ECON435: Financial News Analysis

Financial News: Groupon, Europe rating and U.S. economic activity

2011-12-12T16:42:00.000-08:00

(by Jake Sodeman)

Looking at the Dow Jones Industrial Average over the past three months, one will notice a great amount of volatility in the market. There are periods of major increases, which are evident with the nearly 2,000-point gain between late September and late October. However, shortly after this period the Dow faced its worst Thanksgiving week since 1932. In fact, Bank of America, HP, and Caterpillar all fell around 8% during this week alone. Experts attribute this rapid decline to a number of factors. First, many fear that the European debt crisis is likely to spread. Also, news broke that American policy makers were unable to reach an agreement on reducing the federal budget.

A stock that I have found particularly interesting, as of late is Groupon. Groupon’s initial public offering came on November 4^th of this year at the price of $20. The stock’s price quickly increased but flattened out and eventually began to decline. Unconventional accounting methods used by the company have skewed earnings and left investors skeptical. This combined with poor reports about the company’s 4^th quarter earnings have brought the stock to the level it currently trades, below the IPO price. The predictions about Groupon’s long-term future are mixed, however, the majority of them aren’t bright for the Internet based company. Specialists agree that the company’s lack of ability to innovate and the number of emerging competitors may eventually lead to Groupon becoming obsolete.

A major financial development that took place yesterday, the S&P notified 15 Euro nations that their credit rating would be under review. Six of these countries are currently rated at AAA, including France and Germany. Once this news was announced the Euro reversed its gains for the day and the U.S. treasuries began to rise. This news has the potential to greatly impact the European Financial Stability Facility (EFSF), which is the bailout fund for struggling European nations. It has helped Greece and Ireland in their recent tough economic times. Unfortunately, if the EFSF is forced to pay higher interest rates on bonds then the amount of help it can provide to nations in trouble will be limited.

The unemployment rate went down by .04% to 8.6% in November 2011. There were a total of 140,000 jobs added to the private sector and a loss of 20,000 government jobs coming to a total of 120,000 jobs for the month of November. Most of these jobs come from the retail trade sector (clothing and electronics) contributing 50,000 jobs. Being that it is the holiday season and yet again we have had record breaking black Friday and online shopping for the season gives lots of speculation about jobs that come form retail. Are these jobs long term and will they sustain?

With all of this consumption lets turn to the other side of things, American exports. In the past nine months the U.S. has exported 121 million barrels of gasoline. This is 430,000 more barrels than it imported in September of 2011. This sudden export stems from many reasons. The first being that due to the U.S. demand for gasoline has come down 10% in the past couple of years. Low demand could be a result of the recession and the fuel efficiency of vehicles. Intern because of this low demand U.S. refineries have been refining more gasoline than there is demand for. With this surplus of gasoline refineries have been able to look to other markets such as Mexico, Brazil and Chili to export.

The Keystone Pipeline is one of the main reasons for this as well. A pipeline that now reaches form Hardisty Canada to Steele City, NE and across Wood River and Patoka, Il. But now TransCanada is looking to make another crude oil line (Keystone XL) that would reach all the way to the Gulf refineries. Increasing the total pipelines capacity from 591,000 bpd to 1.3 million bpd. There are many pros and cons to this pipeline. One pro is Jobs, 13,000-20,000 construction and manufacturing jobs to help lay the pipeline. Another is property tax going to the states that the pipeline is going through. Cons include environmental impacts and the cost that comes with spills (Deepwater horizon). Also, the way the pipeline is laid out now it goes through a large aquifer in Nebraska. This aquifer supplies drinking water to many Americans and it would be devastating if this were to be contaminated. This type of oil line needs a Presidential approval and needs to be considered and well though out.

Financial News Analysis Oct

2011-12-10T10:22:00.000-08:00

Banking situation in China and current U.S news by Xu Han and Jermaine Williams

Banking system in China is unique; it has one central bank, 2 policy banks and 4 big nationalized commercial banks. Policy banks are basically enforcing central bank’s policy and government programs while the big 4 commercial banks are focusing on loans and investment in different areas. However, starting last year the four biggest nationalized commercial banks started having problems.

Agricultural Bank of China and China Construction Bank are mainly focusing on assisting policy banks while Industrial & Commercial Bank of China (ICBC) and Bank of China are focusing on private loans and investment. The first big problem for the big 4 commercial banks in China is fewer money coming in while more loans lent out. First 3 quarters of this year, excluding central bank all bonds issued by other banks was 670 billion dollars and 90% proportion of newly issued bonds were either lent out or spent in investment including the big 4 banks. The credit lent out for these 4 banks in first 3 quarters increased by 16% relatively to previous year. The ratio of deposits over credit is decreasing due to big corporations withdrawing/transferring funds out of the banks. Alone with losing funds storage, growth rate of M2 also slowed down in first 3 quarters, so it is getting harder for these banks to collect funds. Other than the regular loans lent out by the 4 banks, they also issued credit expansion of 33 billion dollars in first 3 quarters following the new policy made by central bank.

The second problem with these 4 banks is the risk of the loans and investments they made. Total of 26% loans in proportion these 4 banks lent was to real estate firms and Real estate developing investment increased by 32% in first 3 quarters. Due to the huge housing bubble in China these years Chinese government decided to step in forcing the drop of housing price. As this policy issued by government is taking place, the big 4 will eat the loss. In addition, Construction Bank of China is focusing on small business this year that 90% of the loans they lent was to small & home businesses. Due to the continually increased wage rate (7.8% for tier1-2 cities, increased 13.6% for tier3-4 village and towns) in China this year many foreign firms started withdraw their factories out of China. To prevent high unemployment rate, Construction Bank started massively lending to new small businesses this year regardless of the risks while the two policy banks are backing it up. Agricultural Bank of China is also taking too much risk in order to help national corporations. For instance it has to lend 20 million dollars to China Rail Way Construction Corporation who just had two train crashes this year. On the other hand, ICBC and Bank of China are taking too much risk in international market. ICBC just spent 600 million dollars bought 80% stock rights of Argentina standard bank and Bank of China is planning to invest in retail banks in UK by buying part of Lloyd banking group in UK. After the big losses these two banks had since recession in 2008 people think they should both stop foreign investment but they are still on the move even the eurozone crisis is taking place.

The financial news for the week of November 10, 2011 brought a first class view of panic and major losses in the stock market. For many years economist have tried to figure whether globalization is good or bad for economies and have often revealed mixed emotions on the topic. The Euro debt crisis continued to effect markets around the world, which indicates the negative side to globalization is in full effect. And unfortunately, the three major indices of the US experienced the negative aspect. In the news, Silvio Berlusconi was scheduled to resign amidst the crisis. His resignation was thought to relieve market pressure but instead the announcement of resignation intensified market fears about Italy huge debt load.

How huge? Well the Italian 10yr. debt rose to 7.4%. In the world economy, 7.4% is dangerously high, as seen with countries such as Ireland, Portugal, and Greece, all of which needed bailouts. The problem is Italy is too large for the European Union and IMF to bail out. And amidst the crisis of Greece and then Italy, German Chancellor Angela Merkel and French President Nicolas Sarkozy talked about possibly reorganizing the make-up of the EU, hoping it might be better to push for deeper integration but less expansion. This meant some countries would have to drop the Euro. Once again the argument of globalization is in effect and thus led to US markets diving. The DOW experienced it biggest single day loss since September 22 (-3.2%) while the NASDAQ and S&P 500 experienced biggest losses since August 18(-3.88% and -3.67%). The two major banks also felt the shock from the Euro debt crisis/Italy crisis; Bank of America ended the day with a 5.67% loss and JP Morgan Chase ended with a 7.08% loss.

As you can see, the news in Europe is equally important here in the US. Implications are that if the problem persists, Europe may enter a mild recession which would directly affect our exports, mainly in the technology and consumer goods industry. The US exports about 28% in sales of automobile and component companies while exporting 22% in food, beverage, and Tobacco.

