Firing on Most Cylinders

By: Doug Noland | Fri, Apr 18, 2003
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For the week, the Dow gained almost 2%, with the S&P500 up about 3%. The Transports surged 6%, and the Utilities added 3%. The Morgan Stanley Cyclical index was up better than 3%, while the lagging Morgan Stanley Consumer index added about 1%. The broader market enjoyed strong gains, with the small cap Russell 2000 and S&P400 Mid-cap indices up 3%. The technology sector came to life again, with the NASDAQ100 jumping better than 5%. The Morgan Stanley High Tech index was up 6%, as the Semiconductors surged 10%. The Street.com Internet index jumped 6% and the NASDAQ Telecommunications index 5%. The Biotechs were up 3%. The financial stocks were strong as well, with the Securities Broker/Dealer index up 5% and the Banks up 4%. While bullion dipped about a dollar, the HUI Gold index added 2%.

From March lows (generally March 12th), the Dow has jumped 12% and the S&P500 13%. The Transports have surged 21%, and the Utilities have gained 9%. The Morgan Stanley Cyclical index is up 16%, and the Morgan Stanley Consumer index is up 10%. The Russell 2000 has gained 12% and the S&P400 Mid-cap index 11%. The NASDAQ100 is up 14.4% and the Morgan Stanley High Tech index 11.5%. The Semiconductors and The Street.com Internet index have both jumped about 20%. The NASDAQ Telecommunications index is up 14% and the Biotechs 9%. The Securities Broker/Dealer index has surged 26% and the Banks almost 18%.

Curiously, the Treasury market this week seemed to take the energized stock market in stride. Two-year Treasury yields increased four basis points to 1.68%, and five-year yields added three basis points to 2.93%. The ten-year Treasury yield actually declined two basis points to 3.96%, while the long-bond saw its yield dip six basis points to 4.89%. Benchmark mortgage-back yields jumped 10 basis points, while implied yields on agency futures were about unchanged. The 10-year dollar swap spread narrowed one to 41, while the spread on Fannie's 4 3/8% 2013 note narrowed two to 43. The dollar declined about 1%, while the CRB index gained almost 2%.

Corporate issuance slowed during the holiday-shortened week. JPMorganChase boosted the size of its bond issue by 25% to $1.25 billion. Nordic Investment Bank raised $1 billion and BHP Finance issued $850 million of bonds. Hilton Hotels issued $500 million of bonds, Cox Enterprises $500 million, Alabama Power $195 million, and Ohio Edison $325 million. Lower-tier debt has developed into quite a hot commodity. XTO Energy raised $400 million, Alpharma $220 million, Equistar Chemical $450 million, Ethyl Corp $150 million, Susquehanna Media $$150 million, and Rite Aid $360 million. Bloomberg's total y-t-d U.S. Domestic debt issuance of $633 billion is running 20% ahead of last year. With issuance of $3.7 billion, it was a relatively light week for the booming asset-backed security marketplace. However, year-to-date issuance of $129 billion is running 22% ahead of last year's record volume.

April 15 - Dow Jones (Nicole Bullock): "The high-yield market remains a fertile ground for new issues as cash continues to pour in and the supply pipeline fails to keep up. This week, several junk bond deals have been increased in size, are being priced at tight spreads to Treasuries and still trade higher after launch. 'The demand, I guess you could say, is pretty much unprecedented and the supply of new bonds, quite frankly, is limited,' said Harry Resis, director of U.S. fixed-income at Henderson Global Investors… 'All you have to do is look at the price action.' … So far this year, junk funds have seen inflows of about $12.2 billion, already surpassing the $11.7 billion take-in for all of 2002, according to AMG…" AMG reported this morning that an additional $555 million flowed into junk bond funds this week.

April 18 - New York Times (Jonathan Fuerbringer): "With war winding down, investors have poured more money into stock mutual funds than they have in a year… Stock mutual funds had a net inflow of $5.7 billion, with much of it devoted to the riskiest investments, in the week ended Wednesday. According to AMG Data Services, $1 billion went into aggressive growth funds and $472 million into technology funds."

