RISK PREMIUM ANALYSIS: What’s Wrong With Ben Bernanke?

Perhaps He’s Becoming A Source Of Uncertainty

For the Ninth Week of 2008

Probably the most closely watched performance last week was not at the movies but on Capitol Hill where Federal Reserve Chairman’s Ben S. Bernanke gave his Semiannual Monetary Policy Report to Congress.  Ben Bernanke’s problem is that he is not like his predecessor, Alan Greenspan, who was as opaque as he was incomprehensible.  Chairman Bernanke’s blunt message was not exactly what Congress wanted to hear in an election year. In stating that we now have a “distinctly less favorable” economic environment he became the proverbial bearer of bad news—namely, that we now have slowing growth and rising prices except for housing. His earlier overly-rosy economic forecasts and his slowness in anticipating and acting on the subprime mess have left him vulnerable to much second guessing. And his questionable assumptions regarding oil prices have also left him open to criticism. In an odd way, the problem with Bernanke is that he may risk becoming a source of uncertainty, not what is needed in these increasingly difficult times. 

The chairman’s recent testimony suggests that at this time the Fed is more concerned about a recession than inflation and so will continue to push down interest rates. Analysts are anticipating a cut of 50 to 75 basis points in the Federal Funds rate, to 2.5 or 2.25, when rates are reviewed March 18. What will happen as the rates approach 0%?

In his semiannual update before Congress, Bernanke characterized the current credit markets as “highly dysfunctional.”   It is troubling that he does not seem to us to “play well” before Congress.  This is a source of uncertainty which cannot be quantified.  Thus, investors need to be sensitive to his ability to achieve a certain degree of political immunity and not become a political scapegoat especially since his term as chairman expires on January 31, 2010 (his full-term runs through January 31, 2020).  

HOUSING CONTINUES TO MAKE NEW LOWS

Our Risk Premium Analysis indicators show no reversal from the bear market pattern underway for several months. The Dow Jones Industrials ended the month at 12,266.39, down 0.93% for the week and 3% for February amid news that the economy was still in a state of flux, especially the financial sector.  Statistics on the housing front released early in the week were not good. According to the S&P/Case-Shiller index, in the fourth quarter home prices fell 8.9% nationally from a year earlier, the largest drop in its 20 years of compiling data. The index measures house re-sales in 20 large metropolitan markets around the country.  

The Office of Federal Housing Enterprise Oversight’s index, which measures homes purchased with Fannie Mae or Freddie Mac mortgage guarantees, was down 0.3%, the first year-to-year decline in the 16 years it has been gathering statistics.  Based on the S&P/Case-Shiller national home index, prices have fallen 10.2% from their 2006 highs.  Declines have been much steeper in certain markets such as Miami where prices were 17.5% off their 2006 highs and Las Vegas and Phoenix with declines of 15.3%.  Moreover, the pace of sales of existing homes fell 30 percent between mid-2005 and the fourth quarter of 2007.  The decline in the equity cushion of home values nationwide is worrisome not only to the balance sheets of banks and other lending institutions but to the value of an individual’s total portfolio of assets.  The decline in real value of real estate assets also carries negative implications for the financial institutions used to fund these properties as collateral-to-loan ratios have deteriorated, casting a wide shadow over all financial-based instruments.

BOND INSURERS GET A STAY OF EXECUTION

S&P and Moody’s changed MBIA’s Triple-A ratings from “under review for possible downgrade” to merely “negative.”  In practical terms, a “negative” outlook does not mean there is no longer a downgrade risk. Rather the change in outlook suggests that a work-out designed to retain the Triple-A rating is underway.  However, there can be no assurance that efforts to preserve the Triple-A rating will be successful.  Until some sort of stabilization plan is adopted both Ambac and MBIA will face downgrade risks.

CONSUMER CONFIDENCE FALTERS

Concerns about consumer confidence was not helped by a report of The Conference Board. The New York based business research group noted that its index of consumer confidence fell sharply, to 75 in February from 87.3 in January.  Its index is closely watched because consumer spending is an all- important driver of the U.S. economy.                                                                                                     

CAN A VISA STOCK OFFERING SUCCEED IN THIS VOLATILE MARKET: PROBABLY

One test of market health will be the common stock offering of up to $19 billion by Visa in mid-March. The offering hopes to command a P/E of 24x to 27x, which seems very rich in this market (where the average multiplier is 12x).  Conversely, the market-to-book and liquidity measures are generous and should compensate for the high earnings’ multiple.  Estimates on the size of Visa’s offering vary from $17 billion to $19 billion.

BUYING EARNINGS

Early in the week the market was given a boost by IBM’s announcement that it planned to repurchase $15 billion of its common stock in 2008, a move which should help lift the stock and be accretive to earnings.  Companies who feel their stocks are undervalued and have the free cash flow may see their own common shares as offering better returns than their basic business.  For companies with excess cash flow or those that envision an arbitrage opportunity in their own depressed stock a repurchase plan may be a way “to buy earnings.”  IBM said the buyback will boost its earnings for 2008 above Wall Street's prior forecasts. Shares of Big Blue vaulted $4.30, or 3.9 percent, to $114.38.

THE RISK PREMIUM DATA: STILL MOVING IN A BEARISH DIRECTION

Our Risk Premium analysis remains in bearish territory as the market appears to be “pricing risk” in, resulting in contracting P/E multiples.

For the week ending February 29th the risk premium results are illustrated by the yellow line:

§      The Industrial Risk Premium ended at 6.72% versus 6.66%

§      The Transportation Risk Premium increased to 7.24% from 7.15%

§      The Utility Risk Premium increased to  6.76% compared to 6.51% n

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