The Fed Meeting Fallout, US$ Strength / Smaller than Expected Debt Limit Increase, Shadow Home Inventory on the Rise, State Budget Problems

The Fed chose not to change rates or comments during the Wednesday meeting. While we anticipated this outcome in our Monday post, the market reaction has been anything but expected. In months past the type of Fed commentary exhibited this week led to a lower US$ and inverse strength in commodity and equity markets. This week the results have been anything but ordinary. The US$ gained strength, some commodities have rallied with the US$ (e.g. Oil) but precious metals have suffered. Meanwhile the Treasury markets have rallied and equity markets seem to have stalled.

The Fed's commitment to a lenient stance is not a surprise. The following two stories are just a couple of the driving forces applying pressure to the economy and in turn the Fed...

More homes are poised to hit the market - LA Times
LA Times reports a supply of 1.7 million homes headed for sale because of foreclosure or delinquency looms over the nation's housing market, which could dampen progress toward recovery should the Obama administration fail in its efforts to aid struggling homeowners, researchers said. A variety of measures to keep discounted bank-owned properties off the market -- including moratoriums on foreclosures by major lenders and federal initiatives aimed at keeping people in their homes with mortgage payments they can afford -- has helped increase a backlog of so-called shadow inventory 55% in the year ended Sept. 30, according to a report released Thursday by First American CoreLogic, a Santa Ana-based real estate research firm.

States scramble to close new budget gaps - WSJ
WSJ reports the patches used by states on their ailing budgets just months ago are now failing. Ohio lawmakers were expected late Thursday to vote on a compromise reached with Gov. Ted Strickland to avoid cutting education budgets an average of 10% on Jan. 1. In Arizona, lawmakers met in a special session Thursday -- their fourth on the budget this year -- to grapple with a new deficit. And in New York, Democratic Gov. David Paterson said Sunday he would postpone paying $750 million of state bills to avert a cash crunch. Many states eliminated expected deficits earlier this year with budget cuts, tax increases, short-term borrowing, accounting moves and planned gambling expansions. But despite a slight improvement in the U.S. economy, states are now finding those measures didn't go far enough. Tax collections continue to trail projections in some states, and court rulings and political battles have blocked some gap-filling moves. Plus, some legislatures didn't fully deal with the deficits, leaving the toughest decisions to governors... Only a few states now have cash-flow problems. But if revenues continue to fall below expectations, the list could grow, said Scott Pattison, executive director of the National Association of State Budget Officers.

...the US$'s strength as well as the strength in the Treasury bond market does however, provide some consternation. Apparently, other factors have overshadowed the Fed meeting this week and driven the direction of markets. Many attribute the strength of the US$ to troubles developing in Europe. The fears of a debt default in Greece have led some to believe the viability of the EU is in question. We believe this fear is unfounded and would instead direct your attention to the following story...

House narrowly passes $290 billion increase in debt limit - WSJ
WSJ reports the House approved a short-term $290 billion extension in the nation's debt ceiling, delaying a decision until February about a larger increase in the borrowing cap. The vote comes less than a week after House Majority Leader Steny Hoyer (D., Md.) said he intended to seek a $1.8 trillion increase in the ceiling to support federal government borrowing through 2010. A decision was made to seek the more modest increase after it became clear the larger increase may have failed to win support in the Senate. The Senate must still take up the two-month increase, which it is expected to do next week.

...The decision to delay the "larger increase in the borrowing cap" in our opinion added fuel to a short covering rally already underway in the US$. I will note that the vote has only been delayed and will no doubt be passed in the not to distant future.

In short, year-long trends remain in place although severely tested this week. Seasonality would suggest equity market strength during the last two weeks of the year. Volatility as judged by the VIX index has remained subdued during this week's shenanigans and would add credence to the idea of a resumption in seasonal trends.

Housing Starts Crater, Economy Woes Tie Fed Hands, GLD Warnings, Paulson & Touradji Make Bold Gold Statements

Mid-week and the economic numbers continue to disappoint. However, equity investors should take heart and view the chart above. This is a monthly chart illustrating the direction of the US$ and the inverse relationship with the S&P500. The chart dates back to 2000, but you can see the correlation has become more intense in the last 12 months.