April 17 - Bloomberg: "China's economy expanded at the fastest pace in seven years after factories boosted production to meet surging export demand. Gross domestic product grew a higher-than-expected 9.9 percent from a year ago to 2.36 trillion yuan ($285 billion) in the first quarter, the National Bureau of Statistics said… Retail sales rose 9.2 percent to 1.11 trillion yuan… Increasingly, the mobile phones, computers and toys made in China are also being sold to a growing middle class in cities such as Beijing and Shanghai. The per capita disposable income of China's 500 million urban residents rose 8.4 percent in the first quarter to 2,355 yuan… During the quarter, factory production increased 17 percent, foreign direct investment rose 57 percent, fixed-asset investment, about three-quarters coming from the government or state-backed companies, grew 28 percent and exports surged by a thirdGrowth may be too fast in areas such as real estate. Property investment rose more than a third in the last quarter and home sales increased by more than half. Earlier this month, Vice Premier Zeng Peiyan warned developers to stop making luxury villas, while former premier Zhu Rongji warned last year that a real estate 'bubble' was forming in some parts of the country."

Recent anecdotes from China are consistent with the nature of Credit booms: Initial inflationary manifestations can be quite positive: an investment boom, rampant productivity increases, surging employment and income growth, and general economic prosperity. But extraordinary booms never remain placid. Further into the boom cycle, inflationary manifestations become increasingly unpredictable and often problematic. There's been considerable talk of China exporting global "deflation." I would be cautious when extrapolating this phenomenon too far into the future (they've got a lot of inflated U.S. dollars to spend).

April 17 - Bloomberg: "Russia's economy expanded 6.4 percent in the first quarter, the fastest growth since the last three months of 2000, after oil, gas and metals producers boosted exports and service companies tapped soaring domestic demand."

April 15 - Dow Jones (Arden Dale): "Standard & Poor's took sweeping pensions-related actions Tuesday, putting 13 U.S. companies on watch for possible credit downgrade based on concerns about their post-retirement obligations. S&P acted partly out of its belief that the companies may have to dedicate a greater portion of their cash-flow to fund benefit obligations. The ratings agency also revised its long-term outlook for three companies to negative from stable, and for another to stable from positive, due to pension-related concerns. The 13 companies placed on credit watch negative are Alcoa Inc., Allegheny Technologies Inc., Caterpillar Inc., Caterpillar Financial Services Corp., Consol Energy Inc., Cummins Inc., Delphi Corp., Eaton Corp., Kimberly-Clark Corp., Pittston Co., PPG Industries Inc., SBC Communications Inc. and Visteon Corp."

Broad money supply (M3) dropped $37.9 billion last week. This is not unexpected in an environment of heightened demand for risk assets, with the corresponding diminished pressure on the financial sector to expand "safe" monetary liabilities. For the week, Demand and Checkable Deposits declined $19.3 billion (tax payments?). Savings Deposits surged $25.9 billion, while Retail Money Fund Deposits declined $10.4 billion. Institutional Money Fund Deposits declined $11.2 billion. Large Denominated Deposits declined $1.8 billion, Repurchase Agreements dropped $17.1 billion, and Eurodollars dipped $2.8 billion. Elsewhere, total outstanding Commercial Paper jumped $10.5 billion to $1.33 Trillion (the highest level in nine weeks). Non-financial CP added $2.6 billion and Financial CP gained $7.9 billion. Total Banking System Net Assets declined $15 billion, although Bank Credit expanded by $15.5 billion. Loans and Leases surged $27.1 billion, yet Commercial and Industrial loans declined $7.9 billion. Real Estate Loans jumped $20.8 billion, with two-week gains of $40.7 billion. Security loans expanded $12.9 billion. Year-over-year, real Estate loans are up 18% y-o-y, while Commercial and Industrial loans are down 6.5%. Security loans are up 24% y-o-y.

For our Diligent Observation, we take note that retail surveys from both Redbook and Bank of Tokyo-Mitsubishi posted strong gains last week. With sales up about 2% y-o-y, these were the first positive year-over-year comparisons in seven weeks and basically the strongest gains since early January. Redbook had sales up an impressive 4.4% from a month ago. Manufacturing and employment remain weak, but we should be mindful that these are generally lagging indicators.