¨ People.com.cn

¨ http://finance.people.com.cn/bank /

¨ http://finance.people.com.cn/bank/GB/202339/202449/index.html

¨ http://finance.people.com.cn/bank/GB/16072888.html

¨ http://finance.people.com.cn/bank/GB/16120189.html

¨ http://paper.people.com.cn/zgjjzk/html/2011-11/08/node_1422.htm

¨ http://paper.people.com.cn/zgjjzk/html/2011-11/08/content_955605.htm?div=-1

¨ http://finance.people.com.cn/GB/14280818.html

¨ Xinhuanet

¨ http://news.xinhuanet.com/fortune/2011-08/08/c_121825410.htm

¨ Ifeng HK

¨ http://finance.ifeng.com/bank/zzyh/20110731/4329099.shtml

¨ WallstreetCN.com

¨ http://wallstreetcn.com/node/3292

¨ news sohu

¨ http://news.sohu.com/20111018/n322537793.shtml

¨ Politics Live: G20 discusses eurozone crisis – Friday 4 November 2011

¨ http://www.guardian.co.uk/politics/2011/nov/04/g20-leaders-eurozone-crisis-live-coverage

¨ http://www.reuters.com/article/2011/11/09/us-eurozone-idUSTRE7A831520111109

¨ http://www.marketwatch.com/story/margin-boost-pushes-italy-yields-to-brink-2011-11-09

¨ http://www.marketwatch.com/story/us-stocks-drop-more-than-3-on-italy-debt-fears-2011-11-09

¨ http://finance.yahoo.com/blogs/breakout/why-u-markets-entangled-eu-crisis-174502476.html

Financial News Dec 1st

2011-12-09T00:22:00.000-08:00

On Nov 30^th, in the Euro Zone, the big news is that 6 large central banks, including the Federal Reserve, the European Central Bank, and Central Banks of Canada, Japan, England, and Switzerland, have coordinated to drop the interest rate on US Dollar Swap Lines, which provide loans to ailing central banks. The move will drop the rates by half a percentage point. This move is designed to ease the strain of the financial crisis on small European banks, allowing them to keep extending credit to European households and businesses and prevent the downturn from worsening.

In a move unrelated and uncoordinated with the other central banks, China’s central bank reduced its reserve requirement by ½ a percentage point, freeing up 390 billion yuan (or $61 billion dollars). This move indicates that the Chinese government is worried about keeping growth high and even at the risk of inflation or prolonging its property bubble.

Also in Europe, Germany’s Finance Minister Wolfgang Schaeuble announced that Germany was open to increasing IMF resources, reversing Germany’s previous stance. Additionally, Germany is pushing for greater powers for the European Commission to adjust the budgets of EU countries that breach EU deficit and debt rules.

Just this morning, the Spanish Treasury successfully sold around 4 billion Euros of bonds. These were 4, 5, and 6 year bonds with yields from 5.2 – 5.5%. These yields are about 60 basis points lower than their peak in mid November and the fact that all of their bonds sold provides some relief (at least in the short term).

Though there haven’t been any major developments yet, all eyes are looking forward to the December 9^th EU Brussels Summit. Here the heads of EU countries will meet and make some major decisions about the future of the Euro Zone. Items on the agenda include the financial crisis and a report from EU finance ministers, debate over bringing Turkey into the EU, and a draft 2014-2020 budget.

In domestic news, the US is expected to become a net exporter of petroleum products in 2011, importing 689 million barrels and exporting 753 million to date. This is a large shift from 2005, when the US imported 900 million barrels more than it exported. This shift is a result of dropping US demand as consumers shift to more energy-efficient vehicles and rising production capacity. Despite these developments, energy prices in the US are expected to remain high due to the high foreign demand.

In the stock market, the news about coordinated action between the Fed and other central banks caused the market to skyrocket. The Dow closed Wednesday up 4.2% to a total of 12,046, the S&P 500 closed up 4.3% at 1247, and the Nasdaq closed up 4.2% at 2620. Other contributors to this rise include positive reports in unemployment and housing, and news of looser Chinese monetary policy.

Wednesday’s gains were the biggest single day gains since March 2009. The gains brought the Dow into the positive for the year to date, with the S&P 500 and Nasdaq still down slightly since January.

There is some good news in U.S economy in the past week.

Better-than-expected housing and regional factory data released on Wednesday suggested the U.S. economy was moving more solidly toward recovery. The economy expanded at a 2 percent annual pace in the third quarter, which is better when compares with growth of 1.3 percent in the second quarter and 0.4 percent in the first three months of the year.

The ADP National Employment Report on Wednesday showed private employers added 206,000 jobs this month, surpassing economists' expectations for a gain of 130,000 jobs. It was the biggest gain since December 2010. Small businesses hired the most workers, at 110,000, while medium businesses added 84,000 jobs and large businesses hired 12,000 people. Friday's non-farm payrolls report, which includes both public and private sector employment, is expected to show a rise in overall non-farm payrolls of 122,000 this month.

National Association of Realtors Pending Home Sales Index, which is a forward-looking indicator based on contract signings, jumped 10.4 percent to 93.3 from 84.5 the month before. It was the biggest monthly gain since November 2010.

Economists forecast the confidence gauge would improve to 53, according to the median of 78 projections in a Bloomberg survey. The Conference Board revised the October index down to 49.9 from a previously reported 50.2. Confidence among U.S. consumers rose in November to the highest level in five months.

Cyber Monday sales increased 22% over last year, up to $1.25 Billion. Many retailers are continuing discounts through the week, terming it “Cyber Week”

Walt Disney Co., owner of the namesake theme parks and ESPN sports network, increased its annual dividend by 50 percent, the most in at least 20 years. Disney rose 5.4 percent to $35.85 at the close in New York, a day when the Dow Jones Industrial Average advanced 4.2 percent and every company in the 30-stock index gained.

Boeing and the machinists’ union announced a far-reaching four-year contract extension, which represented a new day between the often-feuding sides. Under the tentative agreement, Boeing would raise wages, improve pensions and add thousands of new assembly jobs in Washington State to build an updated version of its 737 jet.

Standard & Poor's cut its ratings on 15 big banks such as Bank of America Corp and Morgan Stanley, Citigroup Inc. on Tuesday, as it seeks to give more insight into its methods and repair its reputation after the credit crisis.

References:

http://www.reuters.com/article/2011/12/01/us-spain-bonds-idUSTRE7B00SR20111201

http://www.newsahead.com/preview/2011/12/08/brussels-8-9-dec-2011-poland-hosts-final-summit-of-its-eu-presidency/index.php

http://www.reuters.com/article/2011/11/30/us-eurozone-idUSTRE7AR0P320111130

http://online.wsj.com/article/SB10001424052970204012004577069804232647954.html?KEYWORDS=china+monetary+policy

http://online.wsj.com/article/SB10001424052970204012004577069960192509068.html?mod=WSJ_hp_LEFTTopStories

http://www.google.com/hostednews/ap/article/ALeqM5j4d6hbtITkqeIYrRaeXO5F379lBA?docId=a6f6404b153842c295c2b4c5a91853f0

http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/11/30/bloomberg_articlesLVHOKY0YHQ0X.DTL

http://online.wsj.com/article/SB10001424052970203441704577068670488306242.html?KEYWORDS=us+net+exporter

http://www.reuters.com/article/2011/11/30/us-usa-economy-idUSTRE7AL14I20111130

http://online.wsj.com/article/SB10001424052970203441704577068670488306242.html

http://money.msn.com/business-news/article.aspx?feed=OBR&Date=20111130&ID=14573434&industry=IND_BANKING&isub=

http://www.nytimes.com/2011/12/01/business/boeing-agrees-on-contract-with-machinists.html

http://mobile.bloomberg.com/news/2011-11-30/disney-increases-dividend-50-to-60-cents-a-share-after-record-2011-profit

http://www.realtor.org/press_room/news_releases/2011/11/phs_oct

Financial News Nov.21 - Nov.28

2011-12-06T07:54:00.000-08:00

Following is an overview of the U.S. market performance, the status of European countries in debt, from Monday, November 21^st to Monday, November 28^th, otherwise referred to as Thanksgiving week. Retail Sales on Black Friday reached an overall 2.8% increase in relation to the average level of sales in the year of 2011 thus far. The turnout was not as great as the one we observed in 2010 (5.2%), but not disappointing due to the rough conditions of the current economy. Also, the turnout was impressive compared to 2008, when it was extremely low (4.4% less sales on Black Friday in comparison to first three quarters).

However, despite the satisfactory level of sales, stocks eventually dropped on Friday, mostly due to worrying news from Europe (may we note that this was the worst drop during Thanksgiving week since 1932). The S&P 500 fell 4.7%, the DJIA fell 4.8%, and the Nasdaq fell 5.1%, which shows an approximate 5% overall decrease in market performance . On Friday, there were seven consecutive sessions of losses, so this week constituted the worst week in the span of two months.

