As you decode the job losses number, majority of the job losses are still occurring at the small businesses. This trend may take some time to reverse as small businesses are much more dependent on consumer confidence and credit availability which is still lagging. However, manufacturing activity seems to be picking up so there is a hope that job growth can begin in 3-4 months time.

One of the other signs of the early stages of recovery is a pick up in M&A activity as companies become a little more confident in pursuing deals as they find many cheap assets in the market. This seems to be happening now with a rash of deals having been announced recently. However, as with most M&A deals, this does put a downward pressure on jobs growth as companies try to cut redundant functions and realize synergies. This may be a short term negative but is healthy over the longer term.

All in all I believe we may have to wait a few more months to see an uptick in the jobs number. Hopefully this starts to happen before the housing industry starts to lose steam as the tax credits come to an end in November.

However, consumer spending is likely to stay at low levels as unemployment rate will continue to rise for the immediate future. And with the consumer focused on rebuilding savings and paying down debt, one would expect the credit sector and the retail sector to take longer to regain growth.

Cyclical manufacturing companies may be a good place to invest any new funds at this time. Recession and the large price volatility in the commodities last year have left most inventories very lean and even a little growth in demand is likely to produce robust growth in manufacturing. As it is, the numerous stimulus programs (around the world) have mostly focused on infrastructure projects which means the demand will also rise significantly as these projects start to come online.

At this point, inflation is a greater worry and the Feds have now signalled their willingness to raise rates faster if needed to contain recession even before the unemployment trends start reversing. This can be troublesome as it has a potential to cause added stress to the housing market by making new and existing mortgages more expensive for the consumer and also make credit more expensive for the businesses.

This is a very tightrope the fed has to walk and one hopes they are upto it.

Recession almost over, according to the Refrigerated Trailer indicator

Never heard of this before but it kinda makes sense, in the same way as Fedex/UPS or even Transportation index can be a leading indicator of the economic activity. Ingersoll-Rand reported that the sales of its refrigeration trailers are picking up and in the past this has served as a very reliable indicator of an economic recovery. IR also reported a fall in earnings in the most recent quarter but that the business appears to be stabilizing.

Disclosure: Author owns shares in LUK and IR

Bank of America CEO Ken Lewis feels that the economy is bottoming out and the worst is likely behind us. Other business leaders report stabilization in their business as well with some tech CEOs even seeing an uptick in their businesses. The Feds also report seeing tentative signs of economic recovery and estimate that the economy will start showing more palpable recovery later this year. However, they think that the unemployment rate will likely touch 10%.

It is debatable whether the signs out there do point to a real economic  recovery taking place. Calls for the bottom have been made many times during this recession (including Buffett’s call to Buy America) but so far they have been more of a miss. When the economy does indeed recover, the financial landscape in America (and possibly around the globe) will have changed.

Changing regulatory environment

Take for example the two fixtures in the financial regulatory setup, SEC and the Federal Reserve. Federal Reserve was created nearly 100 years ago in response to a financial crisis. It is a curious institution of sorts, as it is not really a government agency but more of a public-private hybrid institutions, where private banks have a great say in how the Federal Reserve is run and who the office bearers are. This quasi-private institution is essentially in charge of some of the basic functions of a state: controlling the money supply and setting the interest rates (cost of credit). As such, there have been questions often asked about the relationship of the Fed with the private banks in the country and whether there are conflicts of interest that impair the Fed from making right decisions at all times.

SEC on the other hand was established to oversee the proper functioning of the securities market in the US. For much too long, SEC has been too close to some of the entities they were supposed to be regulating resulting in much inaction and letting abusive market practices slide by unchecked.

Obama administration now proposes to overhaul the regulatory structure in US by bringing disparate agencies and their functions together and consolidating regulatory powers in a unified agency. Additionally, the administration also wants to regulate mortgages and credit cards through this new agency (or a similar agency for the consumer credit). Already, many credit card companies are up in arms saying new regulations on credit cards will make credit harder to get for an average consumer, even if the consumer sports an exemplary credit history.

While no fan of government regulations, I believe some is needed to avoid the country getting drunk on loose credit as it happened. Reduction in use of credit cards is not bad in my book and if it serves to help the consumers rediscover the benefit of living below their means, that it is all good. I do not believe that the credit card industry has a god given right to expand and grow at all costs. However, the government needs to take care not to extend their reach so deep that credit becomes scarce for legitimate businesses. The concept of risk taking and spirit of entrepreneurship needs to live on. If anything, credit situation needs to be eased for businesses so new start-ups and entrepreunerial companies can get funds without having to tap into a founder’s personal credit card, which will probably become more difficult to do in the future.

Maybe the SBA needs a revamp too.

And the Bank of America stock is up almost 16% today on the news. What gives?

