• The Reserve Bank of India reduced its repurchase rate from an already low of 5.5% to 5.0%, its fifth cut since October. “We see a significant slowdown in investment,” Sailesh Jha, a senior regional economist at Barclays Capital Plc in Singapore, told Bloomberg. “There is scope for more significant rate cuts.”

• ADP Employer Services said that U.S. private employers cut 697,000 jobs in February, an acceleration of the revised 614,000 jobs lost in January. The figures mark the biggest job loss since the report’s launch in 2001, Reuters reported.

• U.S. auto sales sunk 41% in February, as nearly every vehicle model by the country’s six-largest automakers posted at least a 10% drop in year-over-year sales. “It implies we have not reached the bottom, and pushes that bottom out to some point yet to be determined,” Emily Kolinski Morris, senior U.S. economist for Ford Motor Co. (F), told CNNMoney.com.

• For the first time since December 1991, shares of General Electric Co. (GE) fell below the $6 mark. “The market is beginning to anticipate a downgrade to double-A territory,” Pacific Investment Management Co.’s Bill Gross said in an interview on CNBC. “We believe even with the downgrade, it’s a viable, safe, liquid credit going forward.”

• Oil prices jumped more than 9% yesterday (Wednesday) after plans for further stimulus in China stirred the markets from their slumber and U.S. inventories declined more than expected. Light, sweet crude for April delivery rose $3.73 a barrel to settle at $45.38 on the New York Mercantile Exchange, its highest close in six weeks.

• Merrill Lynch & Co’s (MER) 10 highest-paid employees got a total of $209 million in cash and stock in 2008, up from $201 million in 2007, the Wall Street Journal reported. Merrill’s net loss ballooned to $27.6 billion last year

Source: Global Investment News Briefs Thursday, March 5, 2009

Speaking at a dinner at Columbia University, Soros actually compared the current situation to the breakup of the Soviet Union, and said that the whipsaw effects of the crisis are actually more severe than the Great Depression.

“We witnessed the collapse of the financial system,” Soros told his audience. “It was placed on life support, and it’s still on life support. There’s no sign that we are anywhere near a bottom.”

He said the bankruptcy of. Lehman Brothers Holdings Inc. (OTC: LEHMQ) in September marked a turning point in the functioning of the market system.

His comments echoed those made earlier at the same conference by former U.S. Federal Reserve Chairman Paul A. Volcker, who is now a top adviser to U.S. President Barack Obama. Volcker said that overseas industrial production was declining even more rapidly than it was in the United States, which is itself under severe strain.

“I don’t remember any time, maybe even in the Great Depression, when things went down quite so fast, quite so uniformly around the world,” Volcker said.

Market Matters

Nothing has been able to get this economy (and stock market) back on track. Congress passes – and President Barack Obama signs – a near-$900 billion stimulus package and the U.S. Federal Reserve revises (negatively) its economic outlook for the remainder of 2009. Major financial institutions get significant (bailout) assistance from the government and Bank of America Corp.’s (BAC) chief is subpoenaed for misleading investors over Merrill Lynch & Co. Inc.’s (MER) (excessive) bonuses.

Automakers beg Congress for (and receive) a bailout of their own and General Motors Corp. (GM) and Chrysler LLC come back for even more as part of their restructuring plans.  Investors try to look past the unscrupulous practices of Madoff and the U.S. Securities and Exchange Commission (SEC) brings suit against billionaire Alan Stanford’s global enterprises over an apparent $8 billion fraud through its high-yielding CDs (with Venezuelans particularly hard hit).

Stanford Financial manages assets of $50 billion in 140 countries, with the primary bank operations in question based in Antigua.  With the Dow Jones Industrial Average hitting a six-year low and falling below the perceived floor set in November, investors are left scratching their heads.

So much for the “challenging” times setting a tone for bipartisanship in Washington.  As the stimulus package passed with only token Republican support in the Senate, its party leader called it “a missed opportunity, one for which our children and grandchildren will pay a hefty price.“  He then revealed that not one House member even took the time to read the bill.  The Obama administration also announced a plan to help millions of homeowners avoid foreclosure, while attempting to stabilize the housing market (to the tune of another $275 billion).  As long as the Treasury’s checkbook is out, GM wants another $16 billion and Chrysler could live a few more days with an additional $2 billion.

Oil rose (briefly) late in the week as the U.S. Department of Energy revealed a surprising decline in crude inventories and a slight increase in the demand for gas now that prices at the pumps have fallen below $2 a gallon and stayed for a while.

After taking the Dow down more than 300 points following Presidents’ Day, nervous investors sold all the way to a new six-year low and the worst week for equities since October.

Financials continued to be hammered as talks of bank nationalization picked up steam.  Global stock markets followed suit with Japan’s Topix closing at a 20-year low.   With investors shunning equities of all shapes and sizes (and U.S. Treasuries offering little in the way of returns), gold became the safe-haven recipient and futures climbed above $1,000 an ounce.  For now, investors just talk of “values,” “opportunities,” “rallies,” and “rebounds,” but few seem willing to follow-through with any real buying.

Economically Speaking

With U.S. Federal Reserve Chairman Ben S. Bernanke and friends trying any and all tricks in their arsenal to jumpstart the economy, the central bank chief admitted that the efforts to date have resulted in very limited successes.  The Fed negatively revised its outlook for the remainder of the year and now projects that unemployment could reach 8.8% and the GDP may shrink by as much as 1.3% in 2009.  Meanwhile, our global trading partners are struggling with problems of their own.  Japan’s economy experienced its worst quarter in almost 35 years as its manufacturers suffered through substantially declining demand for their goods.

The domestic economic data confirmed that the Fed’s new (weaker) projections may be right on target.  Housing starts in January fell by almost 15% and activity now stands 56% below the pace of construction last year.  Industrial production tumbled more than expected last month, and automakers face even more shutdowns as part of their recently proposed restructuring plans.

The labor market remained incredibly weak as new jobless claims rose again in the most recent release and the number of workers receiving unemployment benefits for over a week stood around a record high 5 million people.  On the inflation front, the cries of deflation can be put on hold for the time being.  Both the producer price index (PPI – wholesale) and the consumer price index (CPI – retail) experienced their biggest gains since July 2008, as energy prices actually rose last month.

Still, consumer prices remained flat (no real increase) on an annual basis, the lowest level of price change since August 1955.

Weekly Economic Calendar

Source: Super-Investor George Soros the Latest to Predict the Worst is Yet to Come

Geithner, currently the president of the Federal Reserve Bank of New York, is viewed by Democrats and Republicans alike as probably the most qualified candidate to succeed current Treasury Secretary Henry M. “Hank” Paulson Jr., since whoever fills this post will have to be able to step right in and make whatever moves are needed to fix a financial system that seems to get worse by the week. Geithner is actually viewed as perhaps the one candidate with the qualifications, personality and personality needed for success.

But there’s a problem.  The man chosen by President-elect Obama to run the U.S. Treasury failed to pay $34,000 in taxes over several years in the first half of the decade. This oversight, which relates to a period when Geithner worked as a senior official with the International Monetary Fund (IMF), will complicate a Senate Finance Committee hearing into his nomination as U.S. treasury secretary, the online edition of the London (U.K.) Times reported. That issue – as well as a second, regarding the employment of a housekeeper without a work permit – emerged in papers released last week by the Senate Finance Committee.

Lawmakers on both sides of the aisle were saying last week that they were still hoping Geithner could be confirmed, but with each passing day there are a growing number of critics, many of whom are calling for him to withdraw. The days ahead will tell us whether Geithner will be able to assume the post so many believe he’s just right for, or whether President Obama will have to settle for a less-than-perfect replacement.

As Obama prepares to take the historic oath of office as the 44th President of the United States tomorrow, he faces the worst financial and economic crises since the Great Depression.  He intends to hit the ground running and put his personal touches on the much discussed stimulus package.

Congressional Democrats revealed plans for the new administration’s stimulus, which has grown to $825 billion and which includes $275 billion in tax cuts.  For good measure, the Senate approved the release of the next $350 billion of Troubled Asset Relief Program (TARP) money, but only after Obama pledged to place restrictions on banks that will be receiving funds.

Market Matters

A light week on the economic calendar gives way to more earnings reports as investors move beyond (depressed) financials and focus on other key corporate releases, including:

• International Business Machines (IBM) (Tuesday).
• Google Inc. (GOOG) (Thursday).
• Microsoft Corp. (MSFT) (Thursday).
• General Electric Co. (GE) (Friday).

Expectations are incredibly dire so any positive earnings surprises (no matter how low) should be well received.  The new Citigroup Inc. (C) will be worth watching as some analysts expect its downward spiral to continue and anticipate a similar fate as the bankrupt Lehman Brothers Holdings Inc. (LEHMQ).

