Zeller Kern’s Weekly Investment Monitor
J.P. Morgan Lost Money? |
May 16, 2012 |
As the media last week reported the news that J.P. Morgan lost $2 billion with their proprietary trading desk in London, it really should come as no surprise. One headline noted that there will be a Federal investigation. Investigate? Why? To find out that the major banks really don’t have any other way to make money under Bernanke’s ZIRP (Zero Interest Rate Policy), so they pursue speculative investment schemes to make money that is borrowed for next to nothing, and then leverage that money? What’s worse, is that they are loaned the money to do so, allowed to leverage that money, and then will be bailed out by the taxpayer once they finally go insolvent.
But wait there’s more – these leveraged investment schemes are not only leveraged through derivatives (in J.P. Morgan’s case, they currently have about $97 trillion in derivatives – yes, you read that correctly per zerohedge.com), they are hedged by counter parties, which are other banks. And if one of these banks goes under from their speculative operations, it will most likely bring the other banks down with them. And once again, you the taxpayer will be told that you must bail them out, or else.
As Reggie Middleton remarked in one of his recent blogs, when capital is priced at zero, people no longer respect that capital. When banks are allowed to borrow money for nothing and speculate with it, they will do so if that is the only way to make a profit. So now, the ratings organizations are finally coming out and lowering the ratings of these banks, which should have been done long ago. The real detriment here, in our opinion, is Bernanke himself, the great enabler in all of this. And the big banks really are not providing a productive service to the marketplace, by lending and maintaining a sound solvent place to do so, but rather they are speculating with cheap capital.
There is a lot surfacing in the news right now. California is once again visiting the spending abyss, posting a deficit of $16 billion. And the solution by the governor is to raise taxes, just like they do in Greece. As we have stated many times before, we feel raising taxes in a credit contracting, deflationary environment is like throwing gas on a fire. What’s even worse is to raise taxes while reducing spending. This happens because raising taxes pulls money out of the system to pay for past expenditures (past consumption), while reducing spending lowers economic activity- a combined double edged sword.
The only real solution we think, at this point, is to radically restructure the state operations, and simultaneous reduce taxes and regulation on the private sector to encourage growth and investments from business owners. We don’t expect that to happen anytime soon. Instead, it will probably be the usual tactic of cutting spending where it hurts the voters the most, which is education and public safety. Hands off the elephant in the room, which is the compensation structure of employees, and yes the pension system. That may sound outrageous, but having to face the music on this is coming whether we like it or not.
This is the outcome of years of borrowing and bloated overhead. It seems to be the way it works unfortunately, especially with public unions and collective bargaining rights, a la New York, Illinois, and California. It just so happens that all three of these states have imploding balance sheets and imploding pension funds. We don’t wish this, it is just a grim reality that many of these pensions are grossly under funded in comparison to the money they are distributing to accommodate the recipients.
There is plenty for the markets to be upset about. The amusing thing is that it has always been there for the most part, but as social mood rises, we tend to ignore the problem, as if it just goes away. This is often followed by an urge to take on more risk. That urge usually happens right around a market peak. Whether or not April and May brought on a market peak or not, remains to be seen. Don’t forget, Bernanke, the U.K. central bank, The Bank of Japan, and the others could launch another round of money printing that could make our heads spin. We’ll just have to see how things play out.
The internals within our technical models have been breaking down in most areas, for the past few weeks. Although this might turn around and suddenly improve, as John Hussman notes, “market internals have deteriorated, with an uncomfortably familiar "two-tier" profile developing between a handful of speculative momentum stocks and the broader market. Coupled with an active new issues calendar, near-panic levels of selling by corporate insiders, heavy beta exposure among mutual funds and institutional managers, record-low mutual fund cash levels, and advisory bearishness at just 20.5% (a level last seen before the steep 2011 decline), there appears to be a lopsided exposure to risk among speculators, and a divestment among issuers.”
We will continue to watch the markets as things unfold, particularly in Europe with the conditions in Greece and Spain. We likely have not seen the worst of it, whether it flares up now or sometime down the road. But as we have suggested many times in the past, when volatility has come back into the market, the prices of stocks, gold, oil, and commodities, have generally risen and fallen together. So, if we get a steep decline or a substantial crisis gets underway, there are few places to hide. Cash and short term instruments have typically held up well.
A Review of Last Week’s Markets
Looking back at last week, the market failed to sustain a rebound and suffered yet another loss of 1%. The market started off on a flat note as a lackluster session unfolded due to an absence of data. Early in the week financials were leading the way but the broader market failed to follow through to the upside.
But the big issue with the market was with J.P. Morgan Chase. Their reported trading loss of over $2 billion caused the stock to drop 9% on Friday. As you would expect, this put plenty of pressure on the financial sector with concerns that the Feds will come in to further regulate an already overregulated sector. However, it is obvious that either their internal risk control is very weak or possibly trades have been put on that are not understood very well.
The sellers came in and reclaimed control of the market and pushed the market down more than 1% on Tuesday before it decided to rebound and close well off the lows. But, this market action was driven primarily by the news out of Greece and the new president of France. Once again, the markets paired the losses and rebounded as the session unfolded but still closed lower.
Continued concerns about Greece kept the market sentiment negative as the markets yet again declined in excess of 1%, trading just down to the March low before rebounding on the session. Market sentiment was helped when there was news that the EFSF offered over €5 billion to Greece despite its political impasse. This didn't fully eliminate the worry about the exposure but it did help soften some of the selling.
This strengthened the dollar which pushed gold prices down to $1584 per ounce for a 3.7% loss. Meanwhile, silver decline to 28.91 and lost 5%. Most of this money appeared to go from gold into the Treasuries as the renewed interest in the 10 year Treasury pushed the yields below 1.8%.
The market continued to decline on Friday and closed lower for the week which confirms the downward reversal from the previous week. This suggests that there is a possibility of at least two more weeks of downward prices. However, the market did manage to close above the key 1350.50 to keep a minor uptrend in place. Many of the upward objectives that were discussed several weeks ago have been negated which suggests that the market will continue to deteriorate.
Earnings season will be winding down this week and we will be back to pure economic drivers to indicate market direction. Expect to see the European news continue to drive most market activity.
Best Wishes,
Zeller Kern Investment Committee