MarketView for March 30

 

 

Summary 

 

Stock prices hit the skids on Monday as General Motors and Chrysler moved one step closer to a bankruptcy filing, and a spate of European bank rescues heightened concerns over the financial system's health. Spain was forced to rescue its first bank since the financial crisis began and Germany and Britain also moved to prop up lenders, sending European markets down.

 

In its latest efforts to shore up the economy and struggling corporations, the administration forced out GM’s CEO, Richard Wagoner, pushed Chrysler toward a merger and threatened bankruptcy for both. Wagoner, who presided over the company's rapid decline in the past five years and had run the automaker since 2000, was forced out at the request of the government's autos panel.

 

GM shares fell 25.4 percent to $2.70, while shares of supplier companies also fell sharply as investors worried that a potential bankruptcy would send ripple effects through the entire economy. President Obama tried to soothe the Street’s nerves by stating that the government did not want to run GM, but added that Wagoner's departure reflected the company's need for a new direction.

 

Chrysler LLC said it had reached an agreement on Monday on a framework of an alliance with Italian peer Fiat SpA that has the support of the U.S. Treasury

 

Meanwhile, bank stocks took it on the chin after Spain, Germany and Britain acted to bolster lenders as the sector felt the impact of rising bad loans. Compounding the problem was this past weekend’s comment by Treasury Secretary Geithner that some banks still need substantial assistance.

 

Geithner said on Sunday the government will have about $135 billion left after other banks give back some of the bailout money, but did not say whether he will ask Congress for more. As a result, Citigroup ended the day down 11.8 percent to $2.31 and Bank of America fell 17.9 percent to $6.03.

 

Before today's sell-off, stocks had rallied around 20 percent after hitting fresh 12-year lows in early March.

 

Inflationary Underpinning for Gold Not There

 

Buying gold remains atop a short list of investment portfolio protection strategies against resurgent inflation as the Federal Reserve cranks up the printing press to jolt the economy out of recession. Nonetheless, a frenzied gold rally because of hyperinflation panic is unlikely as the Fed has the ability to and will rein in the money supply when the economy recovers.

 

On Monday, spot gold traded at about $920 an ounce, about $50 below its one-month high $966.70 on March 20. On March 18, gold rose nearly $70 in a one-day knee-jerk rally after the Fed said it would buy a combined $1.75 trillion in Treasuries and other government bonds. Last week, the Obama administration said it would buy up to $1 trillion in toxic bank assets, sparking inflation fears.

 

The Fed's strong resolve to boost the economy should quash deflation worries, which surfaced in recent months to dampen gold every time it attempted to rally above its all-time high of $1,030.80 on March 17, 2008. However, it is my solid belief that neither inflation, nor deflation, are in the cards during Bernanke's watch.

 

Yes, it is true that a closely-watched gauge on inflation expectations in the government bond market indicates that long-term inflation expectations are rising. Specifically, yield differences between regular U.S. government bonds and Treasury Inflation-Protected Securities, known as TIPS, have sharply widened following the Fed's move to buy long-dated government debt.

 

While gold stands to benefit from higher long-term inflation, the metal's price action will most likely be a tug of war between inflation aversion and recovering risk appetite as governments vowed to boost the global economy.

 

Indeed, gold has become increasingly correlated with the U.S. Treasuries market, which is also considered a safe haven investment, and Treasuries prices showed that investors needed time to contemplate the long-term implications of the Fed's moves.

 

Benchmark 10-year Treasury bond yield, which moves inversely to its price, has now partially erased losses after it plunged nearly 50 basis points on March 18, its largest one-day decline since 1987, in the shock and awe following the Fed's announcement.

Market watchers noted that the Fed was able to curb inflation by hiking interest rates after the recessionary period of 1981-1982.

 

GM and Chrysler Bankruptcy Possible

 

President Obama ordered GM and Chrysler to accelerate their survival efforts and brace for possible bankruptcy, stating that neither company had done enough to justify the taxpayer money they were seeking.

 

Obama, describing the industry as a pillar of the economy, nevertheless gave GM and Chrysler a little more time and money to wring further concessions from workers, creditors and other stakeholders.

 

"We cannot, we must not, and we will not let our auto industry simply vanish," Obama said in White House remarks on Monday that were partly overshadowed by his decision to force out GM CEO Rick Wagoner.

 

A committee representing GM bondholders planned to meet later on Monday to discuss a debt restructuring plan according to a source familiar with the situation. With about $28 billion in debt to bondholders, the GM offer would translate into $2.2 billion in cash, $4.3 billion in debt and an additional stock-based payout in a recapitalized company that would all but wipe out current stockholders.

