Market Commentary

As written yesterday earning season started with a fizzle
January 13, 2010

As written yesterday earning season started with a fizzle as Alcoa disappointed.  This week will be a trickle of profit announcements and then the torrent beings.  As widely noted the markets have surged the last six weeks in anticipation of profit growth greater than the expected 62% rise.  Stocks backed and filled yesterday, perhaps a harbinger of things to come if profits due disappoint.

Regardless earnings are due to rise this quarter snapping a record nine straight quarters of declines.

This turn in corporate profitability has not been lost in the bond market. The cost to protect against defaults on corporate bonds declined to the lowest level since December 14, 2007.  As widely noted the recession commenced that month.

It is against this backdrop I believe it is not “if” but rather “when” bank lending will return.  Excess bank reserves are over $1 trillion versus the historical level of $1 to $2 billion.  The amount of cash banks are hoarding is unfathomable.

I am not remotely suggesting levels will soon return back to long term norms, I am only stating as confidence rises in repayment, lending will increase.  As noted above credit default swaps in the aggregate are at the lowest prices since December 2007 as per the industry accepted CMA DataVision price benchmark.

Will inflation expectations become “unanchored” as monetary velocity rises?  Yesterday China announced an increase in bank reserve requirements, the first change since June 2008.  China is poised to release Q4 GDP and a loan fueled double digit increase is expected.  As widely noted Chinese bank lending surged in 2009.

As per the Peoples Bank of China (PBOC), Chinese CPI is now around 1.4% per month.  Many have stated a bubble is now present in Chinese real estate prices, the direct result of the PBOC’s January 2009 mandate to lend 25% of its $4.6 trillion economy [2008] during the first six months of the year.

Fortunately our Federal Reserve or legislative bodies cannot dictate the same, but I think if excess reserves decline by 50% in relatively quick order, I think the odds are greater than 50% the primary concern of the Federal Reserve will become inflation. Incidentally $500 billion is half of a trillion, or the amount that the PBOC mandated its banks to lend during the first half of 2009.

Speaking of the Fed, the Beige Book is released at 2:00.  This statistical survey will be the basis for the discussion at the upcoming FOMC meeting.

What will occur today?

Last night the foreign markets were mixed. London was down 0.22%, Paris up 0.06% and Frankfurt up 0.35%.  Japan was down 1.32% and Hang Sang down 2.59%.

The Dow should open nominally higher. The 10-year is off 8/32 to yield 3.74%.