No Room for Careful Optimism. Not yet Anyway

We’ve seen some interesting developments this week. Some might be considered reasons for careful optimism regarding the chances of a full blown recession hitting the US. However, several less noticed news were also published which we should consider before reaching a conclusion.

#1 Warren Buffet offers to reinsure municipal bonds

The oracle from Omaha, Mr. Warren Buffet, offered to reinsure $800B in municipal bonds to help the deteriorating bond insurance market. Naturally, If Mr. Buffet sees a business opportunity in insuring municipal bonds then it is likely that Buffet considers municipal bonds to be ‘good credit’ caught in a bad market situation.

The insurance companies, Ambac, MBIA and FGIC, were definitely not too eager to accept the offer. One apparently turned it down already. In doing so these companies gave us good reason to believe the situation might be better than we think. Buffer did not offer to reinsure CDO’s however which indicates more trouble may be brewing.

#2 January retail sales up 0.3% vs. 0.3% drop expected

Surprising news of a small surge in retail sales made up mostly of gas station sales and car sales sent the markets soaring after a continued slump. As always, when expectations are not met a response is usually triggered.

#3 Trade deficit falls after 5 records years

The USA’s trade deficit for 2007 was published today and dropped 6.2% to $711.6 billion. The trade deficit with China continued to rise, this time by 10.2%, to $256.3 billion. The decline in the dollar certainly helped reduce the trade deficit. The reduction in the trade deficit is attributed to increased levels of American export to emerging markets and a reduction in consumption of imported goods and cars, especially Chinese.

The reduction in trade deficit is considered a good macro-economic indicator, especially when it is attributed to higher levels of export and lowered import.

#4 UBS revealed new US loans exposure. Slump in credit markets causes write-offs in technology, health and mining

It seems we have yet to hear the whole story when it comes to exposure to bad credit in financial corporations and also, as is recently discovered, in other companies as well. UBS unveiled $26.6 billion in new exposure to risky US mortgages today. These loans were apparently called Alt-a and were of higher quality than subprime loans but the continued slump in housing has made them risky as well.

Furthermore, more sophisticated financial assets are being written-off and not by financial institutions alone. Apparently due to attractive interest rate levels companies invested in ARS or Auction Rate Securities which were hit as well by the subprime crisis. Bloomberg reports that “ImClone Systems, the biotechnology company controlled by Carl Icahn, wrote down the value of auction-rate securities it owns to $109 million from $149 million and reclassified the investment as long-term amid a slump in credit markets. Also Bristol-Myers's $275 million write-off on subprime investments, reported last week, showed the mortgage crisis is spreading from Wall Street to the drug, technology and mining industries, where companies are posting losses on assets once rated AAA”.

Apparently this is not over yet.

#5 Bernanke tells Congress economic outlook has deteriorated

Bernanke spoke in front of the Senate’s Banking Committee today. Apparently the economic outlook, as the Fed sees it, has deteriorated. Bernanke sent a reassuring comment to the stock market and said the central bank is ready to keep on lowering interest rates to encourage the economy. Lowering interest rates further increases the chances of stagflation and is a risky game with inflation on the rise. It is important to note Bernanke’s forecast for the economy is of a “period of sluggish growth”.

Unfortunately, it seems there still aren’t enough justifiable reasons to be optimistic about the chances of avoiding a full blown recession.