March provided interesting data from the two major West Coast ports. After a relatively subdued February, total imports into the Ports of Los Angeles and Long Beach jumped 10%. Inbound containers were up 22% y-o-y. Outbound containers surged 12% to a new record, and were up 5% y-o-y. Nonetheless, 256,075 containers left the two ports empty, up 23% y-o-y and fully 54% of inbound containers.

The U.S. Treasury today reported a federal deficit of $58.7 billion for March. Half way through the fiscal year, Total Spending is up 6.7% to $1.078 Trillion, while Total Receipts are down 6.1% to $825 billion. The six-month deficit is up 92% to $253 billion. By major department, y-t-d Defense spending was up 12.9%, Social Security 4.1%, Health & Human Services 9.3%, Agriculture 1.3%, Education 44%, and Labor 26%. Interest expense was down 2.3%.

Bankruptcy filings declined markedly last week to 32,839, while remaining up 6% y-o-y. Blow-off week 44 saw both mortgage Refi (down 10%) and Purchase applications (down 6.2%) decline, although total application volume remains robust (up 141% y-o-y). Refi applications were up 345% y-o-y, and Purchase applications were up 11.5% y-o-y. March CPI increased 0.3%, with year-over-year consumer price inflation of 3%. This equals February's 3.0% y-o-y rise, which was the strongest reading since June 2001.

April 15 - Bloomberg: "New York apartment prices fell 3.7 percent in the first quarter and the number of sales declined 8.4 percent to the lowest level since the 2001 terrorist attacks, as the city's recession weakened demand for homes. The average price fell to $779,112 from $808,657 in the previous quarter, the second consecutive quarterly decline… The cheapest apartments showed a price gain… The average price for studios rose 10 percent to $282,431, and the price for one-bedroom units rose 2 percent to $462,917."

April 17 - American Banker (Erick Bergquist): "Interest-Only Loans Becoming More Popular - Here's the pitch: You're an upwardly mobile, financially savvy borrower managing your own investments. Interest rates are at historic lows, home values continue to magically rise, and you do not plan to be living in the same house in five years. What about taking out an interest-only loan? With the lowered monthly payments, you could buy a bigger house, and in a few years, when you're ready to refinance or trade up, you won't be in any worse shape for equity than you would have been if you had taken out a 3-year fixed-rate loan. Across America, more lenders say they have struck a gold mine with interest-only loans."

April 18 - Bloomberg: "Robert Shiller, the economist whose book warning of a stock bubble was published within days of the market's peak in 2000, isn't loading up on equities yet. The 57-year-old Yale University professor said in an interview that only about 5 percent of his wealth is invested in public companies. He bought a Connecticut vacation home with a view of Long Island Sound last year. 'Certain kinds of real estate do have great long-run prospects,' Shiller said in an interview. 'One of them is possibly real estate in rare, beautiful places; that is what I just bought.'"

Housing Starts were reported at a stronger-than-expected rate of 1.78 million, up 6% y-o-y. The 8.3% m-o-m rise largely reversed February's weather-induced 10% decline and was the largest gain since September. March Starts were up 22% from (pre-Bubble) March 1997 and compare to a trough level of 798,000 back in 1991, as well as an average rate of about 1.1 million during the early nineties recession. Homes Under Construction rose to a record 1.06 million, up 4% y-o-y. March Homes Under Construction were up 31% from (pre-Bubble) 1997 levels and compare to the average of about 650,000 during much of the 1991/92 recession. Single-family Homes Under Construction were up 7% y-o-y. And after a few very strong months, Building Permits settled back to a more reasonable but nonetheless quite strong 1.685 million annual pace (up 4% y-o-y).

