May 15, 2010: Market Week In Review

The European Union, the European Central Bank, and the International Monetary Fund (and the Fed as well, although they don't want to truly highlight it) provide $960 billion in backstops for the Euro-zone and what happens? The Euro ends the week lower by 3%!! Ladies and gentlemen, that is nothing more than a major "F&%@ Y*&" on behalf of global investors to the aforementioned central banks and government entities.

Think there is tension in Euroland? As The UK-based Telegraph reports, President Nicolas Sarkozy 'Threatened to Pull France Out of Euro',

President Nicolas Sarkozy slammed his fist on the table and threatened to pull France out of the euro at a meeting of European leaders deciding Greece's aid package last Friday, according to Spain's El Pais newspaper.

The last time there was this kind of tension between these countries, guess who was coming ashore at Normandy?

Then the Marshall Plan. Why does President Obama want to take our nation down the path of a Euro-socialist system? If anything Barack might want to ask the Germans what a period of hyper-inflation does for the national psyche. In any event, do not discount the possibility that we end up providing a backdoor bailout to the EU via the swap lines provided by the Fed to the European Central Bank.

Debt cripples. Massive debts are fatal.

On that note, welcome to the Sense on Cents Week in Review where I provide a streamlined recap of month-to-date market returns. Given recent volatility, I am also providing year to date returns as well. I hope these benchmarks help you 'navigate the economic landscape.'

The stats provided are the week's close (May 14th) vs. April close, month to date returns, December 31st close, and year to date returns:

U.S. DOLLAR
$/Yen: 92.35 vs. 93.81, -1.6%, 93.00 -.7%
Euro/Dollar: 1.2361 vs. 1.3295, -7.0%, 1.4323, -13.7%
U.S. Dollar Index: 86.27 vs. 81.89, +5.3%, 77.86, +10.8%

Commentary: the Euro gapped higher Monday morning after the weekend backstop as highlighted above. After that, the Euro grabbed its tail, bent over , and proceeded to get crushed. The U.S. Dollar Index benefited in a flight to safety, but gold was also a winner as fiat currencies are looking suspect. Our dollar may be winning now but when does the dollar's worth come into question? What then?

COMMODITIES
Oil: $71.85/barrel vs. $86.22, -16.7% !!!!!!!!, 79.62, -9.8%
Gold: $1230.5/oz. vs. $1180.3, +4.2%, 1097.8, +12.1% !!!!!
DJ-UBS (UBS: 14.17 -0.45 -3.08%) Commodity Index: 127.84 vs. 134.70, -5.1%, 139.19, -8.2% !!

Commentary: with the strength in the dollar, commodities in general but oil specifically have given real ground. Gold has been the real beneficiary of recent turmoil within the EU. Will the issues embedded in the EU lead to a double dip recession? Who's to say the real economy has truly had anything more than a mild bottoming process. The DJ-UBS (UBS: 14.17 -0.45 -3.08%) Commodity Index is now down 8.2% on the year!!

EQUITIES
DJIA: 10,620 vs. 11,008 -3.5%, 10,428, +1.8%
Nasdaq: 2347 vs. 2461, -4.6%, 2269, +3.4%
S&P 500: 1136 vs. 1186, -4.2%, 1115, +1.9%
MSCI Emerging Mkt Index: 975 vs. 1020, -4.4%, 989, -1.4%
DJ Global ex U.S.: 188 vs. 202, -7.0%, 201, -6.5%

Commentary: equities ended the week higher with domestic equities returning to positive territory for the year. Economic data reported would seem to indicate our economy is stabilizing but without meaningful improvement in jobs and housing (and it's not getting better anytime soon), the balance of the data is mostly noise. Brace yourself for continued volatility in the markets.

BONDS/INTEREST RATES

2yr Treasury: .79% vs. .96%, -17 basis points or +.17%, 1.14%, -35 bps
10yr Treasury: 3.46% vs. 3.66%, -20 basis points or -.20%, 3.84%, -38bps
COY (High Yield): 6.59 vs. 6.87 -4.1%, 6.89, -4.4%
FMY (Mortgage): 18.36 vs. 18.54, -1.0%, 18.24, +.6%
ITE (Government): 58.29 vs. 57.84, +.8%, 57.07, +2.1%
NXR (Municipal): 14.24 vs. 14.24, -0.0%, 14.64, -2.7%

Commentary: the front end of the Treasury curve benefited as the turmoil in the EU virtually guarantees that the Fed is not tightening anytime soon. The rebound in the equity markets supported a rebound in the credit sectors of the bond market.