Amid all the talk of recession and bailouts, foreclosures and bankruptcies, unemployment and deflation, bear markets and capitulation, there was actually an airline-related story that actually was the feel-good story of the week last week – and it involved perennial also-ran US Airways Group Inc. (LCC). On Thursday, in an incident that the New York governor has labeled as “Miracle on the Hudson” – and in a story that finally lifts the human spirit above the “gloom and doom” of the ongoing financial crisis – U.S. Airways Capt. Chesley “Sully” Sullenberger III made a series of split-second decisions and heroically ditched his Airbus jetliner in the Hudson River after a dual engine failure, saving the lives of all 150 passengers and crew.

Many folks didn’t even get their feet wet. The National Transportation Safety Board (NTSB) said it will be studying this case as an example of all the things to do “right” during such a crisis – in stark contrast to most of its investigations, which look at the sometimes scandalous events that went wrong. Sullenberger, a former U.S. Air Force fighter pilot is also a skilled glider pilot, and is also the airlines’ expert on safety.

So while Vikram S. Pandit (Citigroup), Kenneth D. Lewis (Bank of America Corp. (BAC)), John Thain (Merrill Lynch & Co. Inc. (MER)), G. Richard Wagoner Jr. (General Motors Corp. (GM)), and many others, shirk responsibility over corporate (and shareholder) losses, let’s not forgot that true heroes still exist and their leadership is not measured by the value of their stock options or investment portfolios, or the size of their (missed) bonuses. Thank you, Sully.

Bank of America, fresh on the heals of its first quarterly loss in 17 years, emerged as the initial beneficiary of new TARP dollars (and loan guarantees) to help absorb Merrill into its corporate umbrella (where it joined forces with another failing institution, (Countrywide Financial Corp). While BofA seemed to be embracing the “financial supermarket” concept made famous by Citigroup, the latter took the opposite approach and sold part of its Smith Barney brokerage unit to Morgan Stanley (MS) and divided its remaining operations into two entities (See related stories on both Citi and BofA in today’s issue of Money Morning.)

Citi lost more than $8 billion last quarter, despite its personal government bailout and initial TARP money.  Deutsche Bank AG (DB) warned of a $6 billion quarterly loss of its own, revealing that the financial debacle is not limited to the United States.  JP Morgan Chase & Co (JPM) recorded a slight profit last quarter, but added to its loan loss reserves as CEO James “Jamie” Dimon expressed “disappointment” over the results.

While the financials reported earnings (losses) early to avoid the painful waiting, the news from other sectors was not any better. Alcoa Inc. (AA) kicked off the earnings season by announcing worse-than-expected results, while Intel Corp. (INTC) lived up to its dire outlook by reporting a 90% drop in profits.

Though Thomson Research predicted a 14% decline in Standard & Poor’s 500 Index earnings for the quarter, that forecast may look optimistic after the initial reports.  In other corporate news, Nortel Networks Corp. (NT) filed for bankruptcy; Yahoo Inc. (YHOO) found a new CEO; Circuit City Stores Inc. (CCTYQ) moved into liquidation mode; and Apple Inc.(AAPL) will continue without Steve Jobs for the foreseeable future.

Oil plunged below $35 a barrel for a bit as the Organization of Petroleum Exporting Countries (OPEC) and the International Energy Agency (IEA) each reduced their projections for global demand in 2009.  Stocks resumed their downward spiral (before rebounding slightly late in the week) as the banking sector proved that TARP was no easy fix and that the earnings season could be disastrous.  A horrific retail sales report (see below) added to the economic woes as investors searched long and hard for something to believe in.  Thanks again, Sully, for the welcome relief (no matter how temporary).

Weekly Economic Calendar

Alas, a Ben Bernanke sighting.  During the week, the U.S. Federal Reserve chairman expressed his concern that a new stimulus package might not be enough to provide a “significant boost” to the economy and confirmed that policymakers will “do their part” to promote recovery.  The Fed’s Beige Book depicted a domestic economy growing weaker by the day as conditions deteriorated within virtually all sectors across virtually all regions.  Fearful of a weakening labor picture, consumers disregarded the available (deep) discounts provided by the nation’s retailers and contributed to a very dismal holiday season.  In fact, retail sales plunged by 2.7% in December, more than twice the expected decrease in activity, and suffered the first annual decline on record (since 1992).

While the trade deficit dropped to its lowest level in five years, exports also fell as our international trading partners have lost their unlimited appetites for U.S.-made goods and services.  This bad news for domestic manufacturers will surely be reflected in corporate earnings in the quarters to come.  On that note, industrial production dropped by 2% in December, a far worse showing that analysts expected.  On the housing front, 30-year mortgage rates fell below 5%, though home purchases are still rare and borrowers with less than stellar credit face difficulties in refinancing loans in this environment.

The inflation picture offered a bit of a reprieve from the negativity (though naysayers continued touting deflation or worse).  Wholesale prices plummeted for the fifth consecutive month and experienced their first annual drop since 2001.  In December, gasoline prices fell by another 25% and even food costs suffered their largest decline since early 2006.  The less volatile core producer price index (PPI) – which excludes the “volatile” food and energy components – rose slightly in December, though most economists expect that the lower energy costs will soon impact other sectors of the economy, as well.  Consumer price index (CPI) data reflected another large decline in retail prices, and the smallest increase in annual inflation since 1954.

Unfortunately, few analysts even speak of the stimulus package that Americans have received at the pumps over the past few months as gas prices have plummeted far more than 50% since mid-summer (and this one won’t cost taxpayers a penny down the road).

Source: Could Tax Problems Trip up the Confirmation of the Best Candidate for Treasury Secretary?

“We have not disclosed that to the public. We’re declining to,” Thomas Kelly, a spokesman for JP Morgan Chase & Co. (JPM) told The Associated Press, which surveyed 21 banks that received at least $1 billion in federal bailout money, and asked how that capital was being used. JP Morgan received a $25 billion infusion as part of the U.S. Treasury Department’s $700 billion Troubled Assets Relief Program (TARP).

As an ongoing Money Morning investigation has demonstrated, billions in U.S. bank rescue funds are financing buyouts worldwide – instead of lending at home. Some of those buyouts deals are being done in markets as far away as China. Meanwhile, credit remains tight here in the U.S. market, a situation that could be alleviated if only the banks made the bailout money available to consumers in the form of loans.

Money Morning was one of the first news organizations to really examine how TARP money was being misdirected, and wasn’t being deployed as originally intended. More recently, The AP has joined the journalistic posse and published several investigative pieces, including one that looked at executive pay at financial institutions that received bailout money.

Some experts – such as investing icon Jim Rogers – say that bailouts in general are bad deals. They’re even worse if they’re funded by taxpayers who don’t know how their money is being spent [A related story on Rogers' views about the U.S. banking-bailout initiative appeared last week in Money Morning. To access that story, please click here].

The bottom line: Banks won’t say how they’re using the bailout money. That refusal – coupled with the almost non-existent disclosure and oversight of the TARP program – means the country may well never find out how hundreds of billions of taxpayer dollars were spent.

Anatomy of a Survey

In its latest investigative offering, The Associated Press contacted 21 banks that received at least $1 billion in government money and asked four questions: How much has been spent? What was it spent on? How much is being held in savings? And what’s the plan for the rest?

According to The AP, none of the banks provided specific answers.

For instance, when Kevin Heine, a spokesman for Bank of New York Mellon Corp. (BK) – which received about $3 billion in TARP money – was asked how his institution was using the emergency infusion, he replied by stating that “we have not disclosed that to the public. We’re declining to.”

The words varied, but the basic message was the same from one bank to another. For instance, Barry Koling, a spokesman for SunTrust Banks Inc. (STI), the Atlanta, Ga.-based lender that received $3.5-billion in taxpayer cash, told the wire service that “we’re not providing dollar-in, dollar-out tracking.”

Some banks actually admitted that they simply didn’t know where the money was going.

For instance, a spokesman for the Birmingham-based Regions Financial Corp. (RF) said the company is not tracking how it is spending the $3.5 billion in TARP money that it received.
“We manage our capital in its aggregate,” said Regions spokesman Tim Deighton.

These answers – or lack thereof – highlight both the secrecy surrounding the TARP program, as well as the lack of oversight by Congress. Given that the entire TARP program is worth at least $700 billion – roughly the equivalent of the economy of The Netherlands – those aren’t small issues.

About half of the $700 billion was earmarked for bailouts. But because the U.S. financial crisis was escalating so quickly – and because the Bush administration pushed Congress to approve the TARP plan quickly – Congress attached virtually no strings to the bailout funds. The Treasury Department has been using the money to buy stakes in key U.S. banks, allegedly hoping that the infusion of cash would enable them to heal themselves and start lending again.

As the deepening U.S. credit crisis has shown, that hasn’t happened.

No Oversight, No Accountability

There has been no accounting of how banks spend that money. Lawmakers summoned bank executives to Capitol Hill late last year and implored them to lend the money – instead of hoarding it, spending it on executive bonuses, or for buyouts to get bigger. But there’s no process in place to guide this. And there are no consequences for banks that fail to comply with what U.S. lawmakers are asking.