Among the bad news from abroad was Belgium, whose sovereign credit rating was cut from AA+ to AA, due to a great extent to the lack of federal government since June 2010 because of cultural tension between the French-speaking and Dutch-speaking political figures, making Belgium the third EU country to downgrade in the course of three days, following Hungary in Portugal; however, Belgium is expected to reduce its deficit by the end of the quarter. Greece, during this week, demand even greater losses on part of private investors, sparking great controversy, as happened with the first “haircut”. The severity of the Greek debt crisis is a given, but there are now criminal allegations against Greek Chief Statistician Andreas Georgiou, who is accused of providing false numbers and exaggerating the debt. Georgiou has also worked for the IMF in the past, and, according to rumors, received pressure from Germany and other European countries to present bad figures in order to make austerity measures more easily implemented. The two major Greek banks, Alpha Bank and Eurobank continue the process of merging; Alpha Bank reported a net loss of almost 42 million euros in the third quarter. Italy’s current debt is at a high percentage of the GDP as well (120%), which is not too worrisome because debt has been high the recent years but did not have an extensive impact of the general performance of the economy. The credit rating, however, went from BB+ to BB, which is rather disappointing from a great economy like Italy’s. 8 billion euros were auction off during this week, and there are plans to refinance 200 billion euros by the end of April. Italy’s new prime minister, Mario Monti, plans on carrying out urgent austerity measures that will most likely not be supported by the public, like selling off state assets, reducing bureaucratic government jobs, and cutting pensions. Last but not least, Germany denied rumors reported by Die Welt Newspaper that claimed that “elite/AAA bonds” would be issued jointly from AAA EU countries.

The U.S. stock market ended its seven consecutive losses session and soared on Monday, November 28th, thanks to a strong Thanksgiving shopping weekend and positive news from Europe. Monday was the best day since Oct. 27 for the Dow Jones Industrial Average and S&P 500, as both indexes rallied 2.9%; Nasdaq climbed 3.5%, which made it the best one day gain since Aug.23.

Reports showed a record number of people visiting malls and online stores during the Thanksgiving weekend. A total of 226 million shoppers visited stores and websites, up from 212 million last year. On average, each shopper spent $398.62, up 9.1% from $365.34 a year ago. Shoppers in the U.S shelled out a total $52.4 billion, up 16.4% from $45 billion last year. Due to the increasing availability of tablets and smart phones, online shopping experienced a massive gain as well, with a 25% increase from last year.

However, the market didn't go up just because more people went to mall. A fresh proposal for the solution to the European debt crisis is also a determinant of the jump in markets. Germany and France are about to announce a crisis fighting plan this week. The plan would induce the ECB to intervene more forcefully to calm the euro debt crisis. According to a report by Reuters, "Among the countries in the Stability Pact, there would be a treaty spelling out strict deficit rules and control rights for national budgets." In other words, budges of member nations must observe debt limit, and countries would be liable for each other's debt. No country will be allowed national budgets that breach EU rules under the intrusive power granted by the proposal. A closer fiscal union in the Euro zone will eventually open the door for a joint debt insurance.

Sources:

http://www.washingtonpost.com/business/economy/online-sales-leap-20-percent-on-black-friday-just-sporadic-reports-of-glitches/2011/11/25/gIQAQDg6wN_story.html

http://money.cnn.com/2011/11/25/technology/cyber_monday/

http://lifeinc.today.msnbc.msn.com/_news/2011/11/23/8980324-good-graph-black-friday-holiday-shopping-stats

http://www.bloomberg.com/news/2011-11-25/u-s-stock-futures-decline-as-s-p-500-index-is-poised-for-seven-day-slump.html?cmpid=yhoo

http://www.reuters.com/article/2011/11/25/markets-stocks-idUSN1E7AO10W20111125?feedType=RSS&feedName=marketsNews&rpc=43

http://www.reuters.com/article/2011/11/25/markets-stocks-close-idUSWEN113920111125?type=companyNews&feedType=RSS&feedName=companyNews&rpc=43

http://online.wsj.com/article/SB10001424052970204630904577060354133948944.html?mod=googlenews_wsj
http://www.cbc.ca/news/business/story/2011/11/28/italy-financial-crisis.html
http://finance.yahoo.com/news/stocks-soar-big-holiday-shopping-143913389.html

http://www.marketwatch.com/story/mondays-biggest-gaining-declining-stocks-2011-11-28?siteid=yhoof2

http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/11/28/bloomberg_articlesLVD1UJ1A1I4H.DTL

http://www.marketwatch.com/story/story?Guid=aa98ce7a-2716-4bbc-b471-23788031c56e

http://www.reuters.com/article/2011/11/28/us-eurozone-germany-eurozone-bonds-idUSTRE7AR0AH20111128

http://www.reuters.com/article/2011/11/28/us-greece-statistics-idUSTRE7AR1Q720111128

An October to Remember

2011-12-02T12:33:00.000-08:00

Although our presentation focused specifically on market activity that took place from October 25th to October 31st, we began with a brief summary of the month of October 2011 as a whole. While October has, historically, been seen as a cursed month for the stock market (see the Crash of 1929, Black Monday in 1987, and the Meltdown of 2008), October 2011 was the single best month for stocks in almost a decade. Stocks’ low point of the year occurred on October 3rd, when investors were worried about the slow pace of US GDP growth, the prospect of a double dip recession, and European nations facing default; from that point, they rose in a nearly uninterrupted four week rally. The Dow Jones Industrial Average gained more than 1,000 points, or 9.5%, for its best month since October 2002, and the S&P 500 gained 10.8%, for its best month since December 1991. Many have attributed this turnaround to increasing optimism and confidence in the market, fueled by the European debt plan, stronger US corporate earnings (posted, in particular, by Google and McDonald’s), and positive 3rd quarter GDP growth.

Three major events took place during the last week of this historic month. Two of these events, including the deal reached by the countries in the Eurozone and the release of positive economic indicators, caused the market to surge; however, uncertainty over the details of the Eurozone deal, increasing yields on 10 year Italian bonds, and the bankruptcy of MF Global Holdings caused investors to question the market again.

Perhaps the most important news of the week was the deal struck by the Eurozone countries. The deal has three main components: a 50% haircut on Greek debt, which will force Greece’s creditors to take loses of 50 percent on their holdings of the country’s bonds to lower the Greek debt ratio 120% by the end of the year; recapitalization of European banks, which will require banks to increase their capital reserves to protect themselves and will allow the banks to get rid of their toxic assets; and a leveraged bailout fund, which will maximize the capacity of the European Financial Stability Fund (EFSF) to $1.4 trillion from its present size of $600 billion in order to provide loans to or purchase bonds of Eurozone countries to ensure their borrowing costs do not rise to levels that threaten solvency. The plan presents a problem because its details have not yet been decided, and because negative indicators about its ability to fix the problem have already arisen. For instance, the yield on Italian ten year bonds has increased since the announcement of the deal, which suggests that investors are still requiring high premiums to lend due to a presumption of risk and lack of confidence. If the details of the plan are not specified over the next coming weeks, increasing bond yields and various other issues could become a serious problem for the European and global economy.

Looking towards November, it will be important to watch for a few important indicators, including the European debt plan, the G20 summit, the jobs report, and the Super Committee’s plan to reduce debt in the United States. If the market’s performance in October has any affect on what happens in November, however, we have much to be optimistic about.

Financial News Blog - November 17 2011

2011-11-30T14:26:00.001-08:00

US stock market declined due to fear of the Euro zone financial crisis following the release of the Fitch ratings report. The Dow Jones Industrial Average dropped 191 points, S&P 500 dropped 21 points and the Nasdaq dropped 47 points. The Fitch report outlined U.S banks’ exposure to European’s sovereign debt; the report said that large U.S. banks could be hit hard if Europe’s debt crisis spreads beyond the stressed markets of Greece, Italy, Portugal and Spain. Following the release of the report stocks in the largest banks dropped. Bank of America Corp fell 4.8 %, JPMorgan Chase and Comp fell 3.8%, Citigroup fell 4.1%, Goldman Sachs Group Inc. fell 4.2%, Morgan Stanley fell 8%, Wells Fargo fell 1.4%. Concerns that the debt troubles of Greece and Italy could spread drove up the borrowing rates of France higher in the bond market. The report said the risk to U.S. banks is manageable but investors have been quick to respond. The top Six U.S. banks have a total of 114 billion dollars in loans, deposits and other assets tied to French banks, while they have only 50 billion in the five most stressed markets: Italy, Spain, Greece, Ireland and Portugal. French banks also hold a large amount of bonds issued by Greece and Italy.

Mario Monte has agreed to become Italy’s new Prime Minister and plans to reveal his government’s plans to the Italian senate. Spain has become the forefront of the European markets agenda because the yields on debt have sharply increased and is preparing for government reform. Spain has been mainly left in the shadow because of the situation in Greece and Italy, but has been slowly receiving more attention. Yields on 10-year bonds in Spain have risen to 6.38%, which is the highest all year. There is also concern over Spain’s budget deficit, which is currently higher than 6% of GDP, while the EU target is 3% of GDP. Spain’s budget deficit is closing in on 7%, which many investors believe a bailout is needed. Reducing Spain’s budget deficit will be a long-term project. Property prices are down about 26% from its peak and are projected to fall even more. The Spanish banking system has yet to recover from financing the property boom and the country’s biggest banks may have to be recapitalized. Spain also is expected to miss their target of 1.3% economic growth, growth reduced from 0.2% in the second quarter to 0% in the third. The bank of Spain estimated .8% growth. Spain’s unemployment rate is currently 21.5% and almost 50% among youth. Spain may be sliding back into recession only 18 months after the property bubble collapse in 2010. According to Ben May, economist at Capital Economics in London, “"If Spanish yields surge higher, forcing the government to seek a rescue package, the region-wide debt crisis will become more expensive and complex to solve."