It is again earnings season, providing our best opportunity to analyze the behavior of the nation's leading financial institutions. Are the lenders, financial insurers, and "risk players" becoming, at the margin, more risk averse or instead demonstrating a heightened appetite for risk? At what pace are financial sector balance sheets (money and Credit) expanding? From what sector(s) do we see the most aggressive expansion, and where is the created purchasing power generally being directed (Monetary Processes)? Are we seeing increased lending to commercial enterprise, or do asset markets (real estate) continue to play the major role in the Credit creation process? And we must ask, "Where are the greatest financial profits being generated?" as this provides us important clues as to where the greatest excesses are building. Well, I have yet to grasp any real surprises: Completely dominating the Credit mechanism, the Mortgage Finance Bubble runs unabated. The conspicuous inflationary manifestations include over-consumption and the augmentation of the maladjusted monetary ("service-sector") U.S. Bubble economy.

Fannie Mae reported first quarter Net Income of $1.94 billion, up 61% from the 2002Q1.

Bloomberg's Brian Sullivan: "Tell us what is the greatest underlying factor behind your ability to boost your earnings forecast for this year?"

Fannie Mae's Chairman Franklin Raines: "Well, the biggest factor was the very strong market for mortgage originations. People are still buying homes and they're refinancing their homes. And that has increased our business in the first quarter by about 24 or 25 percent, which allowed us to increase our overall revenue by about 27 percent and bring 24 percent EPS growth to the bottom line. So it's simply strong fundamentals. It's a part of our disciplined growth strategy, and it's working very well."

Brian Sullivan: "Are you concerned that the pace of the growth of your mortgage portfolio is faster than the pace of growth of mortgages as a whole? At what point will you say, maybe we've gotten a little bit too big, and we're going to slow down the pace of growth?"

Franklin Raines: "Well, actually, we're growing at about the pace of the market right now. The market simply is growing very, very fast. And so, traditionally, we've been taking about a point of market share a year. But that's pretty much - has not accelerated over the last couple of years. So what we are growing with is with the market. And that has been quite impressive, because this is a very strong market. It has an underlying growth rate of 8 to 10 percent. But in the last years it's been growing faster than 10 percent and that means that Fannie Mae can then grow faster than 10 percent.

Fannie's Book of Business (mortgages held and guaranteed mortgages sold into the marketplace) surged a record $103 billion (32% greater than the previous record growth set during 2002's fourth quarter) to $1.923 Trillion. This 22.7% quarterly growth rate increased Fannie's y-o-y Book of Business growth to $295.3 billion, or 18%. This amount is greater than total household mortgage debt growth for any year prior to 1998. Two-year Book of Business growth of $557 billion is up 41%. Five-year growth of $1 Trillion has more than doubled (109%). With intense marketplace demand for mortgages throughout, Fannie's balance sheet expanded by (only) 12% annualized during the quarter to $913 billion. Total Assets have increased $105 billion, or 13%, in twelve months. Total Assets have inflated 30% over two years and 126% over five years.

Wells Fargo enjoyed "Record revenue up 9.3% from the prior year." "Most business lines continued to exhibit strong sales during the quarter, including sales of consumer loans, mortgages, deposits and credit cards." "Home equity sales up 25% from a year ago." "Residential mortgage originations of $103 billion, 2nd highest quarter ever." "The response of American homeowners to the lowest mortgage rates in forty years generated a record $157 billion in applications for the quarter. Driven by a monthly record $62 billion of applications in March, Home Mortgage ended the quarter with a record pipeline of $89 billion, up 29% from year-end." For the quarter, Total Assets expanded by $20.4 billion, or 23% annualized, the largest increase in more than three years. Year-over-year Total Assets were up 19%. For the quarter, Total Consumer Loans expanded at a 23.3% annualized rate. "Real Estate- 1 to 4 family first mortgage" loans expanded at a 34% rate, with Home Equity Loans increasing at a 24% rate. Commercial Loans were up only 1.6% y-o-y, but did expand at a 7.2% annualized rate during the quarter. Interestingly, of the $27.5 billion y-o-y increase in Total Loans, Commercial loans increased only $759 million. Year-over-year, "Real Estate - 1 to 4…" increased 44% to $44.5 billion, while Home Equity was up 31% to $33.2 billion.

Bank America saw Total Assets expand at a 12% annualized rate during the quarter. Year-over-year, Total Commercial Loans dropped 11% to $143.0 billion, while Total Consumer Loans jumped 21% to $202.9 billion. From "Financial Highlights": "Mortgage banking income rose 108 percent to $405 million." "Card income was up 18% to $681 million." "Investment banking income rose 11 percent to $378 million." BAC repurchased 18 million shares during the quarter.