Even worse: There’s no vehicle that enables taxpayers to find out what banks are doing – at least, not yet.

“It is entirely appropriate for the American people to know how their taxpayer dollars are being spent in private industry,” Elizabeth Warren, the top congressional watchdog overseeing the financial bailout, told The AP. Stating that it takes “a lot of nerve not to give answers.”

Warren said her oversight panel will try to force the banks to say where they’ve spent the money. But she also noted that she was quite surprised to learn that she even has to ask for that information.

“If the appropriate restrictions were put on the money to begin with, if the appropriate transparency was in place, then we wouldn’t be in a position where you’re trying to call every recipient and get the basic information that should already be in public documents,” Warren said.

In fact, the due diligence on the legislation that created TARP was so lax that lawmakers didn’t realize until much later that the bill they passed actually managed to create a potentially illegal tax loophole that grants banks a tax-break windfall of as much as $140 billion. Lawmakers were furious – but possibly powerless, afraid that a full-scale assault on the tax change could cause already-done deals to unravel, in turn causing investor confidence to do the same.

“Those are legitimate questions that should have been asked on Day One,” said U.S. Rep. Scott Garrett, R-N.J., a financial services committee member who opposed the bailout as it was being pushed through Congress. “Where is the money going to go to? How is it going to be spent? When are we going to get a record on it?”

Buyouts Not Bailouts

Nearly every bank questioned – including Citigroup Inc. (C) and Bank of America Corp. (BAC) – recipients of some of the largest TARP infusions – responded to AP inquiries with generic public relations statements explaining that the money was being used to strengthen balance sheets and to continue making loans to ease the credit crisis.

As a Money Morning story detailed Friday, BofA just finalized its buyout of Merrill Lynch & Co. Inc. (MER), creating the largest U.S. bank – as well as the biggest challenge yet for longtime BofA Chief Executive Officer Kenneth D. Lewis. And Wells Fargo & Co. (WFC) completed its $12.7 billion purchase of Wachovia Corp. (WB) – outbidding Citigroup Inc. (C) and making a massive bet that it accurately quantified the still existing risks in Wachovia’s huge portfolio of mortgage and real estate loans.

Those were just the latest in a long series of buyout deals being funded at least partly by TARP money, the ongoing Money Morning investigation has shown.

In response to The AP survey questions, a few banks detailed company-specific programs, such as a JP Morgan plan to lend $5 billion to nonprofit organizations and healthcare companies over the next year. Marshall & Ilsley Corp. (MI), said the $1.75 billion bailout infusion it received allowed the Wisconsin-based bank to temporarily stop foreclosing on homes, said Senior Vice President Richard Becker.

This “foreclosure moratorium” will run through the end of March, the bank announced in December.

No Real Answers

But no bank provided even the most basic accounting for the federal money. Some even said that the money couldn’t be tracked.

The bailout money “doesn’t have its own bucket,” said Bob Denham, a spokesman for North Carolina-based BB&T Corp. (BBT).

Denham said taxpayer money wasn’t used in BB&T’s recent purchase of a Florida insurance company. When asked how he could make such a statement – after stating that TARP money couldn’t be tracked – said BB&T would have made that deal even without the infusion.

Interestingly, a spokesman for BB&T told the Charleston (W.V.) Daily Mail newspaper just before Christmas that the bank doesn’t like the federal government’s $700 billion financial rescue plan – and actually didn’t want to participate – but took the $3.1 billion because competitors are participating and because the Treasury Department urged it to.

According to the newspaper, BB&T – the largest bank in West Virginia – has been asked how it justifies participating in the federal government’s Troubled Asset Relief Program, or TARP, in light of BB&T Chairman John A. Allison IV’s promotion of the late author Ayn Rand’s philosophy of free market capitalism.

The reticence banks displayed when it came to discussing their use of TARP money bordered on the absurd. Most banks wouldn’t even say why they were keeping the details secret.
“We’re not sharing any other details. We’re just not at this time,” Wendy Walker, a spokeswoman for Dallas-based Comerica Inc. (CMA), which received $2.25-billion from the government, told The AP.

One didn’t even want to say they wouldn’t say, the wire service reported.

Heine, the New York Mellon spokesman who said he wouldn’t share spending specifics, added: “I just would prefer if you wouldn’t say that we’re not going to discuss those details.”
Morgan Stanley (MS) offered to discuss the matter with reporters on condition of anonymity. When The AP refused, Morgan Stanley spokeswoman Carissa Ramirez sent the wire service an e-mail saying: “We are going to decline to comment on your story.”

Lawmakers say they want to tighten restrictions on the second half of the TARP money, the yet-to-be-released block worth $350 billion. U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. said the federal department is trying to build up its monitoring of bank spending.

“What we’ve been doing here is moving, I think, with lightning speed to put necessary programs in place, to develop them, implement them, and then we need to monitor them while we’re doing this,” Paulson said at a recent forum in New York. “So we’re building this organization as we’re going.”

But that may all be too late, says Garrett, the New Jersey Republican congressman. Indeed, it’s entirely possible that U.S. taxpayers will never get a clear answer on where hundreds of billions of dollars went.

Source: U.S. Banks Refuse to Detail How They’re Spending Federal Bailout Money

Editors Note: This is the fifth installment of an investigative series in which Money Morning examines how U.S. banks are using federal bailout funds.

Tomorrow morning the Factory Orders report for November is released, and things might get better. The report is expected to show a decline, but not as large of a decline as the previous month. Whether or not this means that factories are starting to get more orders on a consistent basis remains to be seen, but anytime a decline is shrinking, it seems like a small victory.

The final report I wanted to touch on this week is the December Non-Farm Payrolls report. This will be the final report for 2008, and will allow us to look at the overall loss for the year. As it stands, the country has lost just over 1.3 million jobs this year. The expected loss for December is another 475k jobs, which will put us over 1.8 million jobs lost for the year. The scary thing is that the job losses have increased every month for the last four months, so December may be worse than expected. I remember back in mid-summer when some of us were wondering if we would see one million jobs lost this year. Now we are looking to nearly double that amount.

Earnings:
Wed: BBBY, MON

Thurs: BLK, MER

Source: Employment Data Dominates Calendar, Earnings Season Starts Again

This from Money Morning:

The consensus estimate of earnings for the Standard and Poor’s 500 Index for 2009 is currently about $83. The index itself is currently standing at about 904. That means the market is trading on only 10.6 times next year’s forecast earnings, far below the historical average multiple.

So it is a screaming buy, right?

Not so fast.

“Consensus” estimates of earnings lag reality substantially. Because they include an average of all earnings forecasts over a considerable period, forecasts made in late September would still be included in today’s consensus estimate. But in a period such as the present, when reality has changed substantially since September, the official consensus forecast may differ wildly from what most analysts currently believe. The $83 number is thus a lagging indicator, which doesn’t take account of financial sector disasters, sharply slowing output, or tight credit conditions.

Most analysts, finally made more cautious by five successive quarters of declining earnings on the S&P 500 index, currently believe that the S&P 500 will earn about $60 in 2009. What’s more, David Rosenberg of Merrill Lynch & Co. Inc. (NYSE:MER), who has been exceptionally bearish for some time with an estimate of $50, has been joined in bearishness by Goldman Sachs Group Inc. (NYSE:GS), which has brought its group estimate down to $53.

That’s much more scary. Taking the average S&P 500 multiple at around 14 times earnings, an earnings estimate of $60 would put a “median” estimate of the index at 840; an earnings estimate of $50 would put it at 700. Take a bear market low at 10 times earnings, and you could postulate an S&P 500 low of 600 or even 500.

Still, bear market earnings estimates can be taken only so far, especially those of analysts. After all, on July 7, 2008, a joint report by two top houses predicted that the S&P 500 index would have its best six months since 1982 in the latter half of 2008. That’s about as wrong as they could possibly have been!

Still, one should not be surprised by their failure; while one of the two well respected but wrong houses was Deutsche Bank AG (NYSE:DB), the other was – Lehman Brothers Holdings Inc. (OTC:LEHMQ). Truly, a lot can change in six months.

2009 Bears

Nevertheless, while it’s clear that from an earnings viewpoint 2009 should be approached with caution, it is also clear that some sectors and countries will do reasonably well, while others have futures that are truly scary.

Some of the more bearish sectors and regions include:

• Financial services: The entire industry appears to be scaling down to a fraction of its 2007 size, as many of the innovations of the last 20 years turn out to have been spurious. Investment management also is destined to be much less innovative and less lucrative in the wake of the Bernard Madoff scandal. Eventually, banks and other financial institutions will emerge from the downsizing, but 2009 is much too early to expect that.

• Real estate and construction: Housing won’t bottom out until mid-2009 at the earliest, and will recover only very slowly thereafter. Non-residential construction will also be very limited, as offices, stores and hotels will be in glut. There may be some money to be made in road construction from President-elect Obama’s infrastructure program, however.

