JPMorgan's "Good" Earnings Overshadowed By Bank of America's Need For Bailout

On the surface, JPMorgan's earnings didn't look too bad, relatively speaking (like compared with the run-of-the-mill Citigroup quarter).  The second-largest US bank reported net income of $702 million, or 7 cents a share, compared with $2.97 billion or 86 cents a share in the year-ago quarter.  However, JP's meager profit was boosted by a one-time gain of $1.3 billion from closing a joint venture and "risk-management results" (whatever that means.)  Without the one-time gain the company would've lost 28 cents a share.  This is an earnings "miss" in my book, but investors seem to disagree as the stock is higher on the news.

The scary news out of Bank of America this morning, frankly, overshadows JPMorgan's creative accounting triumph of seven cents of earnings.  According to the Wall Street Journal, Bank of America is close to finalizing a deal for additional aid from the government to help it close the acquisition of Merrill Lynch.  Apparently, Merrill was set to report larger-than-expected losses in the fourth quarter and Bank of America was not likely to complete its purchase.  Bank of America alerted the Treasury Department of the situation in mid-December.  Naturally the Treasury freaked out, fearing another Lehman-like debacle in the market and offered Bank of America help finalizing the deal.  The arrangement more than likely will include new capital in addition to guarantees on further losses.  I suspect this is not the last bailout package we will see for a major US bank.  A friend of the blog asked a very scary but insightful question in recent months.  "What if all bank equity is worth zero?"  I suppose what we'd have left was a bunch of bank stocks trading as if they were call options on some hope for future cash flows that leave something for shareholders, i.e. a bunch of stocks trading in the single digits.  Let review, Citigroup $4, BAC $8.  I'll stop now before it gets any scarier.     

Retail Sales Fall 2.7% and Other Sobering Headlines

Some Economic and Earnings Headlines:

• Retail sales declined by 2.7% in December, the sixth consecutive drop.  
  
• Nortel Networks filed for bankruptcy protection.  To be honest, I'm surprised these guys have hung in there so long.  They seem to lose money every quarter.  Bank of New York Mellon was listed as the largest unsecured creditor in its role as trustee on more than $3.8 billion in notes.
• Deutsche Bank reported a whopping $6.3 billion loss in the fourth quarter.  The bank indicated that significant losses came from sales and trading, although they failed to indicate how much was from prop trading.  Of course, DB's "star" prop trader, Boaz Weinstein, left last week to start a hedge fund (good luck with that), so you had to think the news out of that department wasn't going to be good.  Nevertheless, the losses out of Deutsche Bank should put the fear of God into those hoping for signs of recovery out of the banking sector.
• Tiffany reported a 21% decline in holiday sales.  The company reduced its earnings forecast for the year.  Remarkably, even with the decline, consumers spend $687.4 million on jewelry at Tiffany between November 1 and December 31.  Somebody somewhere still allocates a portion of their money to purchasing jewels, which I suppose is a positive sign.  

Equity markets are in the red, having given back all of their gains since the start of the new year.  So much for that fabled January Effect.  Bad economic and earnings news has overcome any optimism that investors may have faced at the start of the year.

Bernanke Rambles On, Trade Deficit Shrinks

The trade deficit shrank to $40.4 billion in November from $56.7 billion in October.  November exports declined by $8.8 billion from $151.5 billion while November imports fell by $25 billion from $208.2 billion.  Calculated Risk points out that most of the decline was due to the plummeting price of oil which should continue to impact December's numbers as well.  Oil prices aside, a sharp decline in US imports is sobering news for those countries that expect the US to keep buying their products.

Meanwhile, Bernanke is running off at the mouth about the current state of the economy.  To summarize his comments:  Blah blah blah, we need fiscal stimulus, blah blah blah, but stimulus won't be enough, blah blah blah, we need to further stabilize the financial system, blah blah blah, government may need to inject more capital into banks ("Hello Ben?  This is Vikram Pandit calling again.")  blah blah blah, let me explain why what we are doing is different from Japan, blah blah blah, we have many more tools in our arsenal that we have yet to tap and we're certain that these will definitely work, blah blah blah, let me refer you to chapter seven of my book on the Great Depression.  Alphaville has more on "credit easing versus quantitative easing" for those interested in a longer read. 

President Bush is seeking the rest of the $350 billion in TARP funds so that our new President Obama can use them the second after he is sworn in.  Does that make you nervous about the state of the financial system?  Investors who chose to pound shares of Citigroup, Bank of America and various other financial institutions are definitely betting that the government will have to step in and dilute shareholders again.  The new administration has already stated that the terms of the new bailouts will be far more strict and will be monitored closely.

As the crummy economic and earnings news rolls in, the government will attempt to counterbalance it with announcements of bigger and broader stimulus attempts.  I believe that this year will be the year of Bad Economy vs. Big Government Spending.  That is why it is so hard to make predictions about the direction of markets (although really, is it ever easy?) When the rules of the game can change every day based on the whims of our elected leaders, it is difficult to draw a line in the sand and say that the market is going lower because of bad fundamentals.  It is equally as difficult to believe that everything will be fine just because the Government is guaranteeing everything when the fundamentals are so horrible.  Consequently, one grand prediction I have is that of continued volatility, maybe not the kind we witnessed in October, but certainly the markets will be on a roller coaster ride until we figure out which force will win the battle.  The good news is, for those with a strong stomach, roller coasters can be a fun and interesting ride.     