Bank One's Total Assets jumped $10.5 billion, or 15% annualized, the strongest growth since year-2000's third quarter. "Average home equity balances increased $3.3 billion, or 13%, from the prior year…" End-of-period Card Services managed loans were up 12% y-o-y to $72.8 billion.

Washington Mutual saw "loan volume of $106.62 billion, up 62 percent from the first quarter of 2002." Total Assets expanded by $8.7 billion, or 13% annualized, the strongest growth in a year.

Citigroup Total Assets expanded by $39.8 billion, or 15% annualized. Global Consumer income of $2.15 billion was up 26%. "Cards income of $735 million increased 27%" and "Retail Banking income of $942 million, jumped 54%." "Consumer Assets also benefited from continued high demand for mortgage refinancings, and 53% growth in student loan originations." For the quarter, Trading Account Assets jumped 12% to $173 billion, while Loans declined 2% to $426.5 billion. Year-over-year, Total Corporate Loans declined 8% to $131.1 billion, while Total Consumer Loans jumped 25% to $307 billion (partially explained by the acquisition of Golden State Bancorp).

JPMorganChase surprised the Street with Net Income of $1.4 billion, its strongest showing in almost three years. "Sharp revenue growth in the Investment Bank and Chase Financial Services…" From Chase Financial Services: "Operating revenues of $3.74 billion for the quarter were up 21% from the first quarter of 2002 reflecting higher production volumes across all national consumer credit businesses. Home Finance generated record revenues for the quarter, up 116% from the first quarter of 2002, due to record mortgage originations… Auto Finance also generated record revenues in the first quarter, up 17% from the first quarter of 2002… Cardmember Services revenues were up 9% from the prior year primarily reflecting growth in average outstandings; over one million new accounts were originated during the first quarter." "Commercial loans were down 3%, or $3.1 billion, from year-end and decreased 13%, or $13.3 billion, from March 31, 2002. Managed consumer loans increased 3% from year-end and 18% from March 31, 2002." Chase Home Finance End-of-Period Outstandings were up 23% annualized during the quarter and 25% y-o-y. Also worth noting, Derivative Receivables was up 37% y-o-y to $86.6 billion, and Securities were up 39% y-o-y to $85.2 billion. Loans were up 1% y-o-y, as Total Assets expanded 6% to $755 billion. On the liability side of the balance sheet, (average) Federal Funds Purchased and Securities Sold jumped 24% y-o-y to $191.2 billion.

Washington Mutual originated $106.6 billion of loans during the quarter ($214 billion in six months), up 62% from the year earlier period. National Century originated $4.7 billion of new mortgages during the quarter, up 54% from 2002Q1. Total Assets expanded at a 62% annualized rate to $2.8 billion, with 12-month gains of 74%.

It is especially interesting to analyze the business practices of the Credit insurers. It has been a case of waiting to see if these acutely exposed risk players would "retrench" - with major ramifications for the Credit creation process - or instead simply put peddle-to-the metal and attempt to race by festering systemic problems?

Ambac is racing. The company reported Net Income up 19% y-o-y, as total Adjusted Gross Premiums Written surged 52% y-o-y (Public Finance up 20%, Structured Finance 36%, and International 114%). It is truly amazing to witness the continued transformation of the Credit insurers from institutions guaranteeing low risk municipal debt to Structured Finance Kingpins. Looking back at Ambac's Financial Guarantee Portfolio distribution at the end of year-2000, we see that Public Finance accounted for 65.3% of total exposure, Structured Finance 23.4% (Mortgage-back and Home Equity 13.8% and Asset-backed and Conduits 8%), and International 11.3%. During the this year's first quarter - observing the distribution of new guarantees put in force - Public Finance was 29%, Structured Finance (Mortgage-back and Home Equity 25.4% and Asset-backed and Conduits 10.4%) 43.7%, and International 27.3%. For the quarter, Net Financial Claims in Force (NFCF) increased $18 billion, or about 13% annualized, to $575 billion. Year-over-year, NFCF jumped $91.3 billion, or 19%, while Qualified Statutory Capital increased $560 million to $3.9 billon (Total Claims Paying Resources increased $1.4 billion to $8.5 billion). NFCF is up $148 billion, or 35%, in twenty-four months. And, viewing the balance sheet, we see that Total Assets increased at a 26% annualized rate during the quarter to $16.3 billion. Year-over-year, Total Assets jumped 27%.

