Flattening yield curve = flattening bank earnings?

Main Street has a lot of issues but I think the flat yield curve could lead to more pre-announcements like this from regional and large cap banks…

"Main Street Banks, Inc. announced today that it has lowered its forecast for 2005 earnings per share growth over 2004 to between five and eight percent due to a flat net interest margin, investment in internal growth, a higher effective tax rate and the early adoption of FAS 123R….Main Street’s net interest margin has remained flat during the current rising interest rate environment. Strong demand for variable rate loans, a flattening yield curve and higher cost funds used to support rapid loan growth have hindered expected margin expansion. Through February 28, Main Street’s net loans have increased 19.1% on an annualized basis since year-end."

While the financial stocks might see some problems given the flattening yield curve, I don’t think it necessarily spells doom for the markets. 

It seems that every professional money manager is worried about a flattening yield curve but I don’t see much to worry about unless the curve goes totally flat or inverts.  The yield curve was abnormally steep for the past two years.  Now it has simply returned to a more "normal" configuration. 

An inverted curve would probably only happen if the Fed raises rates on autopilot for the remainder of the year.  However, I don’t think that will happen (see my post on The Greenspan Put). 

Here is the yield curve from Dec 2003 (super steep) and today (more normal) from Stockcharts.com:



Iran in the summer…

I’m very concerned what an attack of Iran will do to the financial markets.  The following excerpt comes from one of my favorite editorial sources, Doug Casey‘s latest "What We Know Now".  It contains innuendo that the US will attack Iran in June to prevent them from trading oil in Euros instead of US Dollars.  Yes, it rings a bit conspiratorial, but it probably has a grain of truth to it – which really scares me. 


"In recent weeks, the news media has been overflowing with reports on the increasing tension between the U.S. and Iran, supposedly based on the Islamic country’s unwillingness to drop its nuclear programs. A clear-cut case of another tyrannical nation whose government needs to be ousted in order to make the world a safer place, it seems. But WWNK has found information that’s largely been flying under the radar screen of the mainstream press… and that might paint an entirely different picture.

On February 18, Scott Ritter, ex-Marine and former United Nations Special Commission (UNSCOM) weapons inspector who played a major role in Iraq, dropped a bombshell during a speech delivered to an audience in the Capitol Theater in Olympia, WA. The event’s sponsor, United for Peace of Pierce County (UFPPC), a Washington state activist group that nonviolently opposes “the reliance on unilateral military actions rather than cooperative diplomacy”, had invited Ritter and independent war journalist Dahr Jamail to talk about the war in Iraq.

In his speech, Ritter claimed that President George W. Bush has received and signed off on orders for an aerial attack on Iran planned for June 2005, citing an anonymous official as the source of this information who—according to Ritter—was involved in the manipulation of the election outcome in Iraq, which reduced the percentage of the vote received by the United Iraqi Alliance from 56% to 48%. Ritter also stated that “this would soon be reported by a Pulitzer Prize-winning journalist in a major metropolitan magazine”, an allusion to New Yorker reporter Seymour M. Hersh, believes the UFPPC.

In a January 17 article in the New Yorker, Hersh had written that “Strategists at the headquarters of the U.S. Central Command, in Tampa, Florida, have been asked to revise the military’s war plan, providing for a maximum ground and air invasion of Iran.”

But why? Is Iran really such an imminent threat that it would justify invading that country, with a U.S. army already stretched to the max by its commitment in Iraq? Aside from the ‘official’ nuclear-threat argument, there may be other, economic, reasons that seem far more logical.

In October 2004, William Clark, award-winning writer and author of the soon-to-be published book Petrodollar Warfare—Oil, Iraq, and the Future of the Dollar (spring 2005), gave his opinion on the reasons for a pending U.S.-Iran crisis in an essay titled “The Real Reasons Why Iran is the Next Target: The Emerging Euro-denominated International Oil Marker”.

Clark blames “unspoken macroeconomic drivers” for the U.S.’ determination to attack Iran, in particular the fact that the Tehran government plans to open a euro-based oil exchange in 2005 or early 2006, which—if successful—“would solidify the petroeuro as an alternative oil transaction currency, and thereby end the petrodollar’s hegemonic status as the monopoly oil currency.” This, says Clark, would deliver a devastating blow to U.S. corporations, which own both the London’s International Petroleum Exchange (IPE) and the New York Mercantile Exchange (NYMEX), the main global oil traders.

All three current oil markers, the West Texas Intermediate crude (WTI), the Norway Brent crude, and the UAE Dubai crude are dollar-denominated. Iran, however, has required payment in euros for its European and Asian/ACU exports since spring 2003. “It would be logical to assume the proposed Iranian Bourse will usher in a fourth crude oil marker—denominated in the euro currency,” predicts Clark… a probable scenario in light of the fact that “the European Union imports more oil from OPEC producers than does the U.S., and the E.U. accounts for 45% of imports into the Middle East.”