The ongoing conflict between France and Germany on whether to use the European Central Bank to manage the Euro zone crisis is becoming more heated. Tension between France and Germany is having an adverse affect on market turmoil. France wants the European Central Bank to rescue them from the crisis, spokeswoman Valerie Pecresse said “the European Central Banks role is to ensure the stability of the Euro but also financial stability of Europe”. Germany on the other hand does not think the European Central Bank should intervene in the crisis and is not responsible for it. German chancellor Angela Merkel said, “ the European Central Bank doesn’t have the possibility of solving these problems”. French bond yields are at 3.7% while German bonds are near a record low at 1.8%. Government bonds offered yields that were roughly identical to German bond yields. In other words, bond investors considered French government bonds about as safe as German government bonds. Investors have been dumping the bonds issued by Greece, Portugal, Italy and other “questionable” sovereign issuers; they have been flocking into both French and German bonds as a “flight-to-safety” trade. Investors are beginning to distrust French debt as a “flight-to-safety” asset, at least relative to German debt. So investors have been selling French government bonds very aggressively for the last several weeks, while continuing to buy German government bonds. French banks are holding hundreds of billions of Euros worth of Greek, Portuguese, Spanish and Italian sovereign debt. The price of insuring a 5-year French government bond is now higher than the price of insuring various “junk” and “near-junk” sovereign borrowers.

References:

http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/11/16/bloomberg_articlesLUR8IF6TTDS4.DTL
http://www.bloomberg.com/news/2011-11-16/u-s-stock-index-futures-slide-as-european-sovereign-debt-concern-deepens.html
http://www.cnbc.com/id/45322644
http://money.cnn.com/2011/11/16/news/international/european_debt_crisis_spreads/index.htm?iid=SF_E_LN
http://money.cnn.com/2011/11/15/markets/thebuzz/index.htm?iid=EAL
http://money.cnn.com/2011/11/09/news/international/italy_crisis_bail/index.htm?iid=EAL
http://www.google.com/hostednews/afp/article/ALeqM5ifL4bM_JkOJI7QKyvVVeVh3_7j5w?docId=CNG.19f494967aaa50a790d39ea92606af7d.211
http://www.guardian.co.uk/business/2011/nov/16/eurozone-bond-markets-germany-ecb?newsfeed=true
http://news.businessweek.com/article.asp?documentKey=1376-LURLN51A1I4K01-4BQLI0SD43LE4T00N49C135MAS
http://money.cnn.com/2011/11/16/markets/markets_newyork/index.htm
http://economictimes.indiatimes.com/news/international-business/us-banks-endangered-by-eurozone-crisis-fitch/articleshow/10762360.cms
http://dailyreckoning.com/a-look-at-the-troubling-trend-in-french-bond-yields/

Financial News Blog-Tuesday November 22

2011-11-29T07:24:00.000-08:00

Last week the congressional super committee failed to reach an agreement to cut the federal deficit by 2 trillion dollars. As a part of the debt deal reached earlier this year they were assigned to find 1.2 trillion dollars in savings. This failure triggers automatic cuts in domestic and military programs. However there are attempts within congress to soften these cuts. Congressional Republicans have vowed to safeguard defense spending while President Obama has vowed to veto any softening of the 1.2 trillion cut.

Moody’s stated that the failure of the super committee was “informative but not decisive” and that they are not making a decision about the country’s credit rating based solely on this news. S&P stated that they have no plans to further downgrade the U.S.’s credit rating. However this was based on the assumption that automatic spending cuts will take place.

Last Monday Moody’s warned that they might review France’s AAA credit rating. The reason for the possible review is the worry that France may not be able to pay back all of its debt. As a result French stocks declined 3.4% last Monday. Also in Europe, a new fiscally conservative government was elected, ousting the Socialist party. There was hope that this would help restore confidence in Spanish debt. However Spain was forced to pay sharply higher interest rates in an auction of short-term debt, suggesting that investors remain wary of the country’s financial prospects.

The Dow fell 2.1% last Monday in response to the failure of the super committee and continuing bad news from Europe. The NASDAQ and S&P were also down 1.9%.

Dow performance has flattened over the year with the growth of the first half of the year balanced by the falls of the second half. The financial sector led the decline in the markets followed by the industrial and information technology sector.

Despite the failure of the super committee and further political battles over the country’s debt Treasury yields dropped last Monday indicating continued investor confidence in U.S. debt. However it could be the case that it is just considered less risky than investing in European debt.

October home sales rose 1.4% beating analyst’s expectations to a seasonally adjusted annual rate of 4.97 million. This is below the 6 million that economists say is consistent with a healthy housing market. However more deals are being canceled at the last minute, a sign that those looking to buy are still worried about the housing market. Those who are able to buy a house might still be reluctant and wait for house prices to drop further.

Short term extensions of government funding run out in December. Increased Medicare payments to doctors, unemployment benefits and the payroll tax cut are all at risk of being cut. Analysts do not predict there will be another risk of a government shutdown but they do expect more short term patches in government funding. This is likely to add to investor uncertainty. Economists predict that failing to extend the payroll tax cut could trim GDP growth next year by a percentage point.

On Tuesday morning the commerce department reported the U.S. economy grew 2% in the third quarter. Economists predicted that the economy would grow 2.5% in the 3^rd quarter. However strong consumer spending and decreased business inventories set the stage for stronger growth in the 4^th quarter.

SOURCES:

First Signs of Rising German Bond Yields, Deflation - Video - Bloomberg

Bonds, Rates & Credit Markets - Markets Data Center - WSJ.com

U.S. credit rating faces scrutiny; Fitch in review - Yahoo! Finance

Markets cautious after US debt talks collapse - Yahoo! Finance

TradingEconomics.com - Indicators for 196 Countries.

Daily Treasury Yield Curve Rates

B. of A., Morgan Stanley lead financials' rebound - MarketWatch

October home sales rose 1.4 percent but still weak - Yahoo! Finance

Spain Requests Data Providers Change Reference Bond Price - WSJ.com

2011-11-22T12:28:00.000-08:00

During the weekend of October 14^th, European finance ministers are meeting in France to decide how best to resolve the Greece debt crisis, ensure that no other EU country go into debt crisis and prevent recession in Europe. European countries, mostly France and Germany, wants banks to attempt to raise funds within the privately, before seeking public financing. Their plan also asks investors and banks to be prepared to lose more than 21% of the net worth of Greek bonds. The figure has increased to more than 50%, in recent days. Part of the plan is that investors would not collect insurance they bought on the debt known as voluntary default. This is because if they did the finance and insurance industry might collapse. The European plan is also different from the plan that the IMF and Secretary of Treasury, Tim Geithner, support. Their plan calls for the European Union Central Bank to come into the market as a guarantor of the European government’s debt. This means they would buy up the debt from countries like Greece, Spain, Italy, Portugal and Ireland. This will reduce the yield on the bonds and make it cheaper for these countries to borrow money. The IMF and the U.S. are against European plan because it works too slowly and it could cause a problem for the global economy. If European Union does not act swiftly and decisively the global economy could slow down and go into another recession which would be bad for the U.S because it is just getting out of a recession. Another reason they are against the current European plan being discussed right now is that of Japan’s loss decade. This was caused because Japanese government would not act decisively to help support their financial sector during the early 1990s which led to a decade of underperforming GDP.

News for November 8-15, 2011

2011-11-16T09:20:00.000-08:00

Last week, Italian PM Silvio Berlusconi resigned after the Italian senate passed a new austerity budget, enabling Mario Monti to soon take up position as new Italian PM. The austerity budget is intended to cut spending and boost growth. It includes pension reform, plans to raise retirement age from 65 to 67, privatization of state-owned companies and sale of state-owned properties, investment in infrastructure, and tax breaks for companies that hire young workers. As a result of these austerity measures, Italian 10 year bond yields went down from 7.25% on Wednesday to 6.45% at the end of Friday, but were back up to 7.1% as of Tuesday. Assuming Monti survives confidence vote, he could officially by new PM by Friday.