So, as long as this correlation holds, remember bad economic data equals good equity market performance due to continued Fed accommodation that leads to a weaker US$...

Fed's Bullard says possible Fed won't hike rates until 2012

Housing Starts Crater
The talk that housing starts were stabilizing hit a snag in October as new housing starts plummeted 10.6% to 529,000 units from 592,000. The consensus forecasted an increase in starts to 600,000...Single family starts fell 6.8% to 476,000 and is at its lowest level since May. Multi-family starts fell a whopping 34.5% as only 53,000 new units were started. Multi-family starts have never been this low since the index was created in 1959

I mentioned Monday, "Make sure your precious investment is backed by the actual metal." Below you will find an excerpt from the Gold ETF (GLD) prospectus. This same language can be found in the Silver ETF (SLV) prospectus. Take heed of these warnings. I fear in a world that has become numb to a long list of possible side effects to the drugs taken, you may view this prospectus in the same light. Don't make that mistake! These are very real warnings that could effect your financial health. Why even take the risk, when there are so many quality alternatives? Please, feel free to log onto our website http://www.rosenthalcapital.com/ for a complete discussion of said alternatives...

Gold bars allocated to the Trust in connection with the creation of a Basket may not meet the London Good Delivery Standards and, if a Basket is issued against such gold, the Trust may suffer a loss. Neither the Trustee nor the Custodian independently confirms the fineness of the gold bars allocated to the Trust in connection with the creation of a Basket. The gold bars allocated to the Trust by the Custodian may be different from the reported fineness or weight required by the LBMA’s standards for gold bars delivered in settlement of a gold trade, or the London Good Delivery Standards, the standards required by the Trust. If the Trustee nevertheless issues a Basket against such gold, and if the Custodian fails to satisfy its obligation to credit the Trust the amount of any deficiency, the Trust may suffer a loss. Read More...

...Meanwhile, the best in the business are coming our way. To Touradji and Paulson I will say, from all of us at RCM, welcome to our world!

Paulson & Co. to launch new gold fund January 1; Paulson to personally invest about $250 mln in new gold fund - Reuters

Touradji Capital Management LP, the New York hedge-fund firm that oversees about $2.7 billion, bought 2.23 million shares of Barrick Gold Corp., the world’s biggest gold producer, while selling shares in SPDR Gold Trust, the largest exchange-traded fund backed by bullion. Read More...

Credit Thaw, LIBOR Trend, Commercial Paper,M Hanson Real Estate, CA Home Sales Report, Earning of Interest ABX, NETL

We have been following the LIBOR story since the beginning of the credit crisis. Conventional wisdom suggests that if the LIBOR rate is going up then there are problems with the credit markets and if rates are going down then credit is flowing freely. This story highlights a possible wrinkle in this theory. Rates are clearly going down but the positive effects associated with the ease may not be felt in the economy which may cause some consternation for policy makers.

Credit thaw is spurring appetite for bank IOUs -

WSJ reports investors have developed a voracious demand for short-term debt issued by U.S. and European banks, and an important global lending benchmark has fallen to an all-time low -- welcome signs that bank credit markets have improved.

But beneath the demand for short-term bank debt, known as commercial paper, and a drop in the London interbank offered rate, or Libor, significant kinks remain lodged in the bank markets: Banks are using the fresh cash to repay existing debt, or simply hoarding it. That cash buildup is potentially stymieing efforts by regulators to circulate funds to borrowers and the most needy banks.

In contrast to the panicked days early this year, bank commercial paper "flies off the screen," said one New York trader. The market for this short-term bank debt runs from 7 a.m. to about 2 p.m. in New York. But investor demand has been so strong that some banks are turning away buyers by late morning... There is the possibility that three-month dollar Libor could fall yet further. The most healthy U.S. and European banks are selling three-month commercial paper at a range of 0.3 percentage point, or nearly 0.2 percentage point below the three-month Libor, according to one New York desk that trades commercial paper. That suggests Libor might fall further if it tracked the cost of selling the short-term IOUs.