Bank of America has many options going forward. It may be able to sell its stake in Itau Unibanco, worth about $3B come September. It may also be able to raise capital by selling its remaining stake in China Construction Bank. It is also putting its Columbia Management unit up for sale. But more strikingly, since the capital gap is less than the $45 Billion in TARP funds already commited to BAC, the company estimates that it can meet the tangible equity needs by just converting the preferreds offered to the government under TARP into common equity (and possibly retire $11 Billion in TARP borrowing in the process).

This would of course make the government a significant shareholder in the company and at the same time dilute the existing shareholders.

April ADP report shows the job losses moderating. Mortgage applications also rose by 2% in the week ending May 1. Does this mean that we should now start worrying about inflation?

Here is a post I made over at Personal Dividends talking about investing during periods of high inflation. When the inflation gets going, it is going to be ugly. By some estimates, about 37% of the money supply today was printed in the first 100 days of the Obama presidency. Credit to the administration in its ruthless efficiency in printing money but one wishes some foresight would have gone into it. This statistic alone boggles my mind. Inflation is now the biggest risk to the economy on the horizon. What do you think?

Partnership with private actors such as pension funds, hedge funds and other money management institutions is intended to allow for price discovery of these assets. However, the initial reports suggest that the private money component could be as little as 7% of the total money committed to the program with the government putting up another 7% and the remaining 86% will be in the form of a low interest loan by FDIC. Essentially, the government will be carrying 93% of the risk. However, the risk could be very little if sufficient discount to the nominal value of the toxic mortgages is obtained. But this is a big IF.

Now here is the problem. If the taxpayers are to take on as little risk as possible, the assets will need to be severely discounted. This means that the banks will need to write down the value of the assets further if they have not yet written it down heavily enough. This would make some of the banks who were not aggressive enough in writing down the value of these assets wary of selling into the program. On the other hand, those banks who did write down the value of the toxic assets very aggressively on their books may in theory be able to get a breakeven or better price when selling into the program.

$1 Trillion in commitments should not mean that this much money will eventually be spent. Existing home sales picked up in February, the mortgage rates have declined to a very low level, and if these trends continue, we may see the real estate markets firming up this year. If the program starts buying these toxic assets and that in turn allows the banks to start making new mortgage loans and the buyers start coming back to the market than it is likely that some of these ‘toxic’ assets on the banks books may start increasing in value, in which case the banks may decide not to sell these to the program. In a sense, a lot depends on how well the recent Fed actions on buying up domestic debt and expanding the Fannie and Freddie capacity to buy mortgages work. However, if Geithner is banking on the economy to firm up to make a success out of this plan than we are probably in for a rough ride ahead.

The bigger question is whether institutions will step up and participate in this program. There is very little incentive for them to do so and the recent furor on executive pay will surely make them leery. It all depends on how attractive the pricing is for these assets and a sense of assurance that the administration will not seek to levy extraordinary tax on the profits thus generated sometime in the future.

I am sure there is a sweet spot for pricing where the banks would be willing to sell and the institutions will be willing to buy and the program depends of this to be effective. Hopefully in the weeks and days to come we will know if this is indeed the case. This plan, as demented as it is, is probably the best we can get out of this Treasury and I hope it works.

I will be very tempted to buy stock in the banks that do sell into this program as it would be a signal that they were very aggressive in writing down the asset values. Assuming of course, that there are buyers in the market for these assets.

As an aside, do I think this is the best plan to fix our banking mess? Absolutely not! A far better plan would be to segregate these toxic assets in a bad bank (there will need to be a bad bank carved out of every large domestic bank), spin off the good parts to existing shareholders so they survive and create economic value for the society and shareholder value is enhanced, and then possibly sell the bad bank in the public markets or let it go bankrupt. No tax payer dollars will be at risk and no price discovery will be needed. Please read my earlier article on how the Government can start this process with Citigroup.

Banks are queing up to return the TARP money. No one likes bailouts, specifically, those banks who can carry on their business without government aid.

Fed reports that American household net worth fell by a record 9% in Q4, 2008 or about 20% from its peak. Declining home values, unemployment and fall in investments are the key factors. Total household net worth is now at $51.48 trillion according to the feds.

For an interesting perspective, the total CDS (Credit Default Swaps) market estimates are close to $50 trillion.

General Electric lost its coveted AAA rating at Standard and Poor by a notch mainly due to concerns over GE Capital. However, its industrial arm is performing well and therefore deeper cut is not warranted according to S&P. If you recall, GE recently cut its dividend by 68%, estimating it will save the company about $9 Billion a year.

The markets are up following the rating cut as many feared the cut would be deeper. Additionally, february retail sales fell but not as much as many expected.