On Friday, Lucas Papademos replaced Georgios Papandreou as Greek PM. Papademos had previously served as Governor of the Bank of Greece and as VP of the European Central Bank. Papademos set two conditions in order to accept being named PM of Greece's new interim government: (1) the new government would not have a very restricted life span, and (2) the political figures from both of Greece's main political parties would be represented in his cabinet. The Greek residents strongly back Papademos, polls say. The coalition government's main task is to allow the EU bailout to proceed, and Papademos has said his priority will be to keep Greece in the Eurozone. He will attend the Eurogroup meeting of European finance ministers in Brussels on Thursday, where he will be expected to outline the country's draft budget for next year before bringing it to the Greek parliament for debate.

The EU has said that the Eurozone's growth has stalled and have cut expected growth for 2012 from 1.8% to just 0.5%. The European Commission predicts that if there are no changes in political policy, Italian public debt would remain unchanged at 120.5% of GDP next year. The EC also forecast that next year Greece debt could rise to 198.3% of GDP.

In US news, the Federal Reserve will be conducting a fourth round of stress tests in the coming weeks. Also, with less than 9 days until the deadline, there is still no agreement in the US supercommittee’s debt deal. The goal is to reduce borrowing by at least $1.2 trillion over the next decade. Republicans’ last offer was to cut spending by about $750 billion over the next decade, while raising about $300 billion in new taxes. Democrats have offered a deal with about $1 trillion in tax increases and about $1 trillion in spending cuts.

The annual APEC Summit was held in Honolulu, Hawaii from November 12^th to 13^th. In the summit, Asia-Pacific leaders agree to cut tariffs on environmental goods to no more than five percent and to reduce energy intensity. Obama has touted solar, wind technologies as a way to create jobs and boost economic growth. Chinese President Hu signed onto the plan to cut tariffs to 5 percent even though earlier last week Chinese officials criticized the cuts as too ambitious and beyond the reach of developing economies. In response to China’s concerns, APEC states they would cut tariffs while "taking into account nations’ economic circumstances."

Obama has announced the broad outlines of a 21st-century Trans-Pacific Partnership (TPP) agreement that will enhance trade and investment among its partner countries. Nine APEC nations are involved in the Trans-Pacific Partnership. However, China has so far not expressed interest in joining the talks. According to last year’s data, two-way trade between the U.S. and the eight nations in the TPP totaled $171 billion, so taken together; the eight member economies would be America’s fifth largest trading partner.

During the conversation with Chinese President Hu, Obama called on China to allow the Yuan to appreciate, saying the American public was growing increasingly frustrated with the slow pace of change in Chinese economic policy. However, China's slowing economy makes Beijing less likely to accelerate on the Yuan’s rise. Chinese export growth drops to 15.9 per cent year-to-year in October from 17.1 per cent in September, suggesting Chinese officials may become more concerned about China's exporters as global demand for its products slows. China's inflation also slowed in October that gives Chinese policy makers less of a reason to use currency appreciation as a way to help Chinese consumers offset rising prices.

Japan's GDP grew 1.5 percent in the third quarter from the previous quarter following three quarters of contraction. The rebound is helped by improvement in exports, consumer spending, as well as major reconstruction spending. But the nation’s growth is expected to cool in the final quarter as the yen's persistent strength and a still-weak global economy threaten its key export sector. The impact of recent flooding in Thailand has also hit output for many Japanese multinationals.

Sources:

http://www.bbc.co.uk/news/business-15669197

http://www.washingtonpost.com/business/markets/us-futures-higher-as-italys-senate-passes-reform-bill-greece-readies-a-new-prime-minister/2011/11/11/gIQAHLtqBN_story.html?hpid=z1

http://finance.yahoo.com/news/fed-conduct-4th-round-bank-200921677.html http://finance.yahoo.com/news/end-era-italys-berlusconi-resigns-210043962.html

http://articles.cnn.com/2011-11-11/world/world_europe_italy-government_1_italy-s-senate-prime-minister-silvio-berlusconi-austerity?_s=PM:EUROPE

http://www.washingtonpost.com/politics/lawmakers-urge-supercommittee-to-go-big-on-deficit-reduction/2011/11/16/gIQAoXlWRN_story.html?hpid=z2

ECB, the Eurozone, and MF Global

2011-11-15T14:51:00.000-08:00

News in the past week covered many areas, from the Bank of Japan weakening the strength of the Yen, to average mortgage rates falling to 4% (an all time low), to the job market showing signs of improving. The most important topics however were the European Central Bank lowering interest rates from 1.5% to 1.25%, Greece potentially breaking up the Eurozone, Greece potentially leaving the Euro for the Drachma, and the failure of MF Global.

News of the ECB cutting interest rates confounded economists. Some expected a quarter-point drop, while some expected a half-point drop. What were some of the consequences of this reduction?

· Italian bond yields fell 5 basis points to 6.13 percent

· The Euro fell as much as .8 percent, to 1.3657

· Spain’s 10 year bond fell 1 basis point to 5.41 percent

· German 10 year bond yield rose 9 basis points to 1.91 percent

· Oil prices rose around the world. Brent crude closed at $110.83 a barrel while U.S. crude closed at $94.07 a barrel.

In addition the Prime Minister of Greece, George Papandreou, announced his resignation. Italy’s Prime Minister, Silvio Berlusconi, also promised to resign.

With talks of Greece potentially leaving the Eurozone, it is important to see the effects it may have. First of all, could Greece leave behind the Euro and return to the Drachma?

“In accordance with treaty 128 on the functioning of the EU, eurozone members like Greece have delegated their right to set their own currency to the eurozone.”(CNN)

This means that Greece has given up their right to setting the Drachma as their currency and must use the Euro. No other countries may force Greece to leave either. If they were to leave the Eurozone, they would also have to leave the European Union. If they left the European Union they would most likely place tariffs on exports to the EU (firedoglake).

“Now while leaving the euro, default and explicit default does lead to lower interest payments on government debt, and lower asset prices that could also result in foreign capital inflows to pick up those assets, and while this scenario in Argentina in 2001-02 caused output to rise sharply, Greece may not recover from the capital outflow that is certain to occur, unless greed by the outside of country rich for cheap assets post devaluation overcame any patriotic urge to punish those that mess with the EU (I doubt Germans will forgive – anything).” (firedoglake)

What would happen if they were to return to the Drachma?

· Would most likely default on their 500 billion dollar debt

· 50% devaluation

· Inflation would skyrocket

· Their return to the international credit scene would take some time

Greece, however, called off the referendum which would put the issue of the European deal to cut Greece’s debt to popular vote. It must make a decision quickly as the situation continues to deteriorate, especially with the absence of a Prime Minister.

MF Global was a derivatives broker which was run by Jon Corzine, former Governor of New Jersey and chairman of Goldman Sachs. They were highly leveraged in European bond debt, and used their client accounts to weather the storm while they could.

“We also used the dislocation in the markets to add quality people for strategic roles, as well as expand our client relationships across our businesses”

On October 25^th, 2011, MF Global reported a $191.6 million quarterly loss due to their European government bonds. Because of this, Moody’s and Fitch declared the company’s credit ratings as junk. On October 31^st, 2011, it filed for Chapter 11 bankruptcy. CME Group Inc., MF Global did not properly keep its customer’s money separate from its trading accounts. In bankruptcy papers it filed, it listed debt of $39.7 billion and assets of $41 billion. PricewaterhouseCoopers has been subpoenaed in regards to the separation of accounts, as they were their auditor.

http://www.reuters.com/article/2011/11/03/us-markets-oil-idUSTRE7922QH20111103

http://www.businessweek.com/news/2011-11-08/ecb-unexpectedly-cuts-rate-as-draghi-rules-out-debt-backstop.html

http://www.businessweek.com/news/2011-11-04/german-bunds-decline-after-ecb-cuts-rate-greek-yield-tops-100-.html

http://www.telegraph.co.uk/finance/financialcrisis/8879647/George-Papandreou-resigns-as-Greeces-prime-minister.html

http://www.reuters.com/article/2011/11/03/greece-eu-eurozone-idUSL5E7M33BV20111103

http://my.firedoglake.com/papau/2011/11/03/greece-will-not-leave-the-eueuro-referendum-off-table/

http://business.blogs.cnn.com/2011/11/04/is-greece-angling-for-a-eurozone-exit-and-can-it-leave/

http://www.bloomberg.com/news/2011-11-03/sec-said-to-review-possible-insider-trading-in-mf-bonds.html

http://www.bloomberg.com/news/2011-10-30/corzine-s-mf-global-faces-pivotal-days-as-firm-considers-sale-bankruptcy.html

http://www.ft.com/intl/cms/s/0/0a35504a-0615-11e1-a079-00144feabdc0.html#axzz1dLTDY3Y5

European Turmoil

2011-11-08T15:58:00.000-08:00

Financial news in the past week has mainly focused on the turmoil surrounding the debt problems of Greece and Italy. The G-20 summit also met in Cannes, France to discuss financial aid through the IMF to the euro region. France also came into the spotlight when it announced austerity measures to curb its budget deficit. China was discussed in the news as new inflation and output numbers are due this coming Wednesday. Lastly, news regarding the United States included employment numbers, more information on the bankruptcy of MF Global, and the IPO of internet coupon service Groupon.