• Emerging markets with no money: The emerging markets that rely on borrowing to fund themselves will be out of luck, as debt will be expensive and hard to come by. Eastern Europe and most of Latin America will be in for a thin time, as their balance of payments and in many cases budget deficits will take years to straighten out.

• Western European countries with high cost bases: The Western European countries with expensive labor and high taxes will find life tough in 2009, particularly if they previously enjoyed a real estate bubble or were big in finance. Germany will probably do fine because its high-skill labor is highly competitive and it had no housing boom; Britain, Spain and Italy will be in a much more difficult situation.

2009 Bulls

Conversely, there will be sectors and countries whose earnings can be expected to hold up well, and whose shares are worth looking at:

• Gold mines: Inflation is almost certain to return in 2009, because of all the fiscal and monetary stimulus. That has to be bullish for gold, other precious metals, and mining companies.

• U.S. exporters: The rest of the world will show some economic growth, and the U.S. budget and payments deficits and expansionary monetary policy will make U.S. exporters benefit, unless they are involved in businesses that depends heavily on tourism, such as aircraft.

• Healthcare providers: Pharmaceutical companies may have problems with President elect Barack Obama’s healthcare plans, because the returns for patented drugs will be reduced, but hospital chains and other healthcare providers will probably benefit from an overall increase in government healthcare spending.

• Asian countries: In general, Asian countries will do better than the United States and Western Europe, because their cost bases are less overblown and their competitiveness is greater. China and India may have problems, but I like the prospects for Korea, Taiwan and Japan and for companies in those countries involved primarily in their domestic markets. If the Indian election in spring goes to the pro-business BJP party, it will be a buy too; if not, India will have difficulty funding its overblown government sector.

• Brazil: Brazil has a well-balanced economy, less foreign debt than it used to have, and a monetary policy of high real interest rates. It can, therefore, afford to expand domestically through monetary means in a way no other country can.

Source: Gloomy Earnings Prospects Hold Key To Stock Buying

And Wells Fargo & Co. (WFC) completed its $12.7 billion purchase of Wachovia Corp. (WB) – outbidding Citigroup Inc. (C) and making a massive bet that it accurately quantified the still existing risks in Wachovia’s huge portfolio of mortgage and real estate loans.

The deals are the latest examples of how billions of dollars in U.S. bank rescue funds are helping fuel buyouts worldwide, and not lending at home, as a Money Morning investigative report demonstrated.

By closing its buyout of Merrill Lynch, Bank of America reaches $2.7 trillion in assets, and bypasses both JPMorgan Chase & Co. Inc. (JPM) and Citigroup in size (as measured by assets). To finance the merger, BofA had expected to issue 1.71 billion common shares, equal to $24.1 billion, plus 359,100 preferred shares. Merrill Lynch shareholders received 0.8595 of a Bank of America common share for each of their Merrill common shares.

The transaction, originally valued at $50 billion, was announced in the early morning hours of Sept. 15, about an hour before Lehman Brothers Holdings Inc (LEHMQ.PK) went bankrupt. The deal ends more than 94 years of independence for Merrill, but very likely saved the investment bank from a fate similar to Lehman in a year in which five top Wall Street banks were bought, went bankrupt, or changed their business structures.

By acquiring Merrill, BofA’s Lewis is swallowing Merrill’s so-called “thundering herd” of 17,000 brokers, which he has labeled as the “crown jewel” of the buyout deal. The Charlotte, N.C.-based Bank of America also will absorb Merrill’s big investment bank, which by volume ranked fifth in debt and equity underwriting and third in merger advice in 2008, Thomson Reuters reported.

The combined company’s brokerage, credit card, investment banking, mortgage and wealth management operations, plus its deposit base, will make it the nation’s largest, or close to it.

Bank of America also takes over Merrill’s nearly 50% stake in the powerful money manager BlackRock Inc. (BLK).
“We are now uniquely positioned to win market share and expand our leadership position in markets around the world,” Lewis said in a statement on Thursday.

Big Challenges for the Big Bank

The Merrill Lynch transaction creates new challenges for Bank of America, whose shares fell 66% last year as the worsening economy led to soaring loan losses, including from Countrywide Financial Corp., which BofA bought in July. A big challenge: Lewis must find a way to stem defections of top performers and key executives even as he slashes at least 30,000 jobs in a cost-cutting initiative that should save the big bank $7 billion annually by 2012.

That won’t be enough, however. While Bank of America and Merrill together raised $25 billion of capital from the U.S. Treasury Department’s $700 billion Troubled Asset Relief Program (TARP), and BofA halved its dividend, analysts believe another dividend reduction is inevitable. And it may have to raise additional capital, too.

BofA has managed to navigate the banking mess – and has tried to capitalize on it.

Before buying Merrill, Lewis had spent close to $110 billion to buy FleetBoston Financial Corp, credit card issuer MBNA Corp., LaSalle Bank Corp., the wealth-management business of U.S. Trust, and Countrywide Financial.

Now Bank of America is generally viewed as being “too big to fail.” For his efforts, American Banker, the banking industry trade journal, last month named Lewis “Banker of the Year” for the second straight year.

However, the competitive landscape Lewis faces going forward is changing radically – as is evidenced by Wells Fargo’s $12.7 billion buyout of Wachovia, a Charlotte-based rival of BofA.

John A. Thain, who became Merrill’s chief executive after losses in mortgage-related investments led to the October 2007 ouster of Stanley O’Neal, agreed to run the merged company’s global banking, securities and wealth management businesses. If he remains with the merged entity, Thain will be a prime candidate to eventually replace Lewis, who is 61 and became Bank of America’s CEO back in 2001.

Wachovia Closes Deal, Too

The Wells Fargo/Wachovia merger closed yesterday and more than doubles Wells Fargo’s size, making it the No. 4 U.S. bank as measured by assets. Wells Fargo now also has the nation’s largest retail brokerage operations, as well as its largest branch network, with more than 6,600 offices in 39 states and Washington, D.C.

The San Francisco-based Wells Fargo agreed on Oct. 3 to buy Wachovia, beating out a smaller bid by Citigroup, which was planning to only buy a portion of Wachovia. Citigroup’s bid included government backing, while Wells Fargo’s did not. Wells Fargo said Wachovia branches will keep their brand name – or they will at least for the “near future,” Reuters reported.

Regulators pushed Wachovia to find a buyer after it was pushed to near ruin by zooming losses from “option” adjustable-rate mortgages (ARMs) that it took on back in 2006 when it bought California lender Golden West Financial Corp.

In November, Wells Fargo announced that it expected it would have to write down $71.4 billion of Wachovia’s $482.4 billion loan portfolio, including $36 billion of option ARMs and $9.6 billion of commercial real estate.

According to Reuters, analysts have said Wells Fargo was cautious in its assessment of the risks Wachovia’s mortgage portfolio, but the U.S. economy and housing market have continued to deteriorate so quickly that those estimates might now be out of date.

“We’re not at the end” of the housing slump, Wells Fargo CEO John G. Stumpf said on Dec. 10 at a conference. “But we’re starting to see some early signs that maybe we’ve reached the bottom in housing or close to it.”

Wells Fargo is the nation’s No. 2 mortgage lender. It remained profitable by avoiding many of the risky loans that plagued Wachovia, caused the failures of Washington Mutual Inc. and IndyMac Bancorp Inc. and drove Countrywide Financial into the hands of BofA.

Wachovia shareholders received 0.1991 of a Wells Fargo share for each of their shares, valuing the bank at $5.87 per share. That’s down from $59.39 when the Golden West merger was announced in May 2006, a level never again reached. Wachovia shares closed Wednesday at $5.54, down 85.4% in 2008.

Shares of Wells Fargo closed Wednesday at $29.48, down just 2.4% for the year. The KBW Bank Index, which includes Wells Fargo, fell 50% last year, Reuters said.

Wells Fargo expects the merger to result in at least $5 billion of annual cost savings, and to boost earnings per share by 20% or more in 2011 and higher amounts thereafter.

Including Wachovia, Wells Fargo has about $1.4 trillion of assets.

Source: Bank of America, Wells Fargo End Year by Closing Major Buyout Deals

After such a wrenching plunge, many analysts believe the outlook for the “black gold” remains bleak – and in the short term it certainly is. In the long run, however, dwindling supplies, resurgent demand, and a lack of investment will cause crude oil to double, triple, or even quintuple in price over the next few years.

In fact, the Paris-based International Energy Agency (IEA) – energy advisor to 28 industrialized nations – says oil will rise to $100 a barrel by 2015, as a result of a major “supply crunch,” and will ultimately soar to $200 a barrel.

But before it does, prices are likely to sink even further, perhaps falling as low as $20 a barrel in the first quarter of the New Year.

