A Melman Minute
By: Leonard Melman
There is an amazing and continuing disconnect
between relatively strong recent performance in the financial markets and the
generally negative tenor of the news background, including both current releases
and those that appear to look forward. More surfaced this morning.
For example, while we are being told by U.S. Treasury Secretary Paulsen and
other high-ranking government officials that ‘the worst is over’ in both the
housing and banking crises, the world’s largest bank holding company, Citigroup,
just announced that they were identifying up to $400 billion (all figures US$)
of ‘non-core’ assets that may have to be sold in order to raise funds, reduce
costs and, according to the Financial Times, “…restore profit growth to
double-digit rates.”
Strange concept, isn’t it? In our humble opinion, we always thought that the way
to improve profitability for a bank or other financial institution was to
acquire quality, profit-producing assets, not get rid of them. Of course,
Citigroup’s chief executive, Vikram Pandit, has described the intended actions
in a positive manner, declaring the intent was to cut Citibank’s cost base.
While we certainly cannot gainsay the honesty of Mr. Pandit’s claim, it appears
that an additional underlying purpose in selling assets would be to restore
Citibank’s capital position to where it was before the recent inundation of
operating losses and capital write-downs.
That news was preceded by a report that the world’s largest insurance company,
American International Group (AIG), reported a wider-than-expected loss
amounting to $7.81 billion for the First Quarter 2008. As a result, AIG’s stock
plunged in overnight trading, losing some 7 percent of its value in one session.
To make matters appear even worse, AIG also announced that it was going to be
raising $12.5 billion in coming months.
Just as in the mining world, there are two primary methods for AIG to raise this
capital. The first would be through an equity offering which would dilute their
stock, and the other would be a debt offering which would result in interest
obligations which would reduce future per/share earnings. The stock market
apparently is not too happy with either prospect.
AIG represents yet another financial giant which has suffered through staggering
losses in shareholder value. During the past year, the stock has fallen from a
high of over $72 per share to near $40, a loss of close to $32 per share. Given
the fact that there are about 2.5 billion shares outstanding, this represents a
loss of about eighty billion dollars of shareholder asset values from their
peak. Coupled with declines in homeowner values along with huge losses in other
financial institutional stocks, it can be seen that the ability of consumers to
continue to purchase at their former levels is being seriously compromised.
And if articles such as those two were not enough for the markets to contend
with, another headline read “Oil Price Closes in on $126 per Barrel.” Yes, yet
another in the recent string of daily all-time high prices for Crude was set
again. In addition, heating oil soared by another 8-10 cents this morning and
the price of gasoline was ahead by almost a nickel. The further cumulative
effect of those price increases on already-diminishing consumer discretionary
income is clearly a threat to rosy predictions of a steadily improving economic
picture such as government authorities are proffering almost daily. A new story
about potential confrontation between America and Venezuela was an impetus in
driving the price of petroleum to new heights.
Stock markets do not appear to be quite so forgiving this morning as has been
case in recent weeks. The Dow Industrials opened sharply lower, tried to rally,
but failed. As of 9:00 AM the Dow Industrials are near their daily low at about
12, 750 and the short-term 10-day chart has a very ‘toppy’ look to it.
Metals markets have been weak today with gold fallen sharply after a neutral
opening, the yellow metals trading just after 9:00 AM PDT near $875, down $9 on
the session. Silver and platinum have also given back early gains. Base metals
are being hit hard once again with copper down by nearly 10 cents to the $3.70
per pound level. The U.S. Dollar is weaker as well, the DX Index having lost
about twenty points.
One last note about petroleum. Up until very recently, most economists and
analysts seemed to take an almost complacent attitude about the effects of the
oil price increase on the world’s economies. However, within the past few days,
we have noted several important stories beginning to appear which warn about
potential seriously negative consequences which could develop.
The Wall Street Journal just carried a study by Neil King Jr. and Spencer Swartz
which paints a different picture than had previously been offered. First, they
lead off with this pessimistic prediction: “…factors ranging from unrest in
Nigeria to slumping production in Russia could shove benchmark oil prices above
$150 a barrel, according to a growing number of market watchers.” Next, they
note that, “…Crude prices at that level would deliver a wallop to the global
economy.”
Among the negative impacts noted by the authors which could occur would be a
reduction in the GDP of up to 1.8%. We would also suggest that serious supply
distribution difficulties will occur as a result of semi-trailer operators’
inability to pay phenomenally higher diesel fuel prices, farmers will be unable
to pass on soaring fertilizer and transportation costs, economic contraction
would follow hard on the diminishing ability of consumers to consume and the
cost structure of numerous industries would come under immense pressures. If
Crude were to reach $200 per barrel, as major brokerage house Goldman Sachs has
predicted, all of these effects would be dramatically exacerbated.
We continue to believe that a news background of spreading fear, rising costs
and growing uncertainties would provide a sound background for a major golden
bull market.
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