After having agreed on 50% haircuts on bonds, Greece’s Prime Minister George Papandreou stated his intention to hold a referendum on Wednesday so the citizens could vote on Euro membership. The next day the PM scrapped the referendum plans amid threats of the EU to withdraw all financial aid (130 billion euros) to the country and expel Greece from the EU. Additionally, the PM agreed to resign in order for a unity government to form in which there would be an agreement on the bailout package. The major U.S. stock indexes reacted negatively to the referendum plan and to the ongoing uncertainty as to who will be the next PM and whether Greece will accept the bailout.

Italy has seen its 10-year bond yields rise the highest on record. This is due to its debt problems and the ongoing uncertainty with Greece. On Friday, rumors that the Prime Minister of Italy, Silvio Berlusconi, would resign led the markets to rise. The PM denied funds from the IMF, but agreed to quarterly inspections which would boost its credibility and hopefully reduce bond yields. On Monday, the PM denied the claim, and the markets fell accordingly. Today, the PM Italy agreed to resign and markets rose.

The G-20 summit met on Thursday where world leaders balked at spending more on financial aid for euro-zone countries like Italy and Greece until they do more to fix their own problems. World leaders are also awaiting further details of the week-old rescue package until they commit capital. The summit also ended with agreement on capital buffers for 29 banks including Goldman Sachs and Deutsche Bank. The buffers ensure sufficient capital to counter risk posed by “too big to fail” banks.

On Monday, France introduced austerity measures in order to ensure a consistent AAA rating on their bonds. For the past 30 years, France has been running a budget deficit. France raised the retirement age, raised some taxes, and decoupled welfare from inflation. The austerity package is designed to save 18.6 billion euros in the upcoming year.

China has had high GDP growth rates above 8% for the past 10 years. Many speculators believe this will be unsustainable, as a lot of the growth is built on cheap credit and over-investment. So far this year, every month has experienced inflation (based on CPI) above 4%. Chinese central bank officials are trying to curb inflation in consumer products and housing by tightening its monetary policy and imposing lending restriction on real estate. Some speculators believe that current GDP growth rate of 9% will come crashing down soon and have detrimental effects on the global economy and China. However, a former central bank advisor believes that China will slow minimally to an 8-8.5% growth rate in the coming year.

LINKS: http://www.bloomberg.com/news/2011-11-05/papandreou-s-unity-government-bid-hits-resistance-as-crisis-talks-begin.html

http://www.reuters.com/article/2011/11/08/us-eurozone-idUSTRE7A63QJ20111108

http://articles.economictimes.indiatimes.com/2011-11-04/news/30359646_1_second-tier-banks-capital-buffer-basel-iii

http://www.nytimes.com/2011/11/08/world/europe/french-austerity-measures-aimed-at-new-reality.html

http://www.marketwatch.com/story/asia-awaits-china-price-data-toyota-earnings-2011-11-05

Q3: Investment Banks

2011-11-04T21:19:00.000-07:00

Basically, the quarter was marked by heavy turbulence in financial market brought on by the debt crisis in Europe and the downgrade of the U.S credit rating by S&P to AA+ from AAA. We can also highlight the decline of 14.3% of S&P 500 index during the quarter. This represent the worst quarter for the index since the fourth quarter of 2008 when it fell 22.6%. In addition, the Bank of America Merrill Lynch index of U.S treasuries with over 10 year maturities returned 23.6% over S&P 500.^[1] This sharp divergence between equities and fixed income indicates how deep and broad the concerns in the market place have become surrounding uncertain political outcomes and fragile economic growth. The sharpest divergences between the two indexes during the quarter can be explained by, the downgrade of U.S credit rating on August 5^thand the FED announcement to swap the short term debt in its portfolio with long term debt (Operation Twist).^[2]

The Financial Accounting Standards Board, which adopted the rule known as Statement 159 in 2007, “permits entities to choose to measure many financial instruments and certain other items at fair value.”^[3]The consequence of this rule is that it allows firms, to record gains as traders bet on the firm’s likelihood of default, causing the bond prices of such firms to fall below their par value. The reason FASB allows firms to record a gain is because in theory the firm could buy back the discounted bonds and realize a profit but this “doesn’t mean that their ultimate interest and principal payments changed one iota.”Such practices have been referred to as an “abomination” because DVA do not reflect the core business operation of a firm.^[4]It is important to note that DVA can create volatility in earnings because such gains can reverse given the change in bond spreads.

Goldman Sachs report a loss of $428 million, the second time the bank had reported a loss since going public in 1999 (the first time was Q4 2008). Goldman Sachs investing and lending group comprised of the firms public and private investments, reported negative net revenue of $4.28 billion. Making headlines on October 18^th was the $1.05 billion paper loss in the firm’s investment in Industrial and Commercial Bank of China (ICBC). During the third quarter the Chinese bank’s stock price fell 35%, directly effecting Goldman Sachs investment which was comprised of all common stock. Along with declining revenues, Goldman Sachs reduced costs most notably the firm reduction in its biggest expense compensation and benefits. Compensation and benefits fell 59% compared to the third quarter of 2010.^[5] The firm also chose to hedge against its DVA, causing its total DVA to be $450 million. Unlike Goldman Sachs, JP Morgan and Morgan Stanley did not chose to hedge against their own DVA gains.^[6]

Morgan Stanley had a strong performance in equity Sales & Trading, interest rate and commodities reporting positive earnings of $ 2.2 billion. The firm reported net revenue of $9.9 million and earnings per share (EPS) of $1.14. Yet, $3.4 billion in revenue, and $1.12 of EPS, came from the firm’s own DVA gains.^[7] Its potential loss decreased to $130 million compared to $142 million in Q3 of 2010, while general expenses declined 20.74% from the previous quarter.^[8]

JP Morgan Chase reported solid revenue in consumer and business banking reporting net income of $4.3 billion, while operating expenses declined 24% from the previous quarter. The Investment bank revenue fell 13%, to $6.37 billion from $7.31 billion in the second quarter, beating company forecasts. Without the debt valuation gain, JPMorgan's underlying investment bank revenue of $4.48 billion and EPS was $.72; both slightly lower than pessimistic estimates.^[9] The firm’s value at risk fell to $53 million versus $58 million in Q2, while return on equity fell to 9% from 12% in Q2.^[10]

Going forward, the situation surrounding the debt crisis in Europe will obviously play an important role in the bottom line of the three investment banks, but there is more factors looming that will continue to effect these firms operations. The fear of violating new regulations coming from the Dodd-Frank Act, will continue to shrink profitability lines and slow down the creation of new ones. The Volcker rule in particular, threatens these firms profitability with a ban on proprietary trading.^[11] It should also be expected, to see continuing cuts in expenses including lay-offs. About 10,000 jobs are expect to be lose in the financial sector within the next year.^[12] This is not the first time DVA have made headlines, and will surely not be the last. It will be interesting in the next few quarters to see the actual consequences of the firm’s choices to hedge such gains or not to hedge in order to inflate earnings.

¹ ^{http://www.icrm.com/3q11-quarterly-review-outlook/}

²^{https://www.franklintempleton.com/retail/app/commentary/views/commentary_detailedpage.jsf?category=FUNDMGRCOM&commentaryURL=%2Ftemplatedata%2FCommentary%2FCommentary%2Fdata%2FUS_Market_Perspectives%2FQ311quarterlycommentary.xml}

³^{http://www.fasb.org/summary/stsum159.shtml}

⁴^{http://www.bloomberg.com/news/2010-07-11/bank-earnings-depending-on-debt-writedown-abomination-in-latest-forecast.html}

⁵ ^{http://www.bloomberg.com/news/2011-10-18/goldman-sachs-posts-third-quarter-loss.html}

⁶^{http://blogs.wsj.com/deals/2011/10/18/goldman-sachs-hedges-its-way-to-less-volatile-earning/}

⁷^{http://articles.businessinsider.com/2011-10-19/wall_street/30295621_1_net-revenues-net-loss-net-income}

⁸ ^{http://www.morganstanley.com/about/ir/shareholder/3q2011.html}

⁹^{http://www.investorguide.com/article/9719/jpmorgan-jpm-uses-parlor-tricks-to-mask-its-awful-earnings/}

¹⁰^{http://files.shareholder.com/downloads/ONE/1462717210x0x508392/8adf7e91-978d-4f5c-90d4-f6a327484c71/3Q11_ERF_Supplement_Final.pdf}

¹¹^{http://www.economist.com/node/21533422}

¹²^{http://www.nytimes.com/2011/10/12/business/economy/painful-job-cuts-coming-to-wall-st.html}

Positive Quarterly Earnings Shadowed by Continued Debt Problems

2011-11-01T16:48:00.000-07:00

Overall, it has been an up and down week. The credit rating of the US government is likely to decrease before the year’s end; though some positive quarterly earning reports from companies in the constructive industry may be a sign that things will be good in the future. The debt crisis in Europe is slowly moving towards a resolution; though not after much discussion and delay.