 

The Obama administration is giving GM 60 days to rework its survival plan. Fritz Henderson, GM’s new CEO, said a court-supervised restructuring in bankruptcy might be necessary. Meanwhile, Chrysler's operation would be funded for the next 30 days as it works to complete an alliance with Italy's Fiat SpA, considered Chrysler’s best chance of surviving.

 

GM had sought more than $16 billion in new aid after getting $13.4 billion in December, while Chrysler wanted $5 billion on top of $4 billion at the end of 2008.

 

Jared Bernstein, a member of the government's autos task force said that a process that splits off the "bad" assets of GM or Chrysler, and sends those through a court-supervised bankruptcy, is a possibility. "I don't think we're at that level of analysis until we see the kinds of changes and adjustments, concessions that are going to be made over the next 60 days," Bernstein said.

 

With U.S. auto sales near 30-year lows, Obama moved to reassure would-be car-buyers, saying the government would stand behind the warranties of GM and Chrysler. He also offered his support for a tax credit incentive of up to $5,000 to trade in older and less fuel-efficient vehicles.

 

Obama's auto task force rejected the turnaround plans submitted by GM and Chrysler following their December bailout.

 

"While Chrysler and GM are very different companies with very different paths forward, both need a fresh start to implement the restructuring plans they develop. That may mean using our bankruptcy code as a mechanism to help them restructure quickly and emerge stronger," Obama said.

 

Separately, Canada said plans set out by the Canadian branches of GM and Chrysler did not go far enough to make them viable, but it offered $3.2 billion in bridge loans to tide the companies over while they restructure. A the same time, Chrysler said on Monday it had reached agreement on a framework for an alliance with Fiat.

 

The next step for Chrysler is trying to reach cost-saving deals with creditors and the United Auto Workers (UAW), which could yield a $6 billion government investment if all restructuring and alliance pieces fall into place.

 

Fiat Chief Executive Sergio Marchionne said the talks with the Obama administration have been "tough but fair" and a deal will make Chrysler stronger and preserve U.S. jobs.

 

Henderson said the company would address elusive concession agreements with bondholders and the UAW, conditions crucial elements of its 60-day window extended by the government to prove viability.

 

"Our strong preference is to complete this restructuring out of court," Henderson said. "However, GM will take whatever steps are necessary to successfully restructure the company, which could include a court-supervised process."

 

Wagoner and GM's board had long argued that bankruptcy by any of the major automakers would threaten thousands of jobs, including suppliers, and could lead to GM’s liquidation.

 

Budget Is Critical to Economic Well Being

 

President Barack Obama on Monday tried to sway skeptical Democrats in the U.S. House of Representatives to back an expensive budget plan for 2010 by arguing it was needed to reverse the economy's sharp downward spiral.

 

Obama has said his $3.55 trillion 2010 budget would help pull the economy out of a deep recession and begin overhauling healthcare and energy policies, but his fellow Democrats have scaled it back amid worries it will explode the deficit and backfire against them in next year's congressional elections. Democrats control the House and Senate and are expected to pass separate versions of a five-year budget plan this.

 

"The president's proposition, I think, will be very compelling for all our members, that this is part and parcel of bringing our country back to economic health, of creating jobs, of stopping foreclosures," House Majority Leader Steny Hoyer told reporters after an hour-long meeting with Obama.

 

One of the difficult tasks Obama and House Democratic leaders will face is convincing fiscal conservatives to back the budget and Representative John Larson said the president made his pitch directly, telling them that he would endeavor to cut the deficit and pay for new programs created.

 

"There's no more convincing salesperson in America than Barack Obama," Larson told Reuters. One congressional aide quoted Obama telling lawmakers that he was "serious as a heart attack" about tackling the record trillion-dollar deficits.

 

Obama also told those concerned about his budget to imagine going home next year to face re-election without passing his calls for change, such as upgrading education, expanding healthcare and moving the nation toward energy independence, Representative Jesse Jackson said.

 

To address some concerns, Democrats already have dropped some proposals like making permanent Obama's signature tax credit for workers and a request for more money for the financial bailout program.

 

And while the House and Senate budget proposals embrace Obama's goal of curbing greenhouse gas emissions and overhauling the healthcare system, most of that work would be left for later in the year.

 

While Obama was trying to cement House Democrats' support, the sparring in the Senate began with Republicans arguing the budget included too much spending and masked a massive government expansion and accompanying debt. Democrats challenged Republicans to offer viable alternatives.

 

House Republicans plan later this week to offer their detailed alternative budget. They were widely panned last week after offering a glossy brochure that was full of party platitudes but scant budget details.

 

The budget legislation is not binding but sets guidelines for spending and tax measures Congress will consider later this year. Democrats need only a simple majority in the Senate and House to pass the budget.