SUMMARY/CONCLUSION
The roller coaster continues in terms of the global economy. Problems in the private sector in 2008 were abated with massive public stimulus in 2009 but now the public and sovereign risks are taking center stage. What has benefited? The dollar. Who called this? Jeff Gundlach formerly of TCW and Nouriel Roubini. These Sense on Cents All Stars (Gundlach is a former All Star) had this call last fall and I highlighted it in writing, Jeff Gundlach of TCW Calls for Deflation and Dollar Rally (September 10, 2009) and Nouriel Roubini Agrees with Jeff Gundlach (October 27, 2009).

In regard to my ongoing pursuit of truth, transparency, and integrity on our economic landscape, please join me this Sunday evening (8-9pm ET)  No Quarter Radio's Sense on Cents with Larry Doyle Open Mic. What is on your mind? What do you want to address? Are you steamed and you do not want to take it anymore? Well, you do not have to as all your questions, comments, frustrations and beefs are welcome here as I look to help you 'navigate the economic landscape.'

 

Have a great day and weekend.

 

JPMorgan Partners With Cuscal

 

Cuscal, an Australia-based business-to-business provider of wholesale banking and transactional banking services, has entered into a partnership with JPMorgan Chase & Co. (JPM 41.51 -0.44 -1.05%) to provide a new platform to facilitate international payment transfers to its customers. Cuscal took this action as part of its strategy to control spending.
 
With this new platform, customers of Cuscal (including the majority of Australia's credit unions) will be able to transfer international payments as a retail banking service with low transaction fees.
 
Both the parties worked together to develop a unique solution for the customers of Cuscal. The service became operational in April 2010 and is expected to clear 70,000 inbound payments in the first year of operation.
 
The transaction between JPMorgan and Cuscal under the partnership will be in Australian dollars. This will help Cuscal integrate the transaction with its existing general ledger and banking platforms. As a result, Cuscal will experience reduced development cost.
 
Our long-term recommendation for JPMorgan is Neutral.
 
Earnings Recap
 
JPMorgan's first quarter earnings came in at 74 cents per share, substantially ahead of the Zacks Consensus Estimate of 63 cents. This also compares favorably with earnings of 40 cents in the prior-year quarter.
 
Better-than-expected earnings of JPMorgan were primarily aided by higher revenues as a result of continued strong performance of the Investment Bank, chiefly in Fixed Income Markets. All the other segments except Consumer Lending and Card Services also delivered solid results during the quarter. However, high levels of consumer credit portfolio losses and increased non-interest expense were the primary factors, which negatively impacted the results.
 
Estimate Revision Trend
 
Following better-than-expected first quarter results, significant positive estimate revisions were observed for JPMorgan shares. Over the last 30 days, 15 of the 20 analysts covering JPMorgan have increased estimates for the second quarter of 2010, while only 1 downward revision was witnessed. For 2010, 16 of the 24 analysts covering the stock have increased their estimates, while no downward revision was observed.
 
Currently, the Zacks Consensus Estimate for the second quarter is earnings of 83 cents per share, which would be up by 195.7% from the year-ago quarter. Also, the full year estimate of $3.27 would be up by about 46.0% from 2009.
 
However, the higher number of upward estimate revisions for the second quarter and full year 2010 indicate a likelihood of upward pressure on the performance of the stock in the near term.
 
With respect to earnings surprises, the stock has been steady over the last four quarters, with all positive surprises. The average remained positive at 117.7%. This implies that JPMorgan has surpassed the Zacks Consensus Estimate by 117.7% over that period.
 
While we anticipate continued synergies from JPMorgan's diversification and strong capital position, increasing provisions and a pressured credit quality will drag down future earnings.

U.S. One Inc. Launches ONEF – An Actively-Managed ETF Of ETFs

 

U.S. One Inc, whose N1-A filing with the SEC to launch an Actively-Mananged ETF of ETFs we had previously discussed, today launched its first ETF product called One Fund (ONEF) which will be listed on the NYSE. The company had announced the finalization of ONEF through a press release on May 4th, and it also filed a "Notice of Effectiveness" with the SEC on the same date.