In August 2011, the S&P downgraded the credit score of the US government from AAA (Prime) to AA+. This is an indication of the drop in reliability or trustworthiness in the government in the eyes of the credit agency. This usually translates into greater bond yields (as there is less demand for the bond so they would only sell if they had a yield that outweighed the risk). This was seen when the yield on Greece’s treasury bonds skyrocketed due to declining credit ratings (Upwards of 71% return).

However, the yield on US T-Bills did not increase after the credit score downgrade. Even with the announcement that Moody and Fitch may also downgrade the United States Government’s credit rating to AA+ in November, the yield on US bonds has relatively decreased in the past few months. This is likely because the difference between AAA and AA+ is very minor; and people have a significant more confidence in the government than the economy. As a result, the recent drop in T-Bill yields is likely because people feel they are the safest place to put their money, even if the US credit rating was dropped. The usual setbacks of a decrease in credit rating (such as the increased cost of deficit spending which may translate to increased interest rates) will likely not hurt the US government that much as it is still seen as a very reliable source. It will still be able to cheaply finance spending through bonds. The debt issue is still much more prevalent and real in Europe.

On October 24, after a weekend summit of Euro-zone leaders turned inconclusive in the resolution of the debt crisis, an outline for a deal was agreed upon. So far, Euro-zone leaders have agreed to force banks to protect themselves against future losses and increase the funds in the European Financial Stability Facility, a 440 billion euro bailout fund. Some of the main points agreed on over the weekend was that European banks have to raise more than 100 billion euros in new capital to protect themselves against losses to indebted countries. Commercial investors, national governments and the EU’s bailout fund, would provide the capital. The European Financial Stability Fund will be given 250 billion euros, although it is not clear yet how this will be achieved. Initially, lenders to Greece expected a 21% write off in bond value, but this proposal was eventually dismissed which could mean that lenders can expect up to 50%-60% bond haircuts. The bailout fund will be used as a last resort, if governments are unable to provide the money to support their banks. Some disagreements remain on the table, such as whether the European Central Bank would support the European Financial Stability Facility by providing loans that could increase its capacity to 2-3 trillion euros. Although there’s no definite solution yet, it seems that euro-zone governments are close to an agreement on how to tackle the debt crisis.
On another note, caterpillar reported all time revenue record in its third quarter earnings report. It enjoyed a 40% increase in profits from the previous year. As the world’s largest construction and mining equipment maker, caterpillar’s forecast demonstrates that overall growth and demand around the world is increasing. Revenue in North America increased 32% from the previous year, while Latin America’s operations increased by 31%, Africa/Middle East/ Europe saw a 51% increase and Asia’s revenue spiked 55%. Caterpillar should continue to perform well as it benefits from investments in developing nations on the rise.

Overall, the economy is still struggling to get back on its feet. The unemployment rate is hovering around 9.1%, and though the stock market has increased by approximately 14% last month it has also seen problems here and there such as the Netflix crash. Confidence in the economy is still very low; and T-Bills will likely stay the most reliable place to invest one’s money; at least until the economy turns around. Hopefully with Caterpillar doing very well; it is a sign that countries are beginning to pull themselves out of the recession.

http://www.usatoday.com/money/economy/2011-07-13-moodys-considers-downgrade_n.htm

http://finance.yahoo.com/news/Caterpillars-Earnings-Show-No-tsmf-2971163267.html;_ylt=AoHqHxSBCaiVdHIO3Uma75a7YWsA;_ylu=X3oDMTFhZG0wajZtBHBvcwM3BHNlYwNzcGVjaWFsRmVhdHVyZXMEc2xrA2NhdHNlYXJuaW5ncw--?x=0

The Financial Crisis: A Confidence Issue?

2011-10-11T14:49:00.000-07:00

Although we are covering a wide range of seemingly unrelated topics, they all have one thing in common: uncertainty. In the global economy, issues arising from uncertainty have become increasingly important. This past week of October 1^st through 7^th was quite an interesting week for the economy as a whole. One recurring theme was the overall lack of confidence that we as a domestic and global economy experienced. Whether it’s the renewed possibility of a Greek default, or the recent death of Apple founder and former CEO Steve Jobs, markets around the world will react to the uncertainty created by these events.

Ben Bernanke, the current chairman of the Federal Reserve Board, addressed congress on Tuesday October 4^th to give a progress report on the economic recovery. Bernanke touched upon the notion that uncertainty is proving to be a major obstacle on the road to recovery. He asserted that rising uncertainty and falling consumer confidence were largely to blame for the lower-than-average GDP growth of 1% (the typical growth rate is around 2%). When consumer confidence falls, so does demand, because individuals are more interested in safeguarding their wealth rather than spending it. This means firms will begin to take in less revenue, resulting in falling stock prices, and possibly downsizing. Downsizing means that household spending will fall, further hurting firms’ revenue. And the cycle repeats. Bernanke also mentioned recent events occurring abroad that have contributed to the rising uncertainty here at home, namely the political unrest in the Middle East and Africa, as well as the earthquake and resulting nuclear disaster in Japan. He went on to speculate that GDP should rise in the second half of the year, now that the effects of these events have largely subsided.

Bernanke also reiterated that the Fed would begin implementing “Operation Twist” in the upcoming weeks. Operation Twist is an initiative being undertaken by the Federal Reserve Bank in an effort to drive down long-term interest rates. To accomplish this, the Fed will sell a portion of its short/medium-term bonds and use the proceeds to purchase longer-term 10-Year Treasury Notes. If everything goes as planned, this should exert a downward pressure on long-term interest rates and further stimulate the economy by encouraging more investment and consumption.

Moving on from Bernanke’s address, the fall of the S&P 500 into bear market territory is a prime example of the effects of uncertainty on markets. The definition of Bear Market as given by Investopedia.com is:

“A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market and selling continues, pessimism only grows. Although figures can vary, for many, a downturn of 20% or more in multiple broad market indexes… over at least a two-month period, is considered an entry into a bear market.”

On Tuesday October 4^th, the S&P 500 was down 21% from its previous high on April 29^th earlier this year, and the Dow Jones Industrial Average fell to 18% of its previous high, narrowly avoiding a slip into bear market territory. The blame for these dramatic downturns is widely credited to the Eurozone debt crisis and, again, low levels of consumer confidence around the globe.

The most notable driving factor behind the Eurozone debt crisis is Greece. Fears of a massive Greek default were rekindled last week when the Greek Finance Minister, Evangelos Venizelos, announced that his country would be seeking another emergency loan from the IMF in order to make its interest payments.

Finally, the death of Apple founder and former CEO Steve Jobs is a perfect example of how uncertainty can affect markets. Many would argue that the uncertainty caused by this unfortunate event was irrational; after all, Jobs stepped down as CEO months ago. Despite his diminished ties with the management of Apple, news of his death caused an immediate five-dollar drop in Apple stock when the markets opened Thursday morning.

In short, uncertainty, whether justified or irrational, can have adverse effects on markets around the world. It isn’t brought on exclusively by quarterly growth reports or unemployment statistics; it can be caused by something seemingly unrelated as the death of a former CEO. But, we can be sure of one thing: uncertainty is a leading culprit behind the struggling financial markets worldwide. The only way to jump-start the global economy is to restore investor / consumer confidence. But, judging by the general consensus on the state of the world economy, it doesn’t seem likely that will occur any time in the near future.

U.S. Jobs, European Equities, and The Fed.

2011-09-29T19:03:00.000-07:00

Just recently, President Obama has come up with a new stimulus plan that will create jobs and cut payroll taxes. This jobs bill will end up costing around 447 billion dollars as it cuts payroll taxes, increases infrastructure spending (in order for people such as police officers, teachers, and fire fighters to keep their jobs), and allows the unemployed to collect unemployment payments for a longer period of time as well as directing some of that money towards re-training the unemployed to help them get back into the labor force. Now while President Obama has stated that this bill will not dip the U.S. back into recession, it must be paid for somehow. The funding for this bill will come mainly from limiting tax deductions of the affluent along with removing and limiting other tax breaks and benefits, i.e., oil and gas company tax benefits. If the entire bill gets passed it will boost GDP by 1.25 percent but unfortunately, the likelihood of that happening is very small.

