Which Way Wednesday – Bernanke’s Turn at Bat

February 24, 2010

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Bernanke USUALLY boosts the market.

Will he be able to restore confidence today? He'll be speaking to the House Committee on Financial Services in a hearing titled: "Monetary Policy and the State of the Economy," which used to be called the Humphrey Hawkins Testimony – and that means it's time for another episode of my favorite TV show – something I call "When Ron Paul Attacks." Ron Paul has been on a roll lately and today is the perfect day for him to use his 5 minutes to build a platform for his 2012 run at the White House.

Yesterday was disappointing, to say the least as we blew all of our bounce levels EXCEPT the Russell, which finished right on our 625 line. That makes the RUT our canary in the coal mine today as we'll use it to see which way the market winds are blowing. We didn't mind yesterday's sell-off as it was led by a 2.2% drop in Basic Materials and Energy – two sectors we were betting against anyway and we just upped our bets against CRE after skipping most of February as the timing hadn't seemed right.

Now we are getting a flood of bad new in the Commercial Real Estate space including a report from Real Capital Analytics that shows the Commercial Mortgage Default rate more than doubled in Q4 – from 1.8% to 3.4% and is projected to hit 5.4% this year. “The level of distress continues to rise irrespective of improving economic trends,” Sam Chandan, Real Capital’s global chief economist. Almost $1.1 trillion in commercial loans and $211 billion in apartment loans were held by U.S. banks on Dec. 31, according to Real Capital. “With the concentration of commercial mortgages in small and community banks, there is a potential spillover that will impinge on their ability to make loans to small businesses and families,” Chandan said.

The Congressional Oversight Panel on the financial system bailouts said in a Feb. 10 report that “the ultimate impact of the commercial real estate whole loan problem will fall disproportionately on smaller regional and community banks” that have higher concentrations of such loans. “Some community banks seemed to have abandoned, or never really practiced, sound risk management” by lending too much on real estate in their local markets, David A. Hendler, New York-based analyst for CreditSights Inc., said in a Feb. 22 note.

Meanwhile, the S&P downgraded another $6.8Bn of US CDO's in residential MBS's, which also ultimately impacts lending in a domino-like effect as 39 tranches from 13 CDOs of asset-backed securities are affected. 5.4% here, 6% there and, before you know it – there isn't much left, especially when leverage was 10:1….

What's the net effect? Overall, Banks posted last year their sharpest decline in lending since 1942, suggesting that the industry's continued slide is making it harder for the economy to recover. Besides registering their biggest full-year decline in total loans outstanding in 67 years, U.S. banks set a number of grim milestones. According to the FDIC, the number of U.S. banks at risk of failing hit a 16-year high at 702. More than 5% of all loans were at least three months past due, the highest level recorded in the 26 years the data have been collected. And the problems are expected to last through 2010. FDIC Chairman Sheila Bair said banks are "bumping along the bottom of the credit cycle" and that the number of bank failures in 2010 will likely eclipse the 140 recorded last year.

Yesterday, at 12:13, I said to Members: "Dollar hitting highs against Euro ($1.352) but also lows against Yen so Japan will be in a bad mood in the morning and will likely test 10,200 (now 10,352)." That was 9 hours before the Nikkei opened but I can now officially report that the Nikkei fell 153 points to 10,198 so if you feel you wouldn't want to SUBSCRIBE to our service because there are other people who can come closer than 2 points half a day ahead of a 1.5% market move – I will understand…

Elsewhere in Asia, the Hang Seng fell 155 points to 20,467 and the BSE fell just 30 to 16,255 but the Shanghai had an up day, gaining 1.33% and getting back over the 3,000 mark at 3,022 so all is not lost – yet. China’s economic growth will plunge to as low as 2 percent following the collapse of a “debt- fueled bubble” within 10 years, sparking a regional recession, according to Harvard University Professor Kenneth Rogoff, who used to be the chief economist at the IMF. “We would learn just how important China is when that happens. It would cause a recession everywhere surrounding” the country, including Japan and South Korea, and be “horrible” for Latin American commodity exporters," he said.

Horrible things are happening in Europe as well as Greece is back on strike today and the police are clashing with "tens of thousands" of protestors in Athens in a strike that has affected transport and public services, with government offices, schools and universities all shut and travel around the capital disrupted. Athens International Airport was also closed as air traffic controllers joined the action, with no flights in and out of the country's airports. Train, bus and ferry services were canceled nationwide. Banks are also expected to be affected while state hospitals will operate on skeleton staffing. No newspapers will be published because the journalists' union is taking part too.

Perhaps not coincidentally, Fitch decided today would be a good day to downgrade Greece's four largest banks to Bbb – just 2 grades above junk and slapped a "negative" outlook on them for good measure. Instead of rioting in the streets, perhaps the Greeks should be getting in line to withdraw their cash and hightailing it out of the country at this point! Spain is still a bigger concern to me than Greece and BOS Governor Ordonez is urging his government to push ahead with budget-deficit reduction and labor-market reform efforts, and he told ailing Spanish banks to move forward with restructuring plans. "It's essential that these measures be carried out because if they are not, the credibility of Spain could be very negatively affected," said Ordonez.

The government, grappling with one of Europe's deepest recessions and a budget deficit that reached 11.4% of gross domestic product in 2009, last month announced cost-cutting and revenue-raising measures worth €50 billion ($68 billion). It aims to bring the deficit within the 3%-of-GDP limit for European Union countries by 2013. Following the collapse of its labor-intensive construction industry, Spain's unemployment rate has shot up to nearly 20% and the government has earmarked €30 billion ($48Bn) for unemployment-benefit payments alone this year. Spain's economy and crisis is about the same as California, another thing we should try not to forget about!

Still, all this global strife doesn't change my premise that US equities are still the best place to put your money this year. Not that they won't go down – but they probably won't go down more than other countries and our valuations are relatively cheap compared to other global equities. While there are many problems to work through – as long as we stick with companies that are in our "Top 10% Club," we should be fine regarless of how terrible things are for the bottom 90% (and did you see yesterday's confidence numbers? WE are the ones who should be rioting!).

Yesterday was nothing but a commodity sell-off and we LOVE those so we're going to be forgiving as long as we can stay between our bounce levels (Dow 10,300, S&P 1,105, Nasdaq 2,225, NYSE 7,100 and Russell 625) and our 5% lines (Dow 10,165, S&P 1,088, Nas 2,200, NYSE 7,000 and RUT 620) – The Russell is our leader and will show us the way but we would consider 1,088 on the S&P to be a very serious bearish confirmation so that's another line worth watching (see yesterday's chart-fest).