Are We There Yet?: The Economy and Mixed Messages

For the first time in over a year, the economy showed growth in the third quarter. Many main-stream news programs and financial news shows were reporting that the recession is over. Not so fast. It's a little surprising that financial news programs were making these declarations, since they should be more savvy about what the indications show, versus what is actually the case.

Lest we forget, the portions of the stimulus package which were rolled out over the last 8 months are clearly doing its job in stimulating the economy. So what we are seeing are the results of the (much criticized) steps taken by the Obama administration, under the auspices of the Treasury Secretary, Geitner. The economic growth data was reported by the Commerce Department on Thursday, sending stocks into a much needed rally, following four straight days of losses. Consumer spending for cars and homes amounted to an increase of 3.5% from July through September. That's great news for sure, but it is too soon to break into a Kenny Ortega dance sequence. The stimulus programs, i.e., cash for clunkers, and first-time home buyers tax credit, have artificially induced activity in these sectors. These programs are essentially crutches for the economy to get it hopping along until it can actually go it alone.

The Commerce Department's data showing a decline in consumer spending in September, (which is right after the cash for clunkers program ended), tells the true story about the economy still struggling to get back on its feet. The graph below shows consumer spending in August reaching the same levels of August of 2008.

Although this is encouraging, the September declines are certainly cause for concern for investors and retailers. Nevertheless, Friday’s issue of Investor’s Business Daily reported the increased growth data as “a clear sign that the recession has ended”. They are not alone in their assessment, but it couldn't be further from the truth. Thursday’s triple digit rally was short lived, as the DOW slipped into negative territory during Friday’s trading day. The sell off appears to indicate investors' realization that the so-called “recovery” is superficial, thus not sustainable.

America should put these times of economic uncertainty in perspective: remember how long it took for the country to dig itself into this steep hole, and note that we cannot simply click a “Reset button” to get us out. The country’s economy is moving in the right track, and drifting away from the darkest days of the recession - and no, “we’re not there yet”.

K. Reilly
Cohn-Reilly Report

Regulating the Industry: Derivatives spared harsh regulatory overhaul

Derivatives manage to maintain their smoke-and-mirrors appeal for hedge funds as the House Finance Services Committee approves a Derivatives Bill that would finally put derivative transactions under government regulatory control. The derivatives bill forces many of the complex products and negotiated contracts under the auspices of Commodity Futures Trading Commission, and Securities Exchange Commission, according to the Wall Street Journal.

Derivatives have always been a high risk, high return products that, until now, had little regulation and even less transparency. Derivatives are complex products which are privately negotiated agreements structured to hedge interest rate, credit risk, and commodities. These transactions involve private contracts with various institutions and third parties, often consisting of strips of bonds or interest rate swaps that are extremely difficult to track, or audit. So why did it take the near collapse of the financial market to bring the issue to light? Apparently, last year when authorities were trying to unravel the portfolio of derivatives for the faltering insurer AIG, regulators soon realized that it was next to impossible to figure out who owes who, and what the market value was given the circumstances.

Although the derivatives bill is a step in the right direction, there are exceptions written into it that should be cause for concern. Under the new bill, derivative contracts that are made between institutions are deemed standard and required to be processed through a clearing house. These trades will have to be traded on an electronic platform or exchanges, where dealers are required to use their own funds to make trades. The bill makes exceptions, however, for companies that use swaps as a way to hedge. In this instance, companies won't have to trade on exchanges, nor will they be required to go through a clearing house. Needless to say, this will result in untraceable trades, which could undoubtedly lead to abuses. It's these kinds of unregulated complex transactions that got us into trouble to begin with. It should be no surprise to find that corporations aggressively lobbied against this bill, and very possible that he loop hole left open for under-the-radar transactions is a kind of consolation gift.

The chairman of the Commodity Futures Trading Commission, Gary Gensler, was quoted as saying that "substantial challenges remain", although the passing of the bill marked a significant step (WSJ - Oct. 16). The bill will most likely see several revisions before it is signed into law, which should be by the end of the year.

Click for: Hedge Fund Fraud Article

K. Reilly

Telecoms Decline As The Market Climbs

The major indexes rallied over the last six sessions, approaching twelve month highs established in September. This was bolstered by the first government to raise interest rates in over a year - the Australian Central Bank, and Alcoa, the traditional first Dow component to report earnings, beating analysts expectations by sixteen cents.