Indeed, much of Wall Street expects oil prices to average about $50 a barrel in 2009. Some of the firms and their specific forecasts include:

• Deutsche Bank AG (DB, which says oil prices will average $47.50 for all of next year.
• Merrill Lynch & Co. Inc. (MER), which predicts that prices will average $50 even.
• Moody’s Investors Service (MCO) also says crude will average $50 a barrel in 2009, but says that average will increase to $55 a barrel for 2010.
• Goldman Sachs Group Inc. (GS) is slightly more bearish, predicting that prices will average $45 for all of next year – after falling as low as $30 in the 2009 first quarter. (It’s worth noting that Goldman – just five months ago – predicted oil prices would hit $200 a barrel in 2009).

But analysts also agree on something else: When the recessionary tide finally recedes, all of the factors that drove oil to its record high last summer will once again be exposed, and crude again will again soar to record highs.

“We may see prices drop lower – into the twenties, even – but there’s a better-than-average chance that they’ll be back over $70 a barrel by the end of next year,” says Money Morning Investment Director Keith Fitz-Gerald. “That’s where firms like Goldman and Merrill are getting all of these ‘middle-of-the road,’ $50-a-barrel estimates. And it’s why investors who buy in through the first quarter could enjoy compelling returns at the end of the year.”

In the meantime, however, low oil prices are crimping investment in new capacity, a reality that will lead to much higher prices down the road.

Just ask the IEA.

IEA: Rising Demand + Lack of Investment = ‘Supply Crunch’

According to widely respected energy advisor, global oil demand will slide 0.2%, or 200,000 barrels per day (bpd), this year, falling to an average of 85.8 million bpd. But the IEA also says that oil demand will advance by an annual average of 1.6% between 2006 and 2030.

The bottom line: Regardless of any short-term pullback, daily demand will rise from the current level of 86 million barrels to 106 million barrels in 2030. In other words, daily demand in 2030 will be 23%.

To meet that demand, the agency estimates that the world needs $26.3 trillion in supply-side investments over the next 21 years.

China, India and other developing countries, alone, will need investments of $360 billion a year through 2030, the agency said.

About 7 million bpd of additional capacity needs to be added to the market by 2015. And right now – because of marketplace changes – the financial incentives to make that happen just don’t exist.

Exploration costs have more than quadrupled since 2000, as oil producers have been forced to take on more complex projects, and the costs of both labor and materials have skyrocketed. At the same time, the steep drop in oil prices has put even more pressure on energy companies to curtail their investments rather than increase them.

Earlier this year, for instance, ConocoPhillips (COP) and Saudi Arabia Investment Co. (ARAMCO) were forced to postpone bidding on the construction of a 400,000 bpd export refinery at the Yanbu Industrial City.

“We see and hear about energy investments being delayed … this is a major worry and could lead to a supply crunch and much higher oil prices than we’ve seen before,” said Fatih Birol, the IEA’s chief economist.

The IEA predicts that, by 2015, a lack of investment and rising demand will create a “supply crunch” – that will once again send oil prices up into the triple digits.

“There remains a real risk that under-investment will cause an oil supply crunch in that time frame,” the IEA said in an executive summary of its “2008 World Energy Outlook.” “The gap between what is currently being built and what will be needed to keep pace with demand is set to widen sharply after 2010.”

The agency predicts that crude will average more than $100 a barrel from 2008 to 2015 and rise above $200 a barrel by 2030, as demand far outpaces supply.

“While the situation facing the world is critical, it is vital we keep our eye on the medium to long-term target of a sustainable energy future,” Nobuo Tanaka, the Paris-based agency’s executive director, told reporters in London. “While market imbalances will feed instability, the era of cheap oil is over.”

While it’s probably true that the “era of cheap oil” is in our rearview mirror, a new question has arisen: Just how high do oil prices go?

According to some analysts, the IEA’s target price of $200 a barrel is far too conservative.

$500 Oil?

The lack of exploration and development is certainly a problem. But a much bigger issue is the fact that output from the world’s existing oil fields has sharply declined.

“The future rate of decline in output from producing oilfields as they mature is the single most important determinant of the amount of new capacity that will need to be built globally to meet demand,” the IEA says.

And output from the world’s oilfields is declining faster than previously thought.

In its “2007 World Energy Outlook,” the IEA estimated that output from the world’s existing oilfields was declining by 3.7% a year. But in its latest report, published in November, the IEA revised that estimate to an annual decline of 6.7%. (The November report was based on the first major study of the world’s 800 largest oil fields.)

Unfortunately, the IEA is behind the curve.

For nearly a decade, Matthew R. Simmons has said that the world’s oil production was nearing – or already at – an “inflection point.” While his book “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy,” was scoffed at when it was originally published back in 2005, Simmons is now viewed as perhaps the preeminent expert on the so-called “peak oil” movement.

“Like most people who ignore conventional wisdom, he was scoffed at, ridiculed, and denied,” commodities guru Jim Rogers told Fortune magazine. “And now, of course, people are starting to say, ‘Oh, well, I thought of that.’”

Simmons, chairman of the Houston-based investment bank Simmons & Co. International, poured through hundreds of technical documents submitted by Saudi oil geologists to the Society of Petroleum Engineers over the past 50 years.

“I finished reading the last paper on a Sunday afternoon,” Simmons told Fortune, “and I sat back and thought, ‘Holy crap, this is unbelievable. I’ve just discovered the biggest energy illusion ever in the world. We’re in big trouble. I’m going to write a book.’ ”

Much of the alleged Saudi Arabia subterfuge has to do with a complete lack of transparency with respect to the Organization of Petroleum Exporting Countries. After OPEC decided to base its production quotas on reserve figures in the 1980s, several of the cartel’s producers suddenly raised their levels of  “proven reserves” by 40% or more.

Back in 1988, for instance, Saudi Arabia raised its proven-reserve figure from 170 billion barrels to about 260 billion barrels. That figure has remained more or less constant since then, despite the fact that billions of barrels of oil have been pumped out of the ground.

“Saudi Arabia has announced for 20 years in a row that they have 260 billion barrels of oil in reserve,” Rogers told Money Morning during an exclusive interview in Singapore recently.  “It’s astonishing.  The figure never goes up and it never goes down.  They have produced dozens of millions – billions – of dollars of oil in that period of time.

“Every oil country in the world has declining reserves except Saudi Arabia,” Rogers said. “And I know that every oil company has declining reserves.  So unless somebody discovers a lot of oil very quickly in very accessible areas, the surprise is going to be how high the price stays, and how high it goes.”

Simmons thinks oil prices could hit $300 a barrel – and could possibly even surge as high as $500 a barrel – during the next several years.

“Black Gold” Profit Plays

When it comes to investing, the oil sector poses some very clear risks, especially given the murky near-term outlook. However, there are a number of large-cap integrated oil companies that may offer some truly compelling values at current prices.

Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX) are currently trading at multi-year lows, making them exceptionally cheap in both relative and absolute terms. These companies also have strong balance sheets (Exxon is “AAA”- rated and has more cash on its balance sheet than debt), generate strong cash flows, and have traditionally increased their dividends on a regular basis.

Chevron was actually recommended as a “Buy” by Money Morning Contributing Editor Horacio Marquez in his “Buy, Sell or Hold” column earlier this year.

“Chevron is the kind of company that is capable of continuing to post large profits – propelling its share higher from current levels – even if oil-and-gas prices were to drop from current levels over the next three years,” Marquez said. “That’s because Chevron’s business is well cushioned, since refining, marketing and chemicals margins would expand dramatically if market ‘spot’ prices were to decline. Also, the company’s production is poised to expand strongly and Chevron uses some selective hedging that works very well in downside oil markets.”

Offshore drillers, particularly those capable of drilling in the deepest waters, also offer value at current levels. Petroleo Brasileiro (PBR), also known as Petrobras, is particularly appealing, as it recently discovered one of the largest offshore oil fields on earth off the coast of Rio de Janeiro. Known as Carioca, the field could hold 33 billion barrels of oil and gas, making the world’s largest discovery in at least 32 years.

Fitz-Gerald, the Money Morning investment director, suggests investors look at China National Offshore Oil Corporation, or CNOOC Ltd. (ADR: CEO). The Hong Kong-based company recently got approval for a $29 billion exploration project in the South China Sea. The company expects to produce 50 million tons of oil equivalent per year from that region during the next 10-20 years. That would equal the production of China’s biggest project, the Daqing Oil Field.

Petrobras and CNOOC are also attractive because, as foreign companies, they will also get a boost from any devaluation in the U.S. dollar.

All of these companies have been hit hard by the combination of commodity-price weakness and credit market turmoil. But these operators do not require peak-cycle commodity prices to generate stellar results and have little or no credit-market exposure.

For a more direct play on oil prices, you might also try an exchange-traded fund (ETF), such as the United States Oil Fund LP (USO), the iPath S&P GSCI Crude Oil Total Return Fund (OIL), or the United States Gasoline Fund LP  (UGA).

Source: Why Crude Oil Will Present Investors with a Golden Opportunity in 2009

Editor’s Note: This is the ninth installment of our “Outlook 2009” series, which looks at the global investing outlook for the New Year.

