Report from Europe: Buffett Gets His Check Book Out

Given the slew of positive economic data Monday, you might have been forgiven for expecting a decent rebound in risk assets. There was a rebound of sorts in early New York trading, with the Dow up close to 150 points at one stage. But the rally lost momentum and was largely undone. Indeed the Dow traded in the red for a period.

Perhaps in part, this may have been due to comments made by a Fed official Jon Greenlee who told a House of Representatives Oversight and Government Reform subcommittee hearing that “credit losses at banking organisations continued to rise, and banks face risks of sizable additional credit losses given the outlook for production and employment… Poor loan quality, subpar earnings, and uncertainty about future conditions raise questions about capital adequacy for some institutions." More generally, fears about loan quality were corroborated overnight by the news that business bankruptcy filings jumped in October, reversing two months of declining commercial filings. Overall, the price action looked pretty poor to me. I’d have expected a much more positive reaction to the numbers yesterday

The past two sessions have confirmed the ongoing discrepancy between manufacturing and US consumer trends. US real consumer spending is barely higher than a year ago, yet the US manufacturing is now surfing above 55.0. This may reflect a rebalancing of the world economy (towards less dependency on the US consumer), yet I doubt it can happen so quickly. The optimists will argue that the consumer will finally join the party as stronger growth supports the income dynamics.

Stocks catching the eye in early US trading include Black & Decker (BDK) which has soared on news that Stanley Works (SWK) has agreed to buy them for $4.5 billion. Natural gas producer Chesapeake (CSK) may see some selling after reporting a 94% drop in Q3 net income. Note the stock was the top performer in its sector on the S&P 500 last quarter. Monday’s star turn Ford (F) may be Tuesday’s dog on news that the company plans to offer $2 billion in convertible senior notes. Intel (INTC) is selling some selling on the back of being cut to “equal weight” at Morgan Stanley and Viacom (VIA) (MTV and Paramount) may be well supported after reporting Q3 profits up 15% (beating estimates).US Factory Orders, released at 15.00, came in a smidgen better than expected at +0.9% month-over-month.

Today’s Market Moving Stories

• The big news is that when stocks fall, Buffett puts his money where his mouth is and goes shopping. In a big big bet on railways, Berkshire Hathaway have gone all in to buy Burlington Northern Santa Fe Corp. (BNI) in their biggest ever deal worth a staggering $44 billion (a 30% premium on yesterdays $76 a share price). Looks like Warren is betting on another round of stimulus spending. Needless to say the rail sector (CSX (CSX), Union Pacific (UNP), Norfolk Southern (NSC), Genesee and Wyoming (GWR)) will be very big today.
• British retail sales will rise 1.9% over Christmas, bouncing back from last year’s decline, but below the increases of the previous nine years, according to the Center for Retail Research. The research predicted the rise in sales could result in up to 4,500 new jobs by January. Much of the growth would be driven by online retail sales, which are forecast to rise 24% and account for 20p in every one pound of spending. “The peak weeks of Christmas trading are vitally important to retailers as many earn up to 60% of their profits during this period,” said Bruce Fair, managing director of Kelkoo UK. Retail sales have held up better than many analysts had feared in the recession, though signs of recovery remain patchy.
• The IMF has sold 200 tonnes of gold to India for $6.8 billion, a surprise to many traders who had expected China to be the leading buyer. The IMF has been looking to sell 403.3 tonnes of gold, about one-eighth of its total stock. The deal will increase India’s gold holdings to the tenth largest among central banks. Gold futures jumped $12 on Globex Tuesday. Looks like this IMF to India trade is seen as a further step towards all central banks strengthening their Gold reserves versus the US Dollar.
• And speaking of the greenback, as I mentioned yesterday, the odds on a contrarian Dollar rally were increasing and today, hey presto, the Dollar Index has broken resistance. Check out the chart below.
• The Australian central Bank (RBA) raised its interest rates by 0.25% to 3.5%, the second consecutive increase. The RBA’s statement differed little from that of October’s meeting and once more noted the rise of the AUD, adding that is “prudent to lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker”.
• James McCormack, managing director of Asia Pacific sovereign ratings at Fitch, believes that “China is the most obvious area of concern… The China property issue raises some concerns with respect to asset quality in the banks. The banking system is a sovereign rating weakness. Clearly banks in any country with a property bubble would be affected, but banks in China are, as noted, already a weakness.”
• The curse of Cramer strikes again. This weekend, CIT Group (CIT) filed Chapter 11. Merely four weeks ago, CNBC Mad Money host Jim Cramer said he would buy CIT. Cramer actually recommended buying CIT at the exact top!
• A few things you didn’t know about Google (GOOG) (click to enlarge).