Paltry Debt Recovery Rates Anticipated in Economic Downturn

The Financial Times has a very good article about debt recovery rates taking it on the chin in this economic downturn.  If you thought that Lehman bondholders were disappointed by the paltry 9 cents that resulted in the CDS settlement after the company's bankruptcy, try being a Tribune bondholder.  The settling of credit derivatives linked to the Tribune bankruptcy provided a mere 1.5 cents on the dollar for bonds, with Tribune's loans settling at 23.75 cents.  Historical bond recovery rates have been around 40 cents on the dollar while historical loan recovery rates have hovered around 87 cents.  Moody's head of corporate default research claims those rates might fall as low as 15 cents for bonds and 52 cents for loans in this downturn.  Sadly, even those levels might prove to be optimistic. 

The explanation for the bleak situation facing bond and loan investors who hold debt in companies that go bankrupt is summed up nicely by David Bullock, managing director at Advent Capital: "You have leverage at historically high levels in an economy that is in historically dire straits."  Furthermore, due to loose covenants struck during the go-go days of the credit boom, companies are allowed to operate longer before triggering a default, assets are therefore depleted and liquidations result in lower recoveries once the company finally does go bankrupt.  It would be easy to pity the poor bond investor who is suffering from this unprecedented downturn.  But covenants were invented so that bond investors could protect themselves if conditions at a company deteriorated unexpectedly.  Why bond investors lost their discipline and chose to lend money without asking for any protection in return at record low risk premiums during the credit boom will always be a mystery to me.  Now they must pay the price.  The real pity is that their reckless lending has inflicted so much pain on the rest of the economy.       

Former Peloton Co-Founder Convinces Soc Gen To Fork Over Money

Remember Peloton Partners, the $2 billion hedge fund that spectacularly lost all of its capital in early 2008, before the credit crisis really hit its stride?  One would think that the managers of a hedge fund that punted all of its investors' capital would be shut out of any money management opportunities in this difficult environment where even funds with good performance are battling redemptions.  But no.  The Financial Times reports that Geoff Grant, the co-founder  of Peloton has managed to raise approximately $130 million for a global macro fund, most of it from Soc Gen.  It's funny that a guy who missed one of the largest macro events of the last 50 years and was such a bad risk manager that he lost all of his investors' capital in about a month will now be running a global macro fund.   

Blowing up a hedge fund or a Wall Street trading desk and then quickly moving to another fabulous money making opportunity used to be a common theme.  The twisted thinking goes as follows: "he made a bunch of money before he lost it all, so he can make a bunch of money again."  For some reason, however, I thought that John Meriwether had finally put this ridiculous notion to rest.  After blowing up Long Term Capital and nearly taking down the entire financial system in 1998, Mr. Meriwether went on to found JWM Partners.  Everything was going swimmingly, until we hit another credit crisis, similar to 1998, but more severe.  JWM Partners dropped 43% through November 2008 and has halted redemptions.  The thing is, if you're going to suffer catastrophic losses every time the market has its big credit correction every 4-10 years, you have no business managing money.  You have learned nothing from your previous mistakes, and you're just a one trick pony who only makes money in bull markets.  Even a monkey can make money in a bull market.  The secret to being a good investor is making it though the bad times and being around to take advantage of good opportunities when markets get crazy.

So, Mr. Grant, you get a second chance.  Let's hope you learned your lesson the first time around.  As for Soc Gen, well, at least Mr. Grant's fund will be a better bet than the one they made on Jerome Kerviel.

KB Home Posts Another Loss, Lennar plunges

KB Home posted a $307 million loss on "improved margins and lower write-downs."  While that is a huge improvement over last year, when the homebuilder punted $772.7 million, it's still hard to celebrate those "improving margins" when you're still posting a sizable loss.  Furthermore, the company's revenue declined 56%, new home deliveries slid 52% and the average selling price declined by 6.3%.  CEO Jeff Mezger called the downward pressure on the home-building industry and overall economy "unprecedented."  But why shouldn't an unprecedented boom be followed by an unprecedented bust?  

Meanwhile, as KB Homes stock took a small beating this morning, Lennar's stock was getting hammered by a disproportionate amount.  Could there be some news?  Sort of.  The Fraud Discovery Institute released the Top 10 Red Flags for Fraud at Lennar.  Personally, I've never heard of the Fraud Discovery Institute, but a formidable name like that and a quote claiming that Lennar's joint ventures are a "ponzi" scheme, certainly made my trigger finger itchy.  I'm not sure how many of the red flags were actually new revelations to Lennar's shareholders or those who like to short the stock (yours truly, on occasion), but perhaps the use of the word "ponzi" in a Bloomberg headline woke everyone from their non-farm-payroll induced apathy.  For 2009, "ponzi" is the new "toxic assets."  Prepare yourselves to hear it used prolifically in reference to everything.  Thanks, Bernie Madoff.   

Employment Report: Bad, Really Bad

The US lost 524,000 in December, roughly in line consensus estimates, but the jobless rate rose more than forecast to 7.2%.  The service sector suffered the brunt of the losses (banks, insurance companies, restaurants and retailers) posting a decline of 273,000 workers, after a decline of 402,000 the previous month.  Additionally, the average work week shrank to a record-low 33.3 hours from 33.5 hours.  Average weekly hours worked by production workers dropped to 39.9 hours from 40.3 hours, while overtime decreased to 3 hours from 3.3 hours.  Average weekly earnings declined by $2 to $611.39.

The market is shrugging its shoulders as if to say "ho hum, we knew it would be bad."  But really, this is awful.  A 7.2% unemployment rate is downright miserable.  Furthermore, according to a friend of the blog with a better grasp on economics than myself, the decline in the average work week represents another half a million jobs lost in the economy.  Although the employment report can be written off as "anticipated," often it just takes some time for the bad news to sink in.