Regardless of any formal announcement of whether or not the United States drops into an actual recession, the ongoing credit crisis guarantees a contraction of the American economy by virtually every measure we know. That period of darkness will be marked by a dramatic slowdown in economic activity, as well as by rising unemployment, additional declines in U.S. stock prices, and constant volatility. It could last as long as 12-18 months.

But when the dawn does come, it will be one to remember. If U.S. President-elect Barack Obama gets it right – and I have every reason to believe that he will – then investors will be presented with the greatest investment opportunity of our generation. At that point, shares of American companies will be at such low levels that wholesale buying by individuals, mutual funds, pension funds, institutional money managers, and foreign-controlled sovereign wealth funds, will generate gains that will not only make us whole, they will make us rich once again.

A Market Mandela

Creating an analysis of the U.S. economy’s outlook for the New Year is akin to creating a mandala, a geometric work of art whose pattern, symbolically or metaphysically, represents a microcosm of the universe from the human perspective. In some Buddhist temples, mandalas are made of tiny colored beads, painstakingly created by several monks as a form of meditation. In celebration of the ever-changing nature of the universe, the mandala is then joyously shaken by its creators, until it is once again nothing more than chaos embodied in a box of colored beads.

Regardless of the big picture, analysis of a mandala – or the economy – always starts at the center and emanates outward. With the U.S. economy, that centerpiece is credit. The credit crisis has shaken the complex mandala that is our economy and transformed the United States economy into chaos. It’s complex because this economic-forecast mandala derived its form from thousands of individual pieces – in the case of the economy, from scores of data points, many of which are currently dark and foreboding.

The credit crisis we are experiencing results from the contraction – or worse, the cessation – of lending. Under normal circumstances, institutions and markets freely facilitate capital movement between lenders and borrowers. But that’s not happening, now.

Because of a lack of transparency into the balance sheets of borrowers holding such complex and illiquid securities as collateralized debt obligations, credit-default swaps, and non-performing loans, and because of increasing recessionary fears affecting businesses and households, lenders don’t want to increase their loan exposure. Banks are holding onto the cash and liquid securities they control, using them as a cushion against their own potential losses. The U.S. Treasury Department’s direct-to-bank capital injections do not alter these banking realities. In fact, as a Money Morning investigative story recently demonstrated, instead of using these taxpayer-provided infusions to increase their lending, these banks are using the money to finance takeover deals.

The Recipe for a Recession

Whether or not the United States is technically in a recession ultimately will be divined by the National Bureau of Economic Research (NBER). The business-cycle dating committee of this privately run, nonprofit economic research group is right now studying five factors in an attempt to determine if the United States has entered a recession and, if so, when that downturn started, MarketWatch.com reported. Those five factors are:

• Gross Domestic Product (GDP).
• Industrial production.
• Employment
• Income.
• Retail sales.

Regardless of any formal announcement by the NBER of whether we’re in a recession, the credit crisis guarantees a general contraction of economic activity, by every measure.

“Any doubt that we’re officially in a recession can be put aside,” Anthony Karydakis, former chief U.S. economist for JPMorgan Asset Management (JPM) – and now a professor at New York University’s Stern School of Business – recently wrote in Fortune magazine. “The rapid deterioration of labor markets points to a sharp decline in hours worked and output in the fourth quarter. This is likely to lead to a decline in personal consumption to the tune of 5.0% or so for that period. Since [consumer spending] makes up about 70% of the economy, the stage has already been set for real GDP to shrink at a more than 4.0% rate in the fourth quarter.”

Confirmation of that belief is evident by looking at each of the NBER’s five key indicators.

• Gross Domestic Product (GDP): The U.S. Commerce Department estimated that the U.S. economy, as measured by GDP, rose 0.9% in the first quarter. In the second quarter, GDP advanced an estimated 2.8%. For the third quarter, GDP declined an estimated 0.3%. My own econometric models suggest that GDP actually contracted at a 1.5% pace in the third quarter and will decline another 2.75% in the fourth quarter. For the year, that would mean the U.S. economy actually fell 0.55%. The U.S. economy last posted a full year’s negative GDP in 1991, when it declined 0.2%. Verdict: Recession.
• Industrial Production: This measure of output by the nation’s factories and mines dropped 2.8% in September, and a very steep 6.0% in the third quarter. Verdict: Recession.
• Employment: The U.S. Bureau of Labor Statistics announced Friday that October’s unemployment rate was 6.5%, a jump of 0.4%, which was double what most economists expected, and also its highest level in 14 years. The economy has now lost a total of 1.2 million jobs since the beginning of the year, with nearly half of those losses occurring in the last three months alone, pointing to an acceleration in the pace of erosion in labor markets. Karydakis, the Stern School professor, wrote in
  Fortune : “By way of comparison, during the 2001 recession and in the sluggish growth that followed in 2002-03, the unemployment rate reached a peak of only 6.3%, in June 2003. We’ve already exceeded that mark and, given that we are still in the early phase of the current recession, the unemployment rate should be expected to push toward the 7.5% range – and possibly higher – during the next three months to six months.”
  Verdict: Recession.
• Income: Personal income increased $24.5 billion, or 0.2%, and disposable personal income (DPI) increased $25.7 billion, or 0.2%, in September. Personal consumption expenditures (PCE) decreased $33.6 billion, or 0.3%. Excluding the rebate payments made to U.S. taxpayers under the Economic Stimulus Act of 2008, DPI increased $30.3 billion, or 0.3%, in September, and increased $44.0 billion, or 0.4%, in August. Verdict: Too close to call.
• Retail Sales: October retail sales are coming in well below already-diminished expectations, and some reports have been downright depressing – including The Neiman Marcus Group Inc. -26.8%; The Gap Inc. (GPS) -16%; The Nordstrom Group (JWN) -15.7%; J.C. Penny Co. Inc. (JCP) -13%; Kohl’s Corp. (KSS) -9%;  Ltd. Brands Inc. (LTD) -9%; Target Corp. Inc. (TGT) -4.8%; and Wal-Mart Stores Inc. (WMT) +2.4%. In a report last week, Moody’s Investors Service (MCO) projected that the retail sector’s woes will continue into 2009 as consumers cut back on buying apparel, footwear and accessories “in order to save money for essentials.” The credit rating firm said in a separate report that holiday spending “will prove even weaker than expected,” amid October’s financial-market swoon. Verdict: Recession.

If U.S. exports are taken out of the GDP calculations going back to January, it’s apparent that there has been very little domestic growth in the economy. And when revisions are finalized in the next few months, we’ll be looking back at the recession that we’re all but certain is upon us right now. Until the credit markets are freed up and borrowers are extended credit at reasonable rates, it’s unlikely that credit, the centerpiece of the economy, will be anything other than a major cog in the wheel.

There are some signs of a thaw, but not anytime soon. The U.S. Federal Reserve’s lowering of the Fed Funds target rate to 1.0%, and coordinated rate reductions by the Bank of England and the European Central Bank, as well as other major world-wide central banks, may start to ease the stranglehold gripping the worldwide credit markets. The London interbank offered rate (Libor), a critical interest rate against which trillions of dollars of mortgages, bank loans and derivatives are priced, dropped to 2.39% last week from a high of 4.82% on Oct. 10.

The prospect of President-elect Obama’s choosing a different means of attacking the credit crisis will be closely watched and, by itself, may create an air of confidence that perceptions will change. But changed perceptions will not be enough.

The truth about our economic outlook is that it is predicated on demonstrably better transparency. If U.S. banks follow the lead of their European counterparts, which have recently been freed from fair-value, mark-to-market accounting, and which may retroactively mark assets to “internal models” back to July, then balance-sheet clarity will continue to be cloaked in darkness. Lack of confidence in the banking system will persist, especially among the banks themselves. The first order of attack needs to be the creation of a fundamental leadership position that leads to an open, transparent and accountable measure of balance sheet assets and liabilities. As long as failing banks are being propped up, this cycle of credit contraction will persist.

The outlook for the economy is inextricably tied to the price of oil. The run-up of benchmark crude this summer to the record $145 a barrel level, and its subsequent fall to half that level, has wreaked havoc throughout the economy. Similarly, the run-up in commodity prices, and their subsequent fall, also has caused a lot of damage. Together, the dramatic rise and fall in the pricde of oil and other commodities is a harbinger of greater volatility in the future.

Follow the Money

Follow the money. Capital rapidly inflated the tech-stock bubble. When that bubble burst, capital flowed into and flooded the hard-asset world of real estate. When that bubble burst fast, speculative money dove into oil and commodities. When the U.S. and world economies looked weak, those bubbles burst. The looming threat of inflation this past summer instantly gave way after the drop of oil, gold, metals and agricultural commodities. And now, deflation is seen as the looming threat on the horizon.

Which threat should we worry about?

