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Mid-Week Analysis

Argentina Bond Spreads
Chicago Purchasing Managers Index

The global bear market shows little indication of abating this week, with technology stocks again coming under selling pressure at home and abroad. So far this week, the NASDAQ100 and the Morgan Stanley High Tech indices have declined 7%, the Semiconductors 11%, the NASDAQ Telecommunications index 6%, and The Street.com Internet index 5%. Outside of technology, selling has been considerably less intense, with the blue chips volatile but relatively unchanged. During the past three sessions, the Dow has actually added 1%, while the S&P500 and the Transports are unchanged. The Morgan Stanley Cyclical index has gained 2%, and the Morgan Stanley Consumer index and the Utilities have added 1%. The Biotech index has jumped 3%. The broader market is relatively unchanged, with the S&P400 Mid-Cap index with a slight decline and the small cap Russell 2000 declining less than 1%. Financial stocks are mixed, with the Security Broker/Dealer index down 2% and the S&P Bank index up 2%. As global financial instability mounts, investors have pushed the HUI gold index 6% higher.

Faltering stocks and expectations of more Fed rate cuts are fueling a significant rally in the U.S. credit market. Two-year Treasury yields have declined 14 basis points to 4.39%. The yield curve is flattening, with 5-year yields declining 18 basis points and 10-year yields sinking 20 basis points. The long-bond has seen its yields decline 16 basis points. Mortgage and agency yields have experienced even more dramatic declines, with the yield on the benchmark Fannie Mae mortgage-back dropping 22 basis points to 6.57%. The implied yield on agency securities has dropped 23 basis points so far this week. The dollar is largely unchanged, as gold has jumped about $5.

Emerging markets remains unsettled, as the unfolding financial and economic crisis in Turkey takes hold. This week Turkish bank regulators had to step in as a medium-sized institution failed. This is the 12th bank taken over the past two years, and it is now clear that scores of additional institutions will fail. There is now talk of a significant IMF loan to fight off default and potential financial collapse, but such efforts are doing little to comfort international investors and speculators in the emerging markets. Argentina, with its fixed currency board regime, is under close scrutiny. The Argentina Merval index has dropped 5% this week (almost 20% since its high on January 23rd) and the country’s bonds remain under heavy selling pressure. With the economy faltering and its industry losing its ability to compete due to its fixed-currency regime, many are now calling for devaluation. Trading in currency forwards this week is indicative of heightened nervousness of a break in the Argentine currency. Jose Luis Machinea, Argentina’s economic minister was quoted as saying “devaluation wouldn’t help growth. Quite the opposite, it would be a disaster.” The Brazilian real is under pressure as well, closing today near a 23-month low.

As if things weren't grim enough in the international marketplace, Britain's economy, particularly its badly afflicted agricultural sector, has received another massive body blow with the discovery of an increasing number of foot and mouth disease cases of livestock rising across the country. In addition to the chilling pictures of thousands of animal carcasses being burned at sites across the country, the government has already been forced to cough up some $250 million in compensation for Britain's farmers. This for an industry, which is already experiencing depression-like conditions — the worst, in fact since the Great Depression itself. For students of economic history, it is worth remembering that the dire symptoms of the last century's great depression began to manifest themselves as early as the mid-1920s in America's agricultural belt. A similar phenomenon seems to be repeating itself today in Britain, with farmers' incomes already obliterated by the onset of mad cow disease in the early 1990s, now being destroyed further by the ravages of this new epidemic. The government extended the ban on the movement of all livestock within the country until March 16 and introduced fines to stop people using footpaths and bridleways in rural areas that had been closed because of the virus, which affects cows, pigs, sheep and goats.

A worldwide ban on British livestock and animal products remained in force. And there is talk of food rationing as domestic stocks of meat dwindle in the supermarket, threatening the onset of panic buying in a manner similar to that witnessed during the fuel blockades last year.

Here at home, Bear Stearns’ chief economist Wayne Angel has been the head cheerleader calling for additional rate cuts into today’s Federal Reserve Board’s semiannual monetary policy report to the Congress before the Committee on Financial Services, U.S. House of Representatives. The expectations were for a particularly gloomy Greenspan. The market’s focus was Greenspan’s unusual decision to adjust his testimony during the two weeks between his presentation to the Senate and today’s to the House. It was a big fuss about very little, with Greenspan stating “the exceptional degree of slowing so evident toward the end of last year seemed less evident in January and February.” There was little indication that the Fed was poised for an intra-meeting move, and a vulnerable stock market was sold in apparent disappointment.

Economic data continue to be quite mixed, certainly offering evidence to both those arguing that the economy is slowing sharply and for those stressing the resiliency of the consumer and the service sector generally. This week’s new home sales data was weaker than expected, although previous data from late last year was revised sharply higher. Sales in December originally reported at an annualized rate of 975,000 units were revised to 1.034 million. For the entire year, year-2000 sales came in at a record-tying (1999) 906,000 rate. This morning the Mortgage Bankers Association’s weekly index of mortgage applications declined slightly. Interestingly, however, the purchase application index increased almost 7% and remains about 5% above year ago numbers. The mortgage refinancing boom continues, with applications to refinance running at levels about 5 times last year.