In Thursday's post I made reference to the dire condition of the real estate market. The following piece by Hanson Advisors lays credence to that claim. Please read the red highlights closely as they will protect you from the positive spin chicanery evangelized by government.

M Hanson Advisers – Real Estate & Finance:

Late last week, DataQuick released their monthly CA home sales report. June saw more sales and higher prices than May. More sales are better for the market than less, no doubt. But opening a bottle of Dom and slapping a high-five to your real estate investment partner -- or proclaiming a bottom to the CA market on national tv -- would be misguided and ultimately detrimental to your career.

This is especially true given that loan defaults and foreclosures are surging faster than sales, foreclosure-related resales are at a point of maximum demand, and all-important organic sales are off 65% from levels seen just a few years ago. In addition, the primary reason for the recent house price appreciation is due to mid-to-high end price slashing and short sales, which has led to an up-tick in sales, and a subsequent rise in the median due to the mix-shift. (Very important to understand and yet rarely discussed by traditional media sources.)

While lower prices are needed to ultimately put an end to the housing crisis, price dumping leads to increased negative equity across the homeowner population significantly increasing the likelihood of loan default. As you witnessed at the low-to-mid end of the market beginning in 2007, a lot of pain is experienced while a market finds its bottom.

This up-tick in mid-to-high end sales is the leading indicator I have been waiting for that signals the rest of the housing market is finally beginning its mark-to-market. This time around, however, the mid-to-high end earners and consumers are the ones most affected.

The bottom line is that foreclosure-related resales have peaked and organic sales are off 65% from their peak levels. In the foreclosure resale half of the market, supply is once again outpacing demand. The mid-to-high end is being swiftly re-priced lower. This cannot be viewed as a ‘market getting better’.

Earnings of Interest

(Please click on the link above to review previous EPS posts)

Periodically I will post the EPS news of companies we find interesting. This is not a recommendation to purchase or sell the shares. I will not engage in the hackneyed approach of other bloggers and give advice about when to buy or sell. The purpose of these posts is to give you, the reader, an idea of what companies our research department deems worthy of review.

Of course, if you are an investor in any of the Fortune's Favor Family of Funds or a client of RCM our door is always open. Feel free to call or email questions at any time.

Barrick Gold beats by $0.11, beats on revs (32.86 ) : Reports Q2 (Jun) earnings of $0.49 per share, excluding non-recurring items, $0.11 better than the First Call consensus of $0.38; revenues rose 3.2% year/year to $2.03 bln vs the $1.9 bln consensus. Barrick remains on track with its full year 2009 production guidance of 7.2-7.6 million ounces of gold at net cash costs of $360-$385 per ounce or total cash costs of $450-$475 per ounce. "Our portfolio of operations performed strongly in Q2, exceeding plan, and positioning us well to meet our production and cost targets for the year. The go-ahead decision on Pascua-Lama during the quarter marks an important milestone for Barrick and our strategy of developing long life, low cost mines. Pascua-Lama is expected to be one of the industry's lowest cost gold operations and joins the world-class Cortez Hills and Pueblo Viejo projects in construction. Execution on this new generation of projects, combined with a favorable gold price outlook and our focus on cost management provides the foundation from which Barrick will continue to deliver shareholder value."

NetLogic beats by $0.10, beats on revs (39.43 ) : Reports Q2 (Jun) earnings of $0.35 per share, $0.10 better than the First Call consensus of $0.25; revenues fell 11.0% year/year to $32.5 mln vs the $32.1 mln consensus.

NetLogic guides Q3 above consensus on earnings call (39.43 +0.15) -Update : On call mgmt guides Q3 sales to grow 8% to $46 mln vs $33.69 mln First Call consensus, EPS to $0.32 vs $0.27 First Call consensus. Guidance for Q3 will include the effects of both the acquisitions of network search engine business as well as the pending merger with RMI corporation

IBD Editorial, Truth In Lending, The Housing Market, The Financial Crisis, What it Means for The Health Care Overhaul

A must read story from the Investors Business Daily. The story illustrates how government meddling clearly led to the ruination of the housing market and in turn the financial crisis. We must understand what happened and raise our collective voice if we are to save the health care system from a similar fate.