The European Banking Sell Off Continues
European equities slumped sharply at the open Tuesday after the announcement of further equity issues by RBS (RBS) and Lloyds (LYG) (£46 billion in total). The UK government will raise its stake in RBS from 70% to 84%. And RBS (which is staying in the APS malgré tout), will divest a number of business, including the insurance line and part of its branch network. The stock is off 7%. Again, bad news for European banks that have relied on government aid.

Irish banks were under heavy pressure as the view was taken that this gigantic UK cash call will eat up most of the available monies out there making additional capital raising much more difficult. Additionally, there is also concern at the slow pace and relative lack of progress in restructuring the country’s ailing banking sector compared to what is being done in the UK

With the banking system still heavily dependent on state support, a significant pick-up in UK bank lending continues to look unlikely. I still expect the continued weakness of credit growth to act as a major constraint on the pace of economic recovery. An EU Commission report has predicted further bank write-offs of €200 – 400 billion.

Also in the banking sector, the debate on regulatory changes is raging on. At yesterday’s FSA conference, Josef Ackermann, Deutsche Bank’s (DB) CEO, opposed the ideas of dividing up and significantly downsizing the major banks, and of an aggressive increase in capital requirements, especially for global banks. Both ideas were put forward by the FSA chairman Lord Turner, who advocated a distinction (in minimum regulatory capital terms) between both banks and countries (national/local rules vs. international regulations).

Stocks Wobble
The latest falls in European equity markets primarily reflect weakness in banks, due to uncertainty about asset sales that may be required by regulators, and declines in miners and others vulnerable to the latest wobble in commodity prices. These factors were sufficient to drag the UK FTSE 100 below 5,000 today. But lurking below the surface are growing fears about the early withdrawal of monetary stimulus.

If nothing else, these fears underline the divergence of opinions in the market place. Many commentators are still more worried that major central banks will leave policy too loose for too long, creating fresh asset price bubbles and the risk of runaway inflation. My view, for once, is somewhere in the middle: I expect monetary policy to remain ultra-accommodative for longer than generally anticipated, but this is largely because I fear that the economic recovery will ultimately disappoint and the threat of deflation will linger for many years.

A further (and equally discouraging) reason why the exceptional monetary stimulus will have to remain in place for a prolonged period is that it has still not achieved all of its original objectives. Admittedly, the importance of the different transmission mechanisms varies from country to country. In general, central bank intervention has helped to kick-start credit markets that had frozen up following the collapse of Lehmans.

The purchase of assets and making of loans by central banks has also supported the prices of riskier assets more widely. However, despite some spectacular rallies, key asset prices remain well below the levels seen last year. The US S&P 500, for example, is still at least 25% below last summer’s levels, despite climbing more than 50% from its March lows.

Most importantly, the broader money and credit aggregates remain subdued. These aggregates would presumably have been even weaker without the emergency measures, and it may simply be too soon to expect a decent recovery in bank lending given the weakness of demand. To some extent also, the weakness in lending reflects the normalisation of other types of credit.

But there can be little doubt that the financial system remains fragile on the supply-side too. The latest round of public support for the banks in the UK, announced on Tuesday, highlights the continued problems there that the banks are still too weak to lend Similarly, last week’s ECB’s Bank Lending Survey confirmed that lending criteria in the euro-zone are far tighter than they were prior to the credit crunch. And in the US, the contraction in broad money and bank credit is gathering pace. No major central bank will be rushing for the exit.

And Finally… Cash For Faberge Eggs

Disclosures: None

Comments

[optionsgirl:]

Always good to read your blog, Mole. Do you have an opinion about DB safety? UBS announced losses this morning. online.wsj.com/article...

Nov 03 12:19 PM