In June 2004, the UK Guardian noted that “Some industry experts have warned the Iranians and other OPEC producers that western exchanges are controlled by big financial and oil corporations, which have a vested interest in market volatility.” BP, Goldman Sachs and Morgan Stanley, proud owners of the IPE since 2001, refused to comment. In light of the fact that Iran, holder of the second biggest oil reserves worldwide after Saudi Arabia, exports 2.7 million barrels of crude/day and produces 13 million tonnes of petrochemicals/year, the Guardian foresaw bright prospects for the new oil exchange.

That is not the only reason, though: Other recent events indicate that Tehran’s IPE and NYMEX competitor might be just what a large part of the world has been waiting for. Not only has the euro substantially risen against the dollar since late 2002—in May 2004, the countries using the euro as their currency increased from 12 to 22. Within the last two years, notes Clark, Russia as well as China raised their central bank holdings of the euro, “which appears to be a coordinated move to facilitate the anticipated ascendance of the euro as a second World Reserve currency.”

According to a July 2004 article on Rigzone.com, an insider website for the oil and gas industry, Chris Cook, a former IPE executive turned independent consultant, commented that recently the Saudis, too, have declared their interest in the project. Since 9/11, says Rigzone, “Saudi Arabian investors are opting to invest in Iran rather than traditional western markets as the kingdom’s relations with the U.S. have weakened.”

A lot of good reasons for the U.S. government to set their eyes on regime change in Iran, says William Clark. And it wouldn’t be the first time, he says. His award-winning 2003 essay “The Real Reasons for the Upcoming War with Iraq” suggests that Saddam Hussein signed his own death warrant in 2000, when he announced that Iraq would no longer accept US dollars for oil being sold under the UN oil-for-food program, but that the country’s official oil export transaction currency would be switched to the euro."

Demonstrators have guts

You have to hand it to the demonstrators that came out to voice their displeasure against the on-going terrorism in Iraq.  I’m not sure what it will do, but it seems that if they’re willing to demonstrate, they’re willing to fight to create a better future for their country without having US troops hang around for the next 50 years.  Its a small point but I think it might be an incremental positive for the news flow, which has been unbelievably negative for the past month. 

From the AP report… "Thousands of mostly black-clad Iraqis protested Tuesday outside a medical clinic where a suicide car bomber killed 125 people a day earlier, braving the threat of another attack as they waved clenched fists, condemned foreign fighters and chanted "No to terrorism!"

I am afraid there might be a suicide bomber among the demonstrating crowd," said 30-year-old Ahmed al-Amiry. "It’s very possible."

But anxieties over another attack did not prevent more than 2,000 people from gathering outside the clinic Tuesday, shouting "No to terrorism!" and "No to Baathism and Wahhabism!" and demanding the resignation of interim Prime Minister Ayad Allawi.

Wahhabism was a clear reference to foreign fighters who are supporters of al-Qaida and adherents of the strict Wahhabi form of Islam, which is the version practiced in Saudi Arabia. The Jordanian-born Zarqawi, the country’s most feared terrorist, claims to be affiliated with Osama bin Laden’s organization. "

NYA already hitting new highs

While a lot of analysts and traders are pointing out that the sentiment isn’t quite as pessimistic as you’d like to see it at good market bottoms, I think you have to keep in mind that positive sentiment in a strong market isn’t that unusual. 

It’s only when sentiment reaches a positive extreme is when it becomes a problem. 

Despite all the consternation of whether the S&P or Industrials can break out to new highs, the broader NYSE Composite (NYA) has already hit new highs.  Overall, I can’t see that as a bearish sign.  I would expect the S&P 500 and Industrials to follow the NYSE Composite. 


And the Russell 2000 was hitting new highs last year…


The trend is coming to an end

One of the ways I know a market or economic trend is maturing is when every investment idea is looked at through a "themed" prism.  The classic case of this was during the late 1990s when everything from fish-oil companies to stodgy newspaper companies were looked at as an "Internet Play".   How Mario Gabelli could pitch Reader’s Digest as an internet play on CNBC still astounds me?  I lost all respect for his investment ideas the day he made that pitch. 

Today, everything is being looked at through the "real estate" prism.  After the success of Kmart, everyone is looking for the hidden real estate value in stocks.  Lots of companies have undervalued real estate on the books but few of them will ever unlock it.    It’s like my family’s home which has doubled in value over 5 years – I could sell it, but then what?  I’d have to go buy a more overvalued house somewhere else.  Kmart could sell all of its real estate but then it wouldn’t be a retailer, now would it?   I don’t think that’s what Eddie Lampert has in mind.  Similarly, Saks could sell it’s flagship store in mid-town NY for some absurd value – probably at 1/6s of the stock’s $2 billion market cap.  But then it would loose part of the cache that makes Saks, Saks – it would just be another high end department store. 