We live in interesting economic times.

Nevertheless, there are two very significant deals or almost deals that have come out. Merck buying Schering Plough for almost $41B has been all over the wires. This is a very attractive deal for Schering and it does not appear that Schering shareholders will object. The deal still has to pass the federal scrutiny.

The other news is a likely acquisition in full of Genentech by Roche Holdings. Roche made a $93/share offer last friday and they might go up to $95/share to seal the deal. Roche already owns 44% of Genentech.

Both these deals will create a behemoth health care company. While I do not particularly care for the size of the company as I believe that the company will and should live and die based on the value it can create. If the scale is no longer economic, the markets will force a breakup or a spin off, as should be the case. No, the concern I have is our propensity to term a large company as too big to fail and the inability of the government to let the markets do their work because they get caught up in the populism aspect of the government policy.

In additional news, World Bank now predicts the global economy will shrink in 2009, with international trade declining the fastest in 80 years. As the cost of stimulus in the developed economies keeps rising, poorer nations will get crowded out of the global lending markets and this has a potential to create dislocations and conflicts around the world

• Citigroup stock dipped below $1
• American Express stock dipped below $10
• Unemployment rate surges to 8.1%, the highest in 25 years
• GM’s market capitalization has now dipped below $1 Billion mark (I mean, seriously!) and a bankruptcy appears to be the likeliest outcome regardless of the spin the government will want to put on it. The stock now trades at a 75 year low
• GE, fresh off reporting record profits last year is now trading as if it will default on its debt obligations

On the other hand, it looks like the mythical consumer is now starting to show signs of life as the retail data starts showing an uptick. Hard to reconcile this with the fact that the job losses are accelerating and the credit is drying up. Where is the money coming from for increase in spending?

Still, the irrationality of the pessimism is astounding. I think it is about time that this value investor (and likely other value investing disciples) start to invest again in the market with new money. Over the next few weeks I will be spending time on due diligence scouring the markets for the most undervalued and promising assets that can be picked up for peanuts. Stay tuned.

Or rather, if you have ideas for cheap stocks, let’s hear them.

Option 1: The government can continue to muddle through the bailouts of our financial institutions, hoping something will stick and over time the financial institutions will regain their footing. Problem is that the banks won’t make money unless they lend and the mortgage loan losses on the books will keep piling up as the consumers are unable to refinance. And the banks won’t lend as long as the losses on their toxic assets keep piling up and they are not making money. We can keep throwing money at the banks to resolve this catch-22 until the point that the banks feel confident enough in their capital structure to start taking lending risks again. There are too many ifs in this scenario and surely the plot will have many hair raising twists and turns in it, and will probably make a great case study for the history books on ‘how not to handle a banking crisis that is crippling the economy and causing real hardship to the taxpayers’.

OR

Option 2: The government can force real change now that it owns enough of the bank to call the shots. Whether you prefer the term nationalization or not, you have to agree that the government’s ownership in Citigroup now puts it in a position where it can be a catalyst for major changes in the company. It is time for some restructuring of the business. Citigroup is a vast holding company (or in other words, unmanageable) that has business assets from mortgages, banking, insurance, credit cards, investment banking, wealth management, and everything in between. Most of these operations have real value but the company is sinking due to the toxic assets it holds. The bank needs to be broken up. Give some of the good parts of the company enough capital that it can function on its own profitably, and then spin them off to the current shareholders of the company. These spin offs will be much more valuable on their own without the burden of toxic assets pushing them down. The current shareholders will get assets that are valuable and this will create instant return on the shareholder and tax payer’s investment. The country will be better off as when these well capitalized banks or insurance companies devoid of toxic assets start functioning on their own, they will start lending and go about their business of creating value and this will help restart the economy. A shell containing bad loans and other investments will remain (or so called bad bank) but more likely than not, the losses in this bad bank will be more than offset by the good well capitalized businesses that are spun off.

Ultimately, if and when the economy starts growing again and lending for refinancing and new home purchases and commercial assets becomes available, the toxic assets in the bad bank will either increase in value or will mature and be paid off.

All this can be accomplished without having to find a formula for valuing bad assets, as apparently that is a very hard thing to do and which is why TARP is not working (you know I can go back to my study and look up the elementary finance book and find DCF, but you know it is a very hard thing to do for me in my laziness. Heck, I seem to remember that there are even ways of valuing a security using probabilities to assign to different events or outcomes, but I digress. I would rather muddle through, do things adhoc, something is bound to stick)

Now Option 2 can be a model for other troubled banks as well. Take enough equity stakes in them to call the shots, and then force them to restructure. Maybe you only need to do this with a couple before the other banks get the message and start doing it themselves.

Maybe GM should break up as well and possibly a few of its brands will survive on its own.