In foreign news, the European market has seen a drastic decline as a sentiment of risk aversion sweeps the continent leading to people buying less and less stocks and buying more bonds, leaving a large gap between the yields of dividends and bonds. While this may sound like a bad thing, it is worth noting because investing in European stocks at this time could turn out to be a very smart move; about 46 stocks have been found yielding at least five percent and for those concerned about risk, many of these stocks are in sectors that are “recession-proof” such as food retailers, pharmaceuticals, etc. Adding to that, high-yielding stocks tend to perform at their best in the period that follows after the market hits its bottom. Therefore, if history repeats itself, as it usually does, buying stocks in the European market could be a great investment.

On September 21, 2011 the Fed announced it would be taking further actions to help the economy. The Fed will be purchasing $400 billion in treasury securities with maturities ranging between six to thirty years. They will also be selling off $400 billion in treasury securities with maturities of less than three years. This is a less aggressive move than the previous attempts at quantitative easing in that they are not using newly printed money to complete their desired transactions. They are essentially swapping out $400 billion in short term t-bills with $400 billion in long-term t-bills. The desired outcomes are too push down long term yields and to encourage long term investment. These activities are to be completed by June of 2012. What may have been surprising to some is that even though the Fed announced new efforts to improve the economy in the future, the market on September 21, 2011 endured a heavy decline. A major reason behind the markets reaction is that investors are still speculative over future market performance and economic health. People are hesitant to hold money in the equities market because of the strong possibility of losing money. Investors are protecting themselves from the riskiness of the equity market by pulling their money out and investing in less riskier options.

Some helpful links to further enhance your knowledge on these topics are:

http://www.economist.com/node/21530090

http://www.economist.com/node/21529057

http://www.economist.com/node/21529074

Operation Twist

2011-09-29T12:15:00.000-07:00

Operation Twist

Financial New Analysis: September 22^nd- 29^th 2011

By: Paul Albuquerque & Stephanie Murphy

Over the past few years the Fed has implemented Quantitative Easing in order to lower interest rates, resulting in the increase in inflation rate throughout our country. However, our economy has remained stagnant, despite the record low interest rates we currently exhibit. Operation Twist is a method of Quantitative Easing that theoretically will not affect the inflation rate. The purpose of this method is to lower yields on long term securities. The lowering of these yields can help to encourage long term investments. Another potential benefit is to enable households and firms to refinance older debt at new lower rates. This article will continue to evaluate Operation Twist in terms of how it is implemented, the purpose of this method, impacts, and potential limitations of the Fed’s influence on our current economic state.

There are two major steps involved in the design of Operation Twist. The first step is for the Federal Reserve to sell $400billion in short-term treasury securities (less than 3years) beginning on Tuesday, September 27^th. The second step is for the Federal Reserve to purchase $400billion in long-term securities (6-30year term). The Fed anticipates these steps to occur in a simultaneous fashion, in order to transfer their holdings from short-term to long terms securities.

The most important factor to understand about Operation Twist is that the Fed is not introducing any additional currency into the United States economy. This is intended to inhibit the Fed’s influence on the inflation rate. Currently, short to medium-term security yields are near zero, so there is little the Fed can do to influence the lowering of these yields. However, long-term yields are relatively higher, allowing leeway for the Fed to exercise their influence over yields.

The graph above demonstrates the positive correlation between long-term securities and mortgage rates. Due to the strong correlation exhibited, the Fed can expect that mortgage rates will fall as the intended effects of Operation Twist hit our economy. When these long-term yields lower, the Fed anticipates that households will be able to refinance, therefore having more cash-on-hand to reinvest into the economy.

However, just because mortgage rates are low, doesn't mean that banks are handing out new mortgages, or open to refinancing homes. "Data suggests that roughly a quarter of borrowers have mortgages worth more than their home, and half don't have the 20% equity needed to refinance at a low rate." [Financial Times] Due to circumstances outside of the Fed’s control, Operation Twist will likely be unable to reach its full potential within our economy.

Operation Twist is the last tool that the Federal Reserve can use to influence our economy, given the processes they previously used. Operation Twist demonstrates the limits of the Fed’s influence in our economy. Even though it is expected to take several quarters before all effects of this Quantitative Easing are noticed, it is unlikely to greatly impact our economy.

References:

http://www.npr.org/blogs/money/2011/09/21/140643696/operation-twist-explained-in-4-easy-steps

http://library.hsh.com/articles/more-tools-resources-and-info/mortgage-basics/what-moves-mortgage-rates-the-basics

http://articles.latimes.com/2011/sep/22/business/la-fi-twist-qa-20110922

http://www.ft.com/intl/cms/s/0/b1b508a4-e9d9-11e0-bb3e-00144feab49a.html#axzz1gMooLQxg

http://mobile.nationaljournal.com/economy/with-operation-twist-the-fed-rediscovers-half-its-job-to-gop-s-chagrin-20110921

http://www.fundweb.co.uk/home/news/operation-twist-and-imf-report-continue-to-hammer-markets/1038267.article

Private Equity

2011-09-20T09:36:00.000-07:00

Private equity is an equity security. Equity securities are instruments such as stock as opposed to a debt securities such as bonds or derivative securities such as futures.

The key feature of private equity is what it isn't: public equity, which is publicly traded. Company ownership is generally above individual or small group means. Public trading allows the distribution of ownership into small affordable shares. Without public trading, private equity is limited to entities who can raise enough capital and who want to. Want is important because there exist many large firms with enough capital to acquire many smaller firms. However, the opportunity cost of acquiring smaller firms is investing capital into its own operating activities. For example, Microsoft has enough capital to acquire many playing card factories. However, more profit would be generated if that capital was used towards it's operating activity of marketing software. Though Microsoft has means to acquire card factories, it lacks incentive as doing so generates less profit.

Three entities that have means and want are: venture capital firms, angel investors, and private equity firms. But, private equity isn't just identifying entities. There are two more questions: how the entity raises capital and what to do after acquisition. Some methods of raising capital and subsequent operations are: venture capital, leveraged buyouts, and distressed investments. The questions to ask when analyzing private equity are: who does it and how they do it.

Venture capital is capital invested in whats best called a startup company: a brand new or very new company that is developing an innovative product. Such a company is high risk and has neither collateral nor reputation. Most are unwilling to lend to a startup creating demand for venture capital.

A real example of venture capital: Google was once two graduate students and an idea. The two founders needed many servers to host their new search engine. This expense was beyond the means of two graduate students and they got $100,000 from an angel investor. As the company grew exponentially, so did the costs and the founders asked for and received 25 million in funding from several venture capital firms. Five years later, Google went public and the investors were able to sell their equity for far more than they bought it for.

Venture capital firms are organized to fit the unique needs of startups. VC firms require a high share of equity in return for high risk. Often, the share is a controlling majority. With the majority, the VC puts its own staff in the startup to protect its investment. The VC also uses this influence to pressure or force the startup to sell or go public within a certain time frame. This ensures the VC can see a return on its investment. The risk also forces VC firms to invest in many startups to hedge risk. The cost of many investments requires VC firms to have a large amount of capital.

Angel investors also invest in startups. But, they are generally a single person. The limited resources of one person generally limits investments to a single startup. However, angel investments are usually done early in the life of the startup when they are cheaper reducing the burden on the angel.

Angel investing is usually not a sound strategy because angels are often motivated by reasons other than just profit. Profit motivated angels tend to act like small VC firms.

Leveraged buyouts are usually done by private equity firms. A leveraged buyout is acquiring another firm with mostly loaned capital. LBOs often aim to make a quick profit and pay back the loan.

A generic example of a LBO with interest rates at 5%: A private equity firm has 1 billion dollars available. The firm borrows 9 billion and acquires a 10 billion dollar firm. The acquiring firm improves the acquired firm to maximize its value. From these improvements, a year later the acquired firm is worth 11 billion. The acquiring firm sells the acquired firm and has 11 billion on hand. With interest, the 9 billion loan is now 9.45 billion. After paying the loan, 1.55 billion is left and the acquiring firm increases its equity by 55%.

This example also shows how risky an LBO can be. If the value of the acquired firm stays constant, the acquiring firm would lose 45% of its equity. If the value of the acquired firm drops to 9 billion, the acquiring firm is bankrupt.

Distressed investments are also usually done by private equity firms. Most are unwilling to lend to financially struggling firms. Private equity firms provide the needed capital to the struggling firm in exchange for extremely high interest rates. Another option is to outright acquire the struggling firm and use the injection of capital to revive it.

Private equity firms are very much like fund management firms like mutual funds. The firm gathers the funds of its investors and reinvests them into private equity markets.