Truth In Lending

By INVESTOR'S BUSINESS DAILY Posted Friday, July 10, 2009 4:20 PM PT
Behind The Meltdown: Many Americans are unaware of the causes of the greatest economic calamity of our lifetime. A new congressional report details how government politicized housing, wrecking the economy.

Rep. Darrell Issa of California, ranking Republican on the House Oversight and Government Reform Committee, has released a report that every American should read.
The analysis details how powerful Democrats in Congress insisted that government-subsidized housing be geared to serve the purposes of social justice at the expense of sound lending.

Here are some highlights of Issa's blow-by-blow account:

• With an implicit subsidy to American homeowners in the form of reduced mortgage rates, Fannie Mae and its sister government sponsored enterprise, Freddie Mac, squeezed out their competition and cornered the secondary mortgage market. They took advantage of a $2.25 billion line of credit from the U.S. Treasury.
• Congress, by statute, allowed them to operate with much lower capital requirements than private-sector competitors. They "used their congressionally-granted advantages to leverage themselves in excess of 70-to-1."
• The two GSEs were the only publicly traded corporations exempt from SEC oversight. All their securities carried an implicit AAA rating regardless of the quality of the mortgages.

(The first three bullets illustrate to perfection what happens when the Gov't interferes with the private market. Take note because now the Obama administration is feeding us the line that increased Gov't involvement in the health care system will create healthy competition. THIS IS A LIE! WAKE UP PEOPLE!)

• The Department of Housing and Urban Development set quotas for GSE investment in affordable housing.
• Encouraged by an inaccurate 1992 Boston Federal Reserve Bank study charging racial discrimination in mortgage lending, the two GSEs were strongly pressured to "lower their underwriting standards, particularly on the size of down payments and the credit quality of borrowers."(Barney Frank was perhaps the loudest voice calling for the subversion of underwriting standards. This is one of the reasons why I have repeatedly called for his removal. My issue with Barney is purely based on facts and not partisan prejudice as some may argue.)
• In 1992, Congress directed HUD to establish multiple quotas requiring mortgage quotes for low-income families.
• In 1995, the Clinton administration issued a National Homeownership Strategy, loosening Fannie and Freddie's lending standards and insisting that lenders "work collaboratively to reduce homebuyer downpayment requirements."
• The administration complained that in 1989 only 7% of mortgages had less than a 10% downpayment. By 1994, it wanted that raised to 29%.
• Reduced underwriting standards spread into the entire U.S. mortgage market to those at all income levels.
• A complete decoupling of home prices from Americans' income fed the growth of the housing bubble as borrowers made smaller down payments and took on higher debt.
• Wall Street firms specializing "in packaging and investing in the lowest-quality tranches of mortgage-backed securities, profited hugely from the increased volume that government affordable lending policies sparked."
• Wall Street firms, homebuilders and the GSEs used money, power and influence to block attempts at reform. Between 1998 and 2008, Fannie and Freddie spent over $176 million on lobbyists.
• In 2006, Freddie paid the largest fine in Federal Election Commission history for improperly using corporate resources to hold 85 fundraisers for congressmen, raising a total of $1.7 million.

As the Issa report points out, "the real tragedy of the government's affordable housing policy is the impact on average Americans, particularly those of modest means. "Millions of these borrowers, who were supposed to have been helped by federal affordable housing policy, have now been forced into delinquency and foreclosure, destroying their asset base, their credit, and in some cases their families."

Stalled Stimulus Deters Investment, Subprime Woe Resurfaces, China Attacks US$ Dominance

- If you don’t read the newspaper you are uninformed, if you do read the newspaper you are misinformed. –Mark Twain

RCM Comment: The story below illustrates what happens all too often when government oversteps its mandate and attempts to manipulate the private sector. For those of you who approve of big government read this story very closely. Please understand that I respect your ideals and I'm willing to believe as left wing, big government believers you are only trying to promote equality (those who use big government for their own gain e.g. ACORN, I will not waste time addressing). However, reality must trump blind altruism.