The Telecoms did not participate in the week long rally - why? On Wednesday, AT&T surprised the industry by announcing that they will allow Apple’s iPhone to carry VOIP (Voice Over Internet) applications, such as Skype, over AT&T’s 3G Network. This was applauded by analysts and financial journalists, but the public reacted adversely, dragging down the sector each day since the announcement was made. The investor knee-jerk reaction was due to the concern that long distance earnings will suffer, because customers will use Skype to make overseas calls for free, avoiding the regular per minute charge that is a lucrative source of income.

The same kind of reaction occurred when AT&T decided to subsidize the purchase of the iPhone, resulting in an upfront hit to their revenue stream. This strategy and the opening up of voice Internet applications on their network are both designed to meet customer demands and more importantly, as a long term goal, attract new subscribers. After all, you cannot use the iPhone in this country, unless you sign up to AT&T, and you will not be able to use Skype on your cell phone for international calls, unless you become a subscriber as well. Currently, Verizon and the other Telecoms are not offering this service, so AT&T has a jump on the competition. It is even rumored that AT&T may partner with Google in the near future, to further solidify integrating Internet applications with wireless phones.

Although there is stiff competition and declining revenues in the wire-line area, the major Telecoms have been consistently performing well through the recession. Last quarter, AT&T earned $3.2 Billion, with total revenues of $30.7 Billion. Verizon earned $3.1 Billion with revenues of 26 Billion. Not many companies can make such a claim during these tough times. They are basically cash cows with many sources of income and increasing wireless bases, both consistently paying dividends, with current yields over 6%. Try getting a return like that at your local bank!

Earnings season is upon us and AT&T will be reporting on October 21 - Verizon on October 26. We will be watching closely to see if they can continue their successful track records.

DISCLOSURE: Charlie Cohn owns shares of AT&T and Verizon common stock.

Click Here for Telecom Earning (Oct. '09)

C. Cohn

Banking On Geithner

Part 2 of 2

The Wall Street Journal’s September 18th article about bonuses and compensation reports that the Feds plan to curb compensation for traders, loan officers and executives on Wall Street. The front page article talks about the new policy that endeavors to structure pay for thousands of bank employees nationwide. It is important to note that this policy will only require the approval of the Federal Reserve, not Congress. Perhaps this is a good thing, considering the potential for months of bipartisan antics that could spark political debates, ultimately clouding the issues and stalling progress.

To the question asked by one citizen in the audience: "Given the new and deeper role the government plays in shaping our economy, do we have to reshape our Dreams?" Geithner offered reassurance saying “I think the American Dream is still about freedom and opportunity”. He went on to talk about one of the reasons America had been such a productive country in the past. He continued, citing how much ahead of other countries we were in establishing universal education and many other things that made us strong. The Secretary boasted that we were the envy of the world at one time, “That central vision is still going to be our future”. There were, of course, those questions that we've been hearing in televised round-table debates since the collapse of the financial market last Fall. Geithner fielded the questions with composure and confidence. Another concerned citizen asked: "You let GM fail, but City Bank was too big to fail? Why?": Geithner explained pension funds had already declined 30% by the time Citibank showed exposure, and also reiterated that the government failed to act soon enough. The Treasury Secretary emphasized that the American people played a role by taking on too much debt, and living beyond their means for too long. He went on to say that “you can not solve a crisis by teaching people a lesson”.

Geithner very aptly pointed out that we should be all more committed to never letting this happen again, adding “Never again commit to tax cuts without having a way to paying for them”. He went on to say we should never again finance two wars without a way to pay for them and expand health care without the money to pay for it. In response to the question asked by co-host Steve Liesman, “How much pressure are you under to dial back, and get out of the private sector?” The Secretary adamantly exclaimed “no one is going to be more eager than I am”. Judging by his tone, he meant it. Geithner explained that the TARP program was designed to be used no longer than necessary, adding that there are dangers to withdrawing too soon. He continued saying other country’s have made this mistake in the past, which could reignite the recession and cause even more damage. The Treasury Secretary seemed to believe that the measures that were taken are working. He talked about the recent indications of traction and growth, citing that they already have $88 billion coming back into the treasury from TARP. While predicting that unemployment will stay “unacceptably high?". In closing, Geithner said that after two years, we now have an economy that is starting to grow, but we are just at the beginning. He warned that it is going to take a while to fix this. See Part 1

K. Reilly
Cohn-Reilly Report
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WSJ: 9/18/09,“Bankers Face Sweeping Curbs on Pay”
http://www.cnbc.com/id/32372470