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Jeff Saut: Fed's Slip of the Lip


Bernanke's testimony spooks markets.

Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

"I asked Buffett whether he worried about the trade deficits and budget deficits and all the other problems that upset the financial community.

'We would certainly be happier and our growth rate would be higher if we could close the deficits,' he said, 'We've traded consumption – those cars and VCRs – to the foreigners and they have claim checks on us and they can cash those claim checks. So every few weeks the Japanese buy another office building. When they bought the ABC building in New York, that $175 million was one day's trade deficit. So we're trading real estate for trinkets like VCRs, but there's a certain amount of justice in that because Peter Minuit originally got Manhattan by trading trinkets for it. It took just 300 years to complete the circle.'

So how will we come out, then?

'Either we will make the IOUs the foreigners hold considerably less valuable by having a lot of inflation, or eventually we will produce more than we consume.'

'I like the gas tax because oil is a resource we're running out of. We keep sucking it out of the ground like a giant soda we've stuck straws into. If we don't close these gaps, there's real intergenerational unfairness. We consume more than we produce, the foreigners have the claim checks, and they can present them to the next generation.'

So for the moment you're not pessimistic? 'It's an enormously rich country, and we can continue trading it away for a very long time. It's a powerful machine, and it can take a lot of abuse'."
- Adam Smith, The Roaring '80s

The release of Warren Buffet's annual shareholders letter last week brought back memories of the aforementioned quip from the book The Roaring '80s. My friend Jerry Goodman, whose nom de plume is indeed Adam Smith, authored the book in 1988.

I find it interesting that if one substitutes the words "Sovereign Wealth Fund" for "the Japanese" the quote is as valid today as it was 20 years ago! Verily, "It's an enormously rich country, and we can continue trading it away for a very long time. It's a powerful machine, and it can take a lot of abuse." Recently, however, the prowess of the U.S. economy has been called into question with the "punctuation mark" being last Friday's 315-point Dow Downer.

While most pundits attributed the late week wilt to worrisome economic reports, I believe the main culprit was a "slip of the lips" from none other than Ben Bernanke. Said "slip" occurred during the Chairman's testimony before the Senate Banking Committee on Thursday when he said, "I expect there will be some failures," referring to smaller regional banks that have become too heavily invested in real estate. He then went on to clarify that statement by noting, "Among the largest banks, the capital ratios remain good and I don't anticipate any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system."

To be sure, there are roughly 8,200 depository institutions in America, but only 76 of them are on the FDIC's "watch list." Totaling the average assets of those 76 "troubled" institutions "foots" to roughly $23 billion, so even if all of them failed it would have a de minimis impact on the banking system. Unfortunately, the media only "picked up" the notion that "the Federal Reserve's chairman warned that the troubled housing sector could cause numerous small-bank failures."

And that, ladies and gentlemen, was all it took for the DJIA to stutter-step on Thursday (-142) and then utterly collapse on Friday. Of course, American International's (AIG) quarterly earnings loss was an additional shocker, as well as certain other corporate earnings shortfalls, but I think the esteemed Chairman's comments were the coup d'état for the late week stock-stumble. Other causa proximas were: the "blow up" of the U.K.-based Peloton Hedge Fund that will be forced to liquidate $2 billion of asset-backed securities; the U.S. dollar's break-down to new all-time lows (see attached chart); Russia's quiet shift to selling its crude oil for rubles rather than U.S. dollars; crude oil's vault above $100/bbl.; recessionary worries; and a host of softening economic statistics.

Click to enlarge

Other notable events for the week included: China's revelation that it is considering scrapping its one-child policy; China's sowing of the seeds of mass consumption by giving farmers rebate checks to buy appliances and the sharp slowing of Brazil's inflation rate, yet by far, the most amazing event of the week was MBIA's (MBI) miraculous "save" of its prestigious "AAA" rating. To achieve this feat, MBI was forced to sell surplus notes at par yielding 14% to raise capital, which is way above the yield on current "junk bonds." As Miller Tabak's Peter Boockvar notes:

"What S&P is saying is that a bond yielding 14% in the marketplace is also a AAA [credit]. It's now a game among rating agencies, regulators, and banks with whether the bond insurers are rated AAA, or not, when they clearly are not and their securities don't trade as they are! This is being done in an attempt to prevent banks from going through another round of write-downs."

Write-downs, indeed, for if more write-downs are in the offing the collateral damage (read: forced selling) would surely be impactful for the various markets!

Whatever the reason, the DJIA closed down nearly 1% for the week, while the D-J Transports lost 2.8% and the D-J Utility Average (DJUA) shed a shocking 4%. The action of the Utilities is particularly troubling since last week's decline took out the January reaction closing low of 486.94 despite the fact that the 10-year T'note has been probing the yield-lows of 2003.

As for the DJIA, the senior index broke out of the wedge chart formation to the upside on Tuesday and Wednesday, placing it in a position to travel above its early February reaction high (~12750), as well as its 50-day moving average (12638). Unfortunately, it reversed to the downside on Thursday and Friday, thus negating Tuesday/Wednesday's positive action, leaving what looks conspicuously like a double-top in the charts. That said, Friday was the end of the month, where market machination typically resides.

Also of interest is that all 30 Dow stocks were lower on the session, which is a rare occurrence that historically has suggested the markets are oversold. Then too, at the January 22nd lows there were 1114 new daily lows and 27 new highs, while on Friday's Flop there were only 185 new lows and 31 new highs. Nonetheless, Friday was a pretty negative 90% "down day" (90% of points and volume were on the downside) leaving the DJIA rapidly approaching its February closing low of 12240. Failing to hold that low would imply a full retest of the January lows. Clearly, I was disappointed with last week's action.

On the positive side, I had a number of my investment positions act exceedingly well last week with names like Covanta (CVA), Chesapeake (CHK), and Arch Coal (ACI) challenging new all-time highs, while Delta Petroleum (DPTR), Cogent (COGT), and Wyeth (WYE) all exhibited favorable pricing trends. I will be seeing some of these companies, as well as others, at Raymond James' 29th Annual Institutional Investors Conference, which begins in Orlando today, and hopefully will glean some additional investment ideas.

The call for this week: I agree with Warren Buffett, "It's an enormously rich country, and we can continue trading it away for a very long time. It's a powerful machine, and it can take a lot of abuse."

While it has been 20 years since he made that statement, I think it is as true today as it was then. That's why I am betting that this government-sponsored economic stimulus package will be like all the others since 1948 and be successful and allow the U.S. to skirt a recession. This morning, however, Mr. Buffett is waxing that the U.S. is already in a recession and that stocks are not cheap.

Consequently, look for attempts to sell stocks off early week and then stability. My firm continues to be an opportunistic buyer.
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