Yes, we need to reduce our dependence on foreign oil, but let's do it in a way that promotes private sector innovation not government handouts. If, for example, significant tax breaks were directed at the renewable energy issue the wheels of innovation would already be moving. Private sector innovation has always been the key weapon in the economic arsenal of the USA.

I'm sorry did I just write something? I must have been dreaming. Tax breaks would help everyone equally and this would never do for those controlling Washington. Government handouts, in the form of "stimulus", can be directed at special interest groups and those who donate to political campaigns. Did you really believe Obama's campaign promise to rid Washington of lobbyists and special interests? If, so then you must go directly to jail without passing Go or collecting $200. Your punishment for naivete: stay in jail until the Community Chest gets around to authorizing a "get out of jail free" card. This authorization should take about as long as it takes for the stimulus package to actually stimulate. My advice: bring a good book. Something written by Thomas Sowell perhaps such as "The Housing Boom and Bust".

Stalled stimulus programs deter investments in renewable energy - WSJ
WSJ reports the U.S. government stimulus package passed in February promised to reinvigorate the renewable-energy industry with new capital and programs, but the prospect of large flows of government money to the industry is holding up private-sector investment. New incentive programs haven't yet been defined, and uncertainty about program rules has deterred investors from backing companies that also may get government money. At the same time, companies are holding off from accepting private capital because of the possibility of getting it more cheaply from the government. "It artificially slowed the recovery," Matt Cheney, chief executive of Renewable Ventures, the U.S. subsidiary of Fotowatio SL, a Spanish developer of renewable-energy projects, said of the stimulus plan.

Reality vs. "Green Shoot" Redux...Combine this story with the commercial real estate story from the 7/8 post and you get a good idea of the real headwinds facing economic recovery.

Subprime resurfaces as housing-market woe - WSJ
WSJ reports the U.S. housing market is facing new downward pressure as holders of subprime-mortgage bonds flood the market with foreclosed homes at prices that are much lower than where many banks are willing to sell. While nationwide figures are scarce, a review of thousands of foreclosures in the Atlanta area shows that trusts managing pools of securitized mortgages sold six times as many properties as banks during the six months ended March 31. And homes dumped by subprime bondholders sold for thousands of dollars less on average than bank-owned properties, the data show.

Experts say this is a bad omen for residential real-estate prices and homeowners trying to sell or refinance, because the fire sales, many to cover soured subprime loans, put downward pressure on the value of nearby homes. All of this undermines federal efforts to stabilize the housing market and revive the broader economy. "While the banks are trying frantically to get loans off their books, they face the problem of large shadow inventories of housing being dumped on the market, which would depress prices further," said Anthony Sanders, real-estate finance professor at George Mason University in Fairfax, Va.

RCM Comment: I continue to run these stories about the US$ because you must appreciate that change is coming and you need to protect your assets accordingly. Should you need help devising a plan may I suggest you visit our website. I will also entertain any and all questions as promptly as possible whether they are received via blog comments, email or phone.

China attacks dollar's dominance - Financial Times
Financial Times reports China has launched its highest-profile criticism of the dominant role of the US dollar as a global reserve currency at a meeting of the world's biggest economies. Dai Bingguo, Chinese state counselor, raised the issue on Thursday when he joined the leaders of four other emerging economies for talks with the leaders of the Group of Eight industrialized nations -- including US President Barack Obama -- in L'Aquila. The remarks, in front of Mr Obama, caused concern among western leaders, some of whom fear that even discussion of long-term currency issues could unsettle markets and undercut economic recovery.

Gordon Brown, Britain's prime minister, said he did not remember Mr Dai making the remarks. But he said the focus should be on moving the world out of recession. "We don't want to give the impression that big change is around the corner and the present arrangements will be destabilized," said Mr Brown. (In other words, Gordon would rather lie about the situation than give an honest impression.)

"We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies exchange rates and promote a diversified and rational international reserve currency system," said Mr Dai, according to the Chinese foreign ministry. While he did not name the dollar, Mr Dai was unequivocal in calling for the world to diversify the reserve currency system and aim at relatively stable exchange rates among leading currencies.