In a speech yesterday, Federal Reserve vice chairman Roger Ferguson, Jr. underscored the unusual fact that while consumer confidence has plummeted (to the lowest level since 1996), spending remains strong. This week, the Bank of Tokyo-Mitsubishi weekly retail sales report showed same-store sales running 3.5% above very strong year ago numbers, consistent with where sales have been for the first two months of the year. Interestingly, it appears that February was another stronger than expected month for automobile sales. Analysts are now expecting February unit sales to come in at a rate of 16.8 million units, which would put the first two months of 2001 on track for the third strongest pace on record. Sales will not compare to last February, but sales during that month were the second strongest ever.

And while the consumer continues to spend mightily, it nonetheless is insufficient to ward off the unfolding downturn in manufacturing and the extraordinary collapse in technology. Yesterday, it was reported that durable goods orders dropped a much greater than expected 6%, compared to expectations of a 2.5% decline. This number was certainly not as weak as the surface number indicates. Orders for the key “non-defense capital goods, ex-aircraft” category actually increased 6.5% after declining more than 2% during December. Transportation orders dropped 22% from exceptionally strong orders at the end of 2000. Electronic orders declined 6.2%. This morning the Department of Commerce reported that GDP growth slowed during the fourth quarter to 1.1%, the slowest expansion since 1995. Consumer spending increased 2.8%, the weakest performance since early 1997.

We continue to believe some of the most interesting data is in the pricing area. Today the (NAPM) Chicago Purchasing Managers index jumped three points to 43.2, led by a two-point gain in the “prices paid index” to 64.9. It should be quite disconcerting that pricing remains so “sticky” in the face of manufacturing weakness. Monday’s Wall Street Journal ran a story that U.S. steel manufacturers now believe that the market has bottomed and that they will be successful in their current effort to push through the largest price increase in years.

On another subject, will subprime lending replace tobacco as the nation’s most reviled product? Lawyers looking for deep pockets, tragic stories and a whiff of racism may find the subprime lending industry as their next winning lottery ticket.

Problems, at least as described by community activists, include a lack of accessibility to lower mortgage rates and outright abuse. Qualified minorities, they argue, are often unable to obtain prime loans, a sort of redlining via mortgage rates. Subprime lenders are also accused of using boiler room tactics to lure borrowers into outrageous loan deals. For example, a Chicago mortgage broker persuaded a 72-year-old retiree that she could cut debt and repair her crumbling house with a refinancing deal. Instead, she pocketed no cash, found herself with a house payment $200 a month higher and an $80,000 balloon note due when she turns 86. For this arrangement the mortgage broker "earned" more than $9,000 in fees. Similarly, after succumbing to a series of refinancing solicitations, a Denver homeowner who bought a house 42 years ago for $11,000 now owes $117,000 on the same home. Other hardball tactics include "packing" unnecessary insurance products into home loans or last minute "bait and switch" tactics at closings.

Consumer groups are also making a case that there is more to the subprime problem than questionable tactics. A study by the Denver Post found that subprime home loans and home foreclosures occur mainly in minority neighborhoods. Blacks, for example, are more than three times as likely to borrow from subprime mortgage makers than whites. And according to the findings, differences in earning power can’t entirely account for the discrepancy. In fact, the Denver study showed that in 1999 a black family earning more than $70,000 annually was more likely to get a subprime rate than a white family making less than $30,000. On a loan amount of $150,000, the difference between prime and subprime rates can bump a house payment $300 a month.

You can bet the subprime industry will gain more attention as the slowing economy triggers more bankruptcies. Foreclosures in the Chicago area alone have exploded from 131 in 1993 to 4,958 in 1999. The 3,226 foreclosures in Philadelphia last year were almost double the 1997 figure. And these are the good times. The bad times will bring more foreclosures, and likely, more lawyers.

After all, it’s not as if subprime lenders are fly-by-night operations. Prior to its acquisition by Citigroup, Associates First Capital was spending $19 million to fight more than 700 lawsuits. Community activists called Associates First Capital the "worst predatory lender in America," according to the American Banker. The community leaders are not only miffed about Associates’ lending practices, but also frustrated that Citigroup stopped communicating with them soon after the FDIC okayed the merger. "Citigroup," of course, is lawyer-speak for "deep pockets." Other big banks that have acquired subprime lenders include Bank of America and J.P. Morgan Chase.

Policy makers are belatedly responding to consumers’ concerns. The Federal Reserve Board is said to be considering new rules to combat predatory lending (however defined), and at least 30 state legislatures are working to reign in the practice. As government at all levels looks further into this matter, you can bet that what they lacked in response time will surely be made up for in overkill.

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