What was wrong with the Paulson plan ... companies starved of credit, Fed governors see lost of stimulus ... grains should be higher ... S&P value tra

The S&P closed down 4% last night now and now trades close to where it did when the bail out plan was first rejected by the House of Reps ... deflation is the new inflation. Orders data yesterday was weak, as was the weekly employment data and commodity prices took a bath across the board. They are currently heading for their biggest weekly decline in 50 years. Dollar is stronger while Asian equity markets are softer by a couple of percent overnight, although one market notable for its relative strenth this week is Shanghai, which is up by nearly 3% ...  

The House of Reps are due to vote on TARP again today. It looks as though the plan will be passed this time too, after lengthy and tiring discussions seem to have got to the bottom of what was wrong with the first proposal. Some of the new provisions include the "extension and modification of duty suspension on wool products; wool research fund; wool duty refunds", a "7 year cost recovery period for motor sports racing track facility" and "exemption from excise tax for certain wooden arrows designed for use by children." 

So while the bill in its ealier form was a bail out of Wall St, socialism for the rich and an immoral bequest to the country's grandchildren, its now good for America. And there was me thinking the US wouldn't ever be in a position to pass the bank recapitalisation bill it will ultimately require because it was ideologically constrained ... actually its all about wool and wooden arrows. Why didn't anyone tell Paulson and Bernanke? Whoever drafts the next bail out bill should take note and save us all a lot of trouble ... to think that these people are in charge ... of course, the bill hasn't been passed yet ... I dread to think what will happen if it isn't. 

Asian interbank markets are siezing up too now. Bloomberg reports this morning that Hong Kong's interbank rate jumped 41bps to 3.81 even though the HKMA has since Monday been accepting more securities as collateral in its repo transactions. Last week there was a run on Bank of East Asia, this week Hang Seng Bank said it had "exposure" to debt issued by WaMu .... the Fed data meanwhile showed that the CP market had collapsed, the bond market is effectively closed and financial institutions are now using the Fed for nearly all their liquidity needs. Yesterday they borrowed $348.2bn. Needless to say, non financial institutions just have to do without. Caterpillar and GE are struggling to sell commercial paper at economically viable rates, while the state of Massachusetts pulled a sale ... likewise for Fortescue metals yesterday put a mine expansion on hold because it wouldn't be able to raise the funds. 

Not to worry though. St Louis Fed president Bulllard and Kansas City Fed counterpart Hoenig both said yesterday that "there was very strong stimulus in the economy" and that lowering interest rates would be the wrong response because of an "inflation problem" ... to think that these people are in charge ...

The effect of the recession on the commodity markets is intuitively what you'd expect with the commodity shares currently taking the brunt of the pessimism. But there are some anomolies beginning to develop. Yesterday, for example, gold fell by nearly 5% even though there appears to be a widespread shortage of bullion at the retail level. Agricultural commodities too were down by around 5% yesterday. But will a recession cause people to stop eating? I know there's a biofuel link via sugar and corn but does this justify a near 50% correction? 

Yesterday Mosaic fell by an eyewatering 42% (!!) on an earnings miss and a cut in posphate production, the company cited growing posphate inventories and weaker pricing. Monsanto actually raised its guidance but noone seems to have noticed, and all agricultural stocks in all markets fell heavily. Annecdotally, farmers are scaling back on fertilisers because they can't get the credit for the upfront payments required to purchase. Arable land remains uncultivated for the same reason - banks can't lend the necessary upfront capital. All of these factors suggest farmers are spending less on bringing new supply to the market and while that should explain why agricultural companies might struggle, the same logic should also argue for higher grain prices ... 

There is clear value emerging in large parts of the market as evidenced by Buffet's large and high profile recent investments (although the sage is still manageing to buy at levels of cheapness ordinary people won't be able to buy at). Meanwhile, credit spreads are trading at a 12.2% spread over treasuries, the widest since Merrills started calculating the index and the VIX is trading at levels last seen in the aftermath of 9/11. 

It S&P actually trades on 20x the last 12m earnings which sounds rather rich given the sickness of the credit-desert economy we face. Yet high multiples are normal in recessions. In December 2001, for example, the 12 trailing PE ratio rose to 60x as eaernings collapsed according to Bloomberg so there is plenty of scope to go higher.  Nevertheless, for the losers amongst us, forced into playing the timing game, it is worth bearing in mind that as the US economy entered into recession in 2001, the S&P's PE ratio rose to the high 20s just as it is doing now. Then, the S&P was at around 1300. A year and half later it was trading below 800. 

Why anyone follows the collective wisdom of a group of analysts with no investment experience and little apparent understanding of basic financial analysis I'll never know. As if another example of mass incompetence was needed, the consensus earnings estimate for the S&P500 has earnings rising from the current $52.6 in 2008 to $84 in 2009 - a 60% increase, which would be a fair old performance given the credit desert we now live in.  Who was it that said about analysts that in a bull market you don't need them, in a bear market you don't want them? ... to think that these people are in charge  ...  hang on, they're not - hooray!