I have been pitched everything from REITs (duh!) to Winn Dixie (are run down grocery stores in the middle of nowhere worth anything?) as a real estate plays.  This says to me that the real estate bubble is coming closer and closer to a top. 

You can’t make this stuff up…

File this under the "You can’t make this stuff up" category. 

Home Depot’s Board thanks Tom Ridge for making the company’s first quarter of 2003 by voting him onto its board of directors.  In February 2003, the Department of Homeland Security (led by Tom Ridge at the time) directed Americans to find some "duct tape and a secure room and a couple of gallons of water to tide you over for a day or two in the event" of a chemical attack.   I still remember the pictures of frantic shoppers at Home Depot loading up on duct tape in hopes of saving themselves from the impending chemical attack. 

This of course led to the "Duct Tape Bottom" in the stock market in March of that year.  It’s one of the all-time great panic bottoms in stock market history. 


And I thought the Dick Cheney – Halliburton connection was suspect.

As my favorite comedian, Lewis Black, has said "Our leaders could have calmly stood up and told everyone ‘This is a difficult time for all of us but if we all act sensibly, we’ll get through this together’.  Instead, they yelled ‘Aaahhhhh…we’re all gonna die….buy some duct tape and plastic wrap and hide in the basement!!!!’"  It’s akin to telling schoolchildren to hide under their desks in case of a nuclear attack.

Anyway, if I were long HD, I’d reconsider holding the position.   I’ve never been a big fan of Robert "Jack Welch wanna-be" Nardelli nor Home Depot’s competitve position relative to Lowe’s.  This just solidifies my negative view on the stock.

Why do I know….

Here comes the warm machine
Such a warm machine
This is the life
This is the sound
Here comes a warm machine
Such a warm machine

— Bush "Warm Machine"

Lots of blog posts start with a deep and meaningful lyric.  However, I have found that many things in life are meaningless and non-sensical…like the lyrics to any Bush song.  It’s these stupid pieces of information that seem to take up room in my brain and crowd out information worth knowing such as my wife’s birthday. 

With that, it’s time to play…

Why Do I Know….

That this man’s name is Joel Appel…and why do I have his products in my house?


That Lionel Richie’s adopted daugher’s name is Nicole?


That Jason Giambi injected steroids into his buttocks?


And why do I still know all the girls names from Lou Bega’s Mambo #5?


A little bit of monica in my life
A little bit of erica by my side
A little bit of rita is all i need
A little bit of tina is what i see
A little bit of sandra in the sun
A little bit of mary all night long
A little bit of jessica here i am
A little bit of you makes me your man

The Greenspan Put

Lehman Brother’s incomparable Jim "Fists of" Furey has some interesting comments out this morning on rising interest rates and their effect on small cap stocks:

"We believe Euro-area & Japanese weakness demonstrates what happens to industrialized economies when they do not pursue stimulative policies.  It is our view that should the Fed tighten more than another 100 bp the US economy will suffer as a result of the absence of US demand amplifying Euro & Japanese weakness….Our point: the (yield) curve’s behavior, further tightening & soon to emerge talk of Greenspan’s replacement raises small-cap risk."

Once again, numerous commentators are expounding the benefits of rising short term rates – "it’s a sign of strength in the economy", "rates are still relatively low", etc.   However, I think in an environment of rising global tensions, high oil prices and potentially higher taxes, adding higher interest rates to the mix is a definite drag on growth. 

Balancing against those negatives, Jim also had some interesting comments about Chairman Greenspan…

"Current stock prices reflect actions nine to twelve months forward and Greenspan’s replacement will be front and center in late summer and early winter.  Traditional risk
and inflation expectations measures indicate that investors are confident Greenspan’s successor will be every bit as competent as Greenspan in maneuvering markets, psychology, and the global economy and we are not so sure that as summer approaches that will be the case, particularly if the US weakens and follows other industrial economies."

A quote from Doris Kerns Goodwin is probably very apt in this circumstance…"Once a president gets to the White House, the only audience that is left that really matters is history."  Similarly, Greenspan understands his place in history as presiding over the greatest post-war economic expansion in history and won’t do anything to damage it.

I think the "Greenspan Put" will be in full effect over the next two years.  It’s improbable to me that Greenspan is truly in "auto pilot" mode when it comes to raising short term rates.     I think the Federal Reserve will stop raising short term rates before the yield curve turns negative.  And this should be a positive for stocks.   Therefore, any serious corrections over the next twelve months should be bought, in my opinion. 

However, once investors start looking to a future without Greenspan, the market could face some problems.  Call it the "post-Jack Welsh hangover" – Welsh managed earnings to a tee to ensure General Electric (GE) stock stayed relatively high until his retirement in 2001.  However, once he left, Jeffrey Immelt was left holding the assortment of low-growth financial businesses that took him three years to re-align.  I think a similar fate could fall on the market as a whole as Greenspan enters his final year in 2006.  However, until then, I think Greenspan will make sure his "Maestro" legacy remains in tact.