Mortgage Insurer MGIC continues to struggle. While total Insured Loans increased 1% y-o-y to 1.64 million, Total Loans Delinquent surged 36% to 76,837 (from 3.48% to 4.69%). Delinquencies were up 24 bps during the quarter. Delinquencies excluding Bulk Loans rose eight bps during the quarter to 3.27%, up from the year earlier 2.53%. Losses Incurred rose slightly during the quarter to $142 million, but were up 138% y-o-y. Total Assets expanded at a 9% rate during the quarter and were up 11% y-o-y to $5.4 billion. MGIC increased its risky mortgage "pool" exposure by 12% during the quarter (up 40% y-o-y).

Mortgage Insurer Radian saw Debt Service Outstanding grow at a 16% annualized rate to $109 billion, the strongest rate of growth since the third quarter of 2001. Total Assets expanded at a 29% annualized rate to $5.8 billion. Direct Claims Paid (losses) was up 44% y-o-y to $53.3 million. The insured portfolio's risk profile changed markedly, as the number of "A Minus and below" insured loans surged 34% during the quarter (107,181), while the number of Prime loans declined by 12% (690,647). Delinquencies declined 21 basis points during the quarter (up 46 bps y-o-y).

This week General Motors reported better-than-expected earnings, led by huge gains from its mortgage operations. Financing arm GMAC saw earnings surge 33% sequentially (q-o-q) to $699 million, fully 47% of total General Motors net income. While GM's North American auto revenues were up 2% y-o-y, GMAC revenues jumped 15%. GMAC earnings were up 59% y-o-y. "GMAC Mortgage Group, Inc. earned a quarterly record $371 million in the first quarter of 2003, up 151% from the $148 million earned in the same period of 2002. The higher earnings reflect exceptional production volumes across all three divisions of the group."

Although convoluted earnings-per-share "met expectations," General Electric saw consolidated revenues declined 1% y-o-y. This aggregation, however, cloaks dramatic and significant sector divergences. Indeed, GE's results provide our analytical minds an excellent microcosm of the imbalanced U.S. (monetary) economy. Year-over-year, GE Capital Services revenues (GECS) were up 6%, while the remainder of GE posted 5% y-o-y revenue declines. Interestingly, and a "sign of the times," GECS accounted for 56% of General Electric Net Earnings. By major GE Operating Segment, we see that Aircraft Engines experienced an 8% y-o-y revenue drop, with Consumer Products revenue down 7%, and Power Systems sinking 20%. Yet, Commercial Finance Revenues were up 8% y-o-y, Consumer Finance 16%, Insurance 10%, and Medical Systems 15%. These revenue figures rather clearly demonstrate the economic imbalances impacting the U.S. economy, as well as the ongoing inflationary biases throughout finance and healthcare (at the expense of manufacturing).

Thus far, quarterly earnings reports confirm my view that the Credit system is increasingly Firing on Most Cylinders. First quarter Credit growth will be strong, with another quarterly mortgage debt growth record quite possible. There is today no mystery surrounding the economy's "resiliency," and this Credit Bubble attribute is no virtue. Truly extraordinary monetary looseness now pervades the system, providing an energized financial backdrop for the thus far despondent economy. The good news is that this should be expected to stimulate economic "output" over the near-term. The bad news is that this distasteful monetary stimulus will only exacerbate Bubble economy distortions and imbalances. The precarious Mortgage Finance Bubble has monopolized the financial sector and is increasingly the master of the real economy. There will be a huge price to pay. Moreover, the rampant inflation of non-productive Credit (financial claims) will only augment both dollar vulnerability and, eventually, general financial fragility. We should expect significant inflationary manifestations going forward, imparting unpredictable and distorting effects on imbalanced domestic and global economies and markets.


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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