying-out $11.8B, including $3.24B in cash. The US government is attempting to bring-on more lenders, and the total settlement could total close to $40B. The only state not to agree was Oklahoma, which signed a separate deal worth $18.6 Million.

This deal only covers the State Attorney Generals, so private liability (i.e. lawsuits over CDO's) is still an issue. Since the liability ring-fence was so narrow, the markets did not look favorably on this deal and Bank of America declined 1.34% on a day when the broader S&P 500 index only dropped 0.69%. The liability covered by the agreement covers improper foreclosure procedures, but not illegal registration of mortgages through the bank-owned Mortgage Electronic Registration Systems. The New York AG's office is currently pursuing this avenue, so the specter of further bank losses certainly haunts this deal. In addition, although the terms of the agreement are public, the deal itself is not fully developed and no term sheet has been made public so there's still a great deal of uncertainty attached to this arrangement.

The bullish impulse that intensified over the past two weeks is starting to abate. Initial buying pressure was due to some degree by record amounts of dollar liquidity being loaned at a near-zero interest rate to European banks by the Fed. This action drove the S&P 500 higher from ~1200 in mid-December to its recent peak of 1354 on Thursday, a gain of ~13%. Although this is encouraging, as the crisis in Europe returns to the forefront of investor thinking the volatility index (VIX) has begun to creep-up again, closing the week at 20.86. From 1990-2007 the VIX bottomed during periods of market calmness at around 10.5. Since that point, it has begun bottoming at around 15, indicating that the market has about 50% more baseline volatility compared with recent history. As well, it is key to note that this increase in volatility has occurred during a period where trading volumes are dropping rapidly.

This increased systemic volatility has lead to a migration out of stocks and into bonds, even though the bonds of developed nations can't beat inflation. The Investment Company Institute, which compiles industry statistics for mutual funds, is reporting that total equity fund outflows in January were likely in the $7B range, which though improved from $28.8B out in December, is not signaling a turnaround quite yet. The first week of February saw an estimated draw-down of $1.7B. Last week Larry Fink, the CEO of BlackRock Inc. (a $3.5T New York-based asset management firm), openly called for investors to start investing again in order to “get our economies moving again”.

The problem with his appeal is that it comes at a time when housing prices are still falling and wages are deflating in a background of increased volatility. Although consumer credit increased $19.3B in December, personal spending for the month was flat. This indicates that consumers are using credit to maintain their lifestyle, not expand their spending patterns. Aditionally, data from the Energy Information Administration shows that gasoline shipments are dropping because consumers are driving less.

Companies are flush with liquidity, but corporate credit is not being extended, as the Credit Manager's Index for January showed an increase in applications, but also an increase in rejection and a decrease in the amount of credit extended from a level of 64.7 in December to 63.3 in January. Globally, weakening demand from China (15.3% drop in January imports from last year) and a pickup in domestic Chinese inflation from 4% in December to 4.5% in January indicates that the Chinese government is limited in their ability to stimulate growth through more quantitative easing. As such, the money supply in China only grew 3.1% in January, a drop from 7.9% in December and roughly 15% growth this time last year.

As well, we're seeing very weak coal prices and coal industry equities (American metallurgical coal prices are down from 2011 peak of ~$84 in April/May 2011 to $58.17 today with a '09 low of $60). Coal equity appreciation would suggest a global industrial recovery is in the cards, but since coal prices and equities are still declining this suggests that temporarily good data (i.e. a 'good' jobs number based on seasonally warm weather and part-time jobs) should be watched carefully and that caution is still prudent.





The LCC Working Capital Newsletter© is meant as a source of financial opinion only. It in no way reflects the opinions of Liquid Capital Corp. Nothing in this document is to be construed as an offer to buy or sell securities.

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