The answer is – both. The prospect for near-term deflation seems all too real. As raw material prices fall and finished good prices fall due to a lack of purchasing power resulting from lack of credit and world-wide recessionary fears, the U.S. consumer has fundamentally changed his or her collective psychology. Is U.S. consumerism, which is responsible for 70% of GDP, in full retreat? If it is, as all measures project, then it’s likely that government stimulus efforts will overshoot their intended mark.
Just look at what the United States has done already as it battles this financial crisis. It has:

• Handed out more than $150 billion in stimulus rebate checks.
• Floated a $700 billion financial bailout rescue plan – almost $160 billion of which has already been placed.
• Bailed out American International Group Inc. (AIG), to the tune of $125 billion.
• Covered JP Morgan Chase & Co.’s bet on taking over
  The Bear Stearns Cos. – to the tune of $29 billion.
• Looked to lend struggling automakers $25 billion.
• Agreed to guarantee depositors at all banks.
• Stepped in to buy commercial paper that no one else will buy.
• Guaranteed money-market-fund investors.
• And backstopped the Federal Deposit Insurance Corp. (FDIC), Fannie Mae (FNM) and Freddie Mac (FRE).

And now we’re getting wind of another stimulus package and more help for everyone.

If, in six months to a year, the credit markets are facilitating borrowers again, the massive buildup of U.S. debt will result in a falling dollar and higher interest rates.

That spells inflation.

A massive re-inflation of the economy portends another flood of speculative money into oil and commodities. The cycles are increasingly condensed, more volatile and will be increasingly more disruptive.

Welcome to the brave new world of global finance and speculation.

The Federal Reserve’s balance sheet has ballooned from $900 billion to more than $1.8 trillion. That’s 13% of GDP. The Treasury Department has telegraphed its intention to float $550 billion of debt in the fourth quarter and estimates it will have to float another $368 billion in the first quarter of 2009. Our national debt will then be close to 49% of GDP.

If there is an easing of credit in the economy, and borrowers come to market with the pent-up demand that has not been met for the past year, the competition for funds will raise interest rates. Higher interest rates will counter any stimulus effect from government programs.

Who will buy U.S. Treasury debt if the world is less apprehensive about credit quality? Lenders will once again seek higher returns, potentially forcing the Treasury Department to increase its rates. The potential of this event may sink the dollar if investors perceive that the U.S. economy is stagnant and the world is awash in dollars. The yield curve – the spread between the Treasury’s two-year and the 10-year paper – has been steepening. A steepening yield curve, where short-term borrowing costs are low and long-term rates considerably higher, is good for banks that borrow short and lend long.

But if the perception of risk diminishes, and the perception of future inflation increases, the yield curve will invert and the threat of rising rates will cause a sell-off in the short end of the curve and a rush into longer-dated maturities. Any increase in short-term interest rates would be painful for struggling banks. An inverted yield curve would be devastating, and inevitably would lead to more bank failures.

Home on the Range …

At the core of the U.S. economy sits a desperately ailing piece of the mandala – the U.S. housing market. The once bright prospect of home ownership, which historically formed a beautiful economic picture, right now doesn’t exist. For most Americans, the family home constituted the bulk of their wealth. Or at least it did. And this family financial portrait will get worse before it gets better, since the real estate collapse is far from over. Goldman Sachs Group Inc. (GS), for instance, projects another 15% drop in housing prices.

I think that’s conservative. Mortgage rates are actually rising as Fannie and Freddie have to pay higher interest on their short-term notes and bonds. Thirty-year fixed-rate mortgage paper averaged 6.47% last week, up from its 52-week low of 5.36%. The 15-year fixed paper was trading at 6.18%, up from its 52-week low of 4.91% (based on Bankrate.com (RATE) rate surveys). This trend is definitely not our friend. As housing prices continue to fall, and inventories stagnate and grow in many areas, homeowners are increasingly underwater and are increasingly entertaining foreclosure as a viable economic alternative to indentured servitude.
The Hope for Homeowners Plan, which looks to lower interest rates and reduce principal on mortgages, and which makes homeowners pay a share of the appreciation on their home to their lender when they sell it, was initiated in October and was expected to garner some 400,000 takers. As of last week, according to The Wall Street Journal, there had been only 42 takers. That’s not a misprint – 42 – I even checked with The Journal.

In the real estate realm, the proverbial “other shoe” hasn’t dropped yet, but certainly is dangling – and that’s commercial real estate. As homeowners writhe in agony and stop spending, retailers will go out of business, businesses of all stripes will suffer and commercial real estate will implode. The leverage left over from just the private equity foray into commercial real estate in the acquisitive 2006-2007 period is staggering. Refinancing will be impossible. Banks are stuck with hundreds of billions of dollars of leveraged loans that they took on as bridge and mezzanine financing from the private-equity shops alone, at the time believing they would  be able to securitize those loans and sell them off to investors.

There’s no chance of that, now.

One deal in particular illustrates this entire mess.  Private equity behemoth The Blackstone Group LP (BX) took Hilton Hotels Corp. private for $26 billion. Blackstone put up $6 billion of its own money as equity and borrowed the other $20 billion from Bear Stearns, Bank of America Corp. (BAC), Deutsche Bank AG (DB), Goldman Sachs, Morgan Stanley (MS), Merrill Lynch & Co. Inc. (MER) and Lehman Brothers Holdings Inc. (OTC: LEHMQ).

Based on a current analysis of the deal at the multiple of seven times projected cash flow that the market currently puts on Starwood Hotels & Resorts Worldwide Inc. (HOT) -  Hilton’s nearest rival – if Blackstone values its property comparably, it will have to mark its Hilton holdings down 50%, because it paid 13 times projected cash flow. That wipes out all of Blackstone’s equity in the deal. What’s more, the $4 billion portion of the loan that Bear Stearns took on, courtesy of JP Morgan Chase casting off Bear’s orphaned liabilities, now sits on the Fed’s balance sheet – and isn’t likely to go anywhere anytime soon.

Until the real estate cycle completes its implosion and begins to stabilize, there’s nothing that will fundamentally alter the outlook for the economy. This is Ground Zero. President-elect Obama must resist creating only a political solution to the overwhelming economic problem of declining house prices and declining real estate prices in general. Any attempt to put a band aid on this economic plague will only delay the day of reckoning. I regret deeply the conclusion that the lake must be drained before we can realistically climb out of it. But there just aren’t enough ferrymen to get us all to shore.

Always a Silver Lining – My Forecast

The outlook for the economy is not rosy – and that’s an understatement. But there is a silver lining. Even in the near term, the stock market will present innumerable wealth-creation opportunities.

• First, there are plenty of shorting opportunities out there now, and more will present themselves in the future.
• Second, in due course – in perhaps 12-18 months – we will be presented with the investment opportunity of our generation. If President-elect Obama gets it right, and I believe he’s got the potential to bring us all together and get the country through this (and if you’re reading this Mr. President-elect, I’d like to put in my vote for [New York Fed President] Timothy Geithner as next U.S. treasury secretary), American companies will be able to be purchased so cheaply that fortunes will be made. The recovery will not only make us whole, it will make our people and our nation rich again.

I have absolutely no doubt that the United States will lead the world back into balance. The sea change that has arrived is the result of the conservative experiment having lost its true moorings, pushing the economy into disaster. Not that a wholesale swinging of the pendulum to the other side would be good. In fact, it would be disastrous. We have the potential to end up with a new, fair, transparent and judiciously regulated environment where capital formation can again spread its wings and the U.S. economy can fly.

There are new hands reaching into the colorful box of beads that comprise the American landscape and economy. From any human perspective, the United States is more than a microcosm of the universe; it is the center of the world as we know it. It will take time to construct the new mandala. We all need to meditate on the process to ensure that the design we embrace will ultimately be inclusive, forward-looking and – like all great art – an inspiration to all who view it.

For the U.S. Economy in the New Year, the Pain Will Precede the Promise

Editor’s Note: This is the second installment of a new series that looks at the global investing outlook for 2009.

This from Money Morning:

Oil prices have fallen 70% since hitting a record $147.27 a barrel in July, which means in just five months, crude has given up all the price gains it made in the past four years.

After such a wrenching plunge, many analysts believe the outlook for the “black gold” remains bleak – and in the short term it certainly is. In the long run, however, dwindling supplies, resurgent demand, and a lack of investment will cause crude oil to double, triple, or even quintuple in price over the next few years.

In fact, the Paris-based International Energy Agency (IEA) – energy advisor to 28 industrialized nations – says oil will rise to $100 a barrel by 2015, as a result of a major “supply crunch,” and will ultimately soar to $200 a barrel.

But before it does, prices are likely to sink even further, perhaps falling as low as $20 a barrel in the first quarter of the New Year.

