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Five Things You Need to Know: President Bush, Congress Weigh Economic Stimulus Package Targeting Economic Stimulus Package


Bear market rallies; the one time bulls and bears agree on the same thing at the same time.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. President Bush, Congress Weigh Economic Stimulus Package Targeting Economic Stimulus Package

Concerned that the initial $145 billion economic stimulus package announced last Friday may not be sufficient, President Bush and Washington lawmakers are reportedly considering additional measures to shore up the U.S. economy.

According to the Wall Street Journal, while details remain hazy, an expended stimulus package is expected to include tax rebates, tax incentives to hopefully stimulate business investment and increased spending on food stamps and benefits for unemployed workers.

As well, there is talk of a second-phase plan that would kick in if economic conditions deteriorate further, according to the Journal.

What has this country come to when even our economic stimulus proposals themselves require economic stimulus proposals?

2. Why Do the Biggest Rallies Occur in Bear Markets?

Why do the biggest rallies seem to occur in bear markets? The Wall Street Journal asked us this yesterday, and the short answer is that, psychologically speaking, greed is a far more lasting and motivating factor than fear.

But what's the longer answer? Why do the largest rallies seem to occur during bear markets?

The long-term historical upward drift of the stock market supports the wisdom of succumbing to greed more readily than fear. Bullish investors with a long enough time frame have historically been bailed out of many poor stock market decisions.

But there's also a mechanical answer. Mechanically, it's related to the fact that stocks can go up millions of percent, even if not all at once, while they can only go down 100%, absent leverage of course.

Therefore, just to level the playing field, a very smart bear has to be in stocks that go down in 20% clips thousands of time (before hitting zero), literally, just to be on par with the average bull who is not doing anything more clever than sitting back and relying on the historical, long-term upward drift of stocks. It hardly seems fair.

The net result are those breathtaking bear market rallies; the one time bulls and bears agree on the same thing at the same time.

3. Fifth Third Reveals Credit Paradox

A couple of interesting comments came out of the Fifth Third (FITB) conference call yesterday.

First, the bank has largely seen the same credit deterioration as its peer group, so no surprises there, but here is the contradiction facing the Federal Reserve:

FITB said the impact of the Fed's rate cut yesterday is muted because the bank hedges its income for changes in rates, and so the effectiveness of the rate cut largely depends on whether the cut "spur[s] economic activity in our customer base." Yet at the same time, like many other banks, FITB has actively sought to diminish the impact of a deteriorating credit environment by exercising "more disciplined underwriting standards."

Follow that? Let's clarify. The Fed is trying to stimulate credit growth while banks are trying to protect themselves by actively reducing it.

4. KEY Tell?

Key Corp. (KEY) is an interesting stock, up 13.5% yesterday, so I checked out the company's conference call to see what the fuss was about.

Turns out the company is doing quite a few things right. In addition to strengthening its loan loss reserves, KEY sold its subprime lending unit more than a year ago and has curtailed so-called "out-of-footprint" operations, focusing instead on customers within its Community Banking footprint.

The company also launched an expense review in the fourth quarter. The net result of that was the elimination of 570 existing positions and 300 open positions. This ruthless efficiency will continue in 2008 with the elimination of another 170 existing positions. And this is from a financial that, by and large, is doing things right; it's seen 43 consecutive years of dividend growth.

Things were humming along pretty well until we got to loan growth. The company saw growth in its C&I portfolio. That's kind of unexpected, right? How did it manage strong loan growth in a credit crunch? Because the loan growth itself was due to the credit crunch.

"This growth was partially due to the disruptions we saw in the fixed income markets during the second half of 2007. Customers who may have financed their transactions in the capital markets in the past look to us and other banks to help them with their funding needs," CFO Jeffrey Weeden said. Average commercial loan balances were up 7.5% in the fourth quarter versus a year ago and up 15.3% annualized from the third quarter of 2007.

That won't continue. Moreover, KEY said it expects a return to low single digit growth for consumer loans "given our belief that consumers will be guarded with respect to taking on additional debt until they get a better feel for the direction of the U.S. economy and the value of their homes."

But still, KEY is an interesting case study because the bank was early in perceiving and preparing for a difficult credit environment. It has no meaningful exposure to CLO, CDO, ABCP or SIVs. As a result, it is operating somewhat "normally" while it has seen competitors continue to hoard capital. As Weeden noted, "[M]any competitors chose to maintain or increase their deposits, even given the Fed – even while the Fed was cutting rates. We chose to remain competitive with our pricing and at the same time we reduced rates in many areas in response to the cuts in the targeted fed funds rate."

The problem is that KEY, like other banks, will not be able to operate "normally" for long. As Chief Risk Officer Charles Hyle noted at the end of the call, "I think we will perform in line with the economy, but as we look at the economy and our view of the economy changes, that has an impact on the model. And our models are very sensitized to economic activity. And we are certainly seeing some migration we would attribute to a weakening economic environment and they do show up in the models we use."

KEY should be an interesting tell going forward. If it gets hurt, that would suggest the credit crunch and economic decline is deepening beyond what even the most aggressive bears have thought possible.

5. Cutting Back and Trading Down

Two related items:

First, the comments from Coach (COH) this morning, which posted its smallest profit gain in eight years, highlight two ongoing themes I expect to become entrenched this year; consumers cutting back and trading down.

In the company's conference call this morning, Mike Tucci, president of Coach North American Retail, noted that against traffic challenges last quarter the good news was that more customers converted, meaning customers who entered the store were prepared to buy. The bad news was that "some customers were definitely trading down to lower-priced items."

Second, speaking of cutting back and trading down, faced with a slowdown in customer traffic last year and increased competition from the likes of McDonald's (MCD) and Dunkin' Donuts, Starbucks (SBUX) this morning said the company is testing a $1 cup of coffee and experimenting with free refills.

As the Journal noted, the SBUX dollar test "undercuts even low-cost coffee purveyors."

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