Indeed, much of Wall Street expects oil prices to average about $50 a barrel in 2009. Some of the firms and their specific forecasts include:

• Deutsche Bank AG (DB, which says oil prices will average $47.50 for all of next year.
• Merrill Lynch & Co. Inc. (MER), which predicts that prices will average $50 even.
• Moody’s Investors Service (MCO) also says crude will average $50 a barrel in 2009, but says that average will increase to $55 a barrel for 2010.
• Goldman Sachs Group Inc. (NYSE:GS) is slightly more bearish, predicting that prices will average $45 for all of next year – after falling as low as $30 in the 2009 first quarter. (It’s worth noting that Goldman – just five months ago – predicted oil prices would hit $200 a barrel in 2009).

But analysts also agree on something else: When the recessionary tide finally recedes, all of the factors that drove oil to its record high last summer will once again be exposed, and crude again will again soar to record highs.

“We may see prices drop lower – into the twenties, even – but there’s a better-than-average chance that they’ll be back over $70 a barrel by the end of next year,” says Money Morning Investment Director Keith Fitz-Gerald. “That’s where firms like Goldman and Merrill are getting all of these ‘middle-of-the road,’ $50-a-barrel estimates. And it’s why investors who buy in through the first quarter could enjoy compelling returns at the end of the year.”

In the meantime, however, low oil prices are crimping investment in new capacity, a reality that will lead to much higher prices down the road.

Just ask the IEA.

IEA: Rising Demand + Lack of Investment = ‘Supply Crunch’

According to widely respected energy advisor, global oil demand will slide 0.2%, or 200,000 barrels per day (bpd), this year, falling to an average of 85.8 million bpd. But the IEA also says that oil demand will advance by an annual average of 1.6% between 2006 and 2030.

The bottom line: Regardless of any short-term pullback, daily demand will rise from the current level of 86 million barrels to 106 million barrels in 2030. In other words, daily demand in 2030 will be 23%.

To meet that demand, the agency estimates that the world needs $26.3 trillion in supply-side investments over the next 21 years.

China, India and other developing countries, alone, will need investments of $360 billion a year through 2030, the agency said.

About 7 million bpd of additional capacity needs to be added to the market by 2015. And right now – because of marketplace changes – the financial incentives to make that happen just don’t exist.

Exploration costs have more than quadrupled since 2000, as oil producers have been forced to take on more complex projects, and the costs of both labor and materials have skyrocketed. At the same time, the steep drop in oil prices has put even more pressure on energy companies to curtail their investments rather than increase them.

Earlier this year, for instance, ConocoPhillips (NYSE:COP) and Saudi Arabia Investment Co. (ARAMCO) were forced to postpone bidding on the construction of a 400,000 bpd export refinery at the Yanbu Industrial City.

“We see and hear about energy investments being delayed … this is a major worry and could lead to a supply crunch and much higher oil prices than we’ve seen before,” said Fatih Birol, the IEA’s chief economist.

The IEA predicts that, by 2015, a lack of investment and rising demand will create a “supply crunch” – that will once again send oil prices up into the triple digits.

“There remains a real risk that under-investment will cause an oil supply crunch in that time frame,” the IEA said in an executive summary of its “2008 World Energy Outlook.” “The gap between what is currently being built and what will be needed to keep pace with demand is set to widen sharply after 2010.”

The agency predicts that crude will average more than $100 a barrel from 2008 to 2015 and rise above $200 a barrel by 2030, as demand far outpaces supply.

“While the situation facing the world is critical, it is vital we keep our eye on the medium to long-term target of a sustainable energy future,” Nobuo Tanaka, the Paris-based agency’s executive director, told reporters in London. “While market imbalances will feed instability, the era of cheap oil is over.”

While it’s probably true that the “era of cheap oil” is in our rearview mirror, a new question has arisen: Just how high do oil prices go?

According to some analysts, the IEA’s target price of $200 a barrel is far too conservative.

$500 Oil?

The lack of exploration and development is certainly a problem. But a much bigger issue is the fact that output from the world’s existing oil fields has sharply declined.

“The future rate of decline in output from producing oilfields as they mature is the single most important determinant of the amount of new capacity that will need to be built globally to meet demand,” the IEA says.

And output from the world’s oilfields is declining faster than previously thought.

In its “2007 World Energy Outlook,” the IEA estimated that output from the world’s existing oilfields was declining by 3.7% a year. But in its latest report, published in November, the IEA revised that estimate to an annual decline of 6.7%. (The November report was based on the first major study of the world’s 800 largest oil fields.)

Unfortunately, the IEA is behind the curve.

For nearly a decade, Matthew R. Simmons has said that the world’s oil production was nearing – or already at – an “inflection point.” While his book “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy,” was scoffed at when it was originally published back in 2005, Simmons is now viewed as perhaps the preeminent expert on the so-called “peak oil” movement.

“Like most people who ignore conventional wisdom, he was scoffed at, ridiculed, and denied,” commodities guru Jim Rogers told Fortune magazine. “And now, of course, people are starting to say, ‘Oh, well, I thought of that.’”

Simmons, chairman of the Houston-based investment bank Simmons & Co. International, poured through hundreds of technical documents submitted by Saudi oil geologists to the Society of Petroleum Engineers over the past 50 years.

“I finished reading the last paper on a Sunday afternoon,” Simmons told Fortune, “and I sat back and thought, ‘Holy crap, this is unbelievable. I’ve just discovered the biggest energy illusion ever in the world. We’re in big trouble. I’m going to write a book.’ ”

Much of the alleged Saudi Arabia subterfuge has to do with a complete lack of transparency with respect to the Organization of Petroleum Exporting Countries. After OPEC decided to base its production quotas on reserve figures in the 1980s, several of the cartel’s producers suddenly raised their levels of  “proven reserves” by 40% or more.

Back in 1988, for instance, Saudi Arabia raised its proven-reserve figure from 170 billion barrels to about 260 billion barrels. That figure has remained more or less constant since then, despite the fact that billions of barrels of oil have been pumped out of the ground.

“Saudi Arabia has announced for 20 years in a row that they have 260 billion barrels of oil in reserve,” Rogers told Money Morning during an exclusive interview in Singapore recently.  “It’s astonishing.  The figure never goes up and it never goes down.  They have produced dozens of millions – billions – of dollars of oil in that period of time.

“Every oil country in the world has declining reserves except Saudi Arabia,” Rogers said. “And I know that every oil company has declining reserves.  So unless somebody discovers a lot of oil very quickly in very accessible areas, the surprise is going to be how high the price stays, and how high it goes.”

Simmons thinks oil prices could hit $300 a barrel – and could possibly even surge as high as $500 a barrel – during the next several years.

“Black Gold” Profit Plays

When it comes to investing, the oil sector poses some very clear risks, especially given the murky near-term outlook. However, there are a number of large-cap integrated oil companies that may offer some truly compelling values at current prices.

Exxon Mobil Corp. (NYSE:XOM) and Chevron Corp. (NYSE:CVX) are currently trading at multi-year lows, making them exceptionally cheap in both relative and absolute terms. These companies also have strong balance sheets (Exxon is “AAA”- rated and has more cash on its balance sheet than debt), generate strong cash flows, and have traditionally increased their dividends on a regular basis.

Chevron was actually recommended as a “Buy” by Money Morning Contributing Editor Horacio Marquez in his “Buy, Sell or Hold” column earlier this year.

“Chevron is the kind of company that is capable of continuing to post large profits – propelling its share higher from current levels – even if oil-and-gas prices were to drop from current levels over the next three years,” Marquez said. “That’s because Chevron’s business is well cushioned, since refining, marketing and chemicals margins would expand dramatically if market ‘spot’ prices were to decline. Also, the company’s production is poised to expand strongly and Chevron uses some selective hedging that works very well in downside oil markets.”

Offshore drillers, particularly those capable of drilling in the deepest waters, also offer value at current levels. Petroleo Brasileiro (ADR:PBR), also known as Petrobras, is particularly appealing, as it recently discovered one of the largest offshore oil fields on earth off the coast of Rio de Janeiro. Known as Carioca, the field could hold 33 billion barrels of oil and gas, making the world’s largest discovery in at least 32 years.

Fitz-Gerald, the Money Morning investment director, suggests investors look at China National Offshore Oil Corporation, or CNOOC Ltd. (ADR:CEO). The Hong Kong-based company recently got approval for a $29 billion exploration project in the South China Sea. The company expects to produce 50 million tons of oil equivalent per year from that region during the next 10-20 years. That would equal the production of China’s biggest project, the Daqing Oil Field.

Petrobras and CNOOC are also attractive because, as foreign companies, they will also get a boost from any devaluation in the U.S. dollar.

All of these companies have been hit hard by the combination of commodity-price weakness and credit market turmoil. But these operators do not require peak-cycle commodity prices to generate stellar results and have little or no credit-market exposure.

For a more direct play on oil prices, you might also try an exchange-traded fund (ETF), such as the United States Oil Fund LP (NYSE:USO), the iPath S&P GSCI Crude Oil Total Return Fund (NYSE:OIL), or the United States Gasoline Fund LP (NYSE:UGA).

Source: Why Crude Oil Will Present Investors With A Golden Opportunity In 2009