The launch of One Fund highlights the inherent flexibility of an actively-managed ETF structure. Today, Active ETFs house everything from municipal bond portfolios to long-short relative value strategies, plain vanilla equity growth funds to seasonal rotational strategies, money-market instruments and even absolute return funds. And with the launch of ONEF, there are now two actively-managed ETF of ETFs on the market. And waiting in the wings to launch are even more varied strategies such as international equity funds, ADR-focused funds and global macro strategies. The kind of diversity the Active ETF structure allows, combined with the benefits of ETFs in general – tax efficiency, liquidity, transparency, low cost – makes for a compelling argument for issuers and fund managers to consider.

This latest addition to the Active ETF line up, One Fund (ONEF), will have an investment objective of achieving long-term growth but its investment strategy will rely entirely on low cost Index ETFs that it will invest in. The fund aims to provide pure asset class exposure to an internationally diversified equity portfolio representing in excess of 5,000 companies worldwide in different sectors. Paul Hrabal, the Chief Investment Officer of the fund elaborated, "We have taken a top level view of how a global stock portfolio should be allocated by region and company size, then selected index-based ETFs that represent each of those segments at the lowest cost. The Fund will then hold that allocation long term. There is no intent to make short term, tactical changes to the allocation based on any view of how one country/region/industry/size company will perform vs. another." ONEF is hoping to take advantage of low cost index ETFs that track individual markets and provide the desired exposure cheaply. As a result, the fund's expense ratio is a relatively low 0.51%, in comparison to other funds providing exposure to multiple ETFs or structured as a fund-of-funds. The strategy emerges from Paul Hrabal's belief that high cost actively-managed mutual funds are not providing much value to investors and that "long-term, buy and hold, passive index-based investing" is the way to go.

Paul Hrabal is the President of U.S. One Inc. and also the Chief Investment Officer for the ETF. He has 20 years of experience in the financial management and business development and will be the person responsible for making day-to-day investment decisions for ONEF.

Paul also mentioned that ONEF will undergo rebalancing only once a year and will have tolerance bands set for each segment of the fund's allocation, which if breached, would trigger rebalancing. "We believe annual rebalancing with a 5% band is the best approach to 1) ensure adherence to our allocation targets while 2) keeping transaction costs and, hence, the overall fund costs, to a minimum", Paul said. The fund is expected to have a turnover of less than 10%.

Euphoria Over Greek Bailout Fades QuicklyIn The Markets

Yesterday's EU/IMF $1 trillion reaction sent risky assets into orbit. Spain's stock exchange rose 14.4%, Greece's 2 yr debt dropped below 5% and the EURUSD briefly traded up to 1.3089. But like the morning after a long night of partying, investors seem to be regretting yesterday's buying frenzy. The bailout package is being viewed today by the numbers and not emotions. As we suspected, investors are realizing the bailout is adequate to address the short-term problems of Greece & Co., but the long term implications remain unclear.

Economists are highlighting the fact that the cost of the bailout is not only financial - the austerity measures must hinder EU growth in the future and in essence will further saddle debt-burdened nations with you guessed it, even more debt. In addition, the ECB's policy reversal on intervening directly in bond markets, although initially a positive, will be highly Euro negative as it continues. Although the sterilization of the ECB purchases has been mentioned, the finer points of the process remain hidden from investors. As the ECB continues its fully-engaged quantitative easing, we suspect Gold will be heading higher.

Overall, we are still bearish on the EURUSD as the market will be unforgiving to any negative EU data, while comparably the US enjoys positive momentum. The final nail on a macro-level, is that there is little hope the Euro will enjoy any rate-differential advantages in the years to come. Just above Europe in the UK, the newfound willingness of the Liberal Dems to possibly back Labour has considerably increased political uncertainty. In the short term, this will be a sterling negative, but over a slightly-longer term we hold the UK as a better bet than the EU, thus shorting EURGBP looks attractive.

Over in Asia, we see that yesterday's risk appetite was further eroded by the release of some Chinese data. China's CPI y/y came out at 2.8% - higher than the expected 2.7% and well ahead of its previous 2.4%. Industrial production numbers were 17.8% y/y against an anticipated 18.5%. The trends in the data suggest Chinese inflation is on the rise while domestic production is slowing down. To steady China, policy makers will have to tighten monetary policy to avert any further drifting, which we forecast will occur in Q3/Q4.

Buy, Sell Or Hold BP Stock?

The Exxon Valdez dumped 260,000 barrels of oil off the coast of Alaska, and Exxon Mobil Corp. (XOM: 65.05 +1.35 +2.12%) ended up spending about $4 billion in the wake of that disaster. That means Exxon spent nearly 600 times more on cleanup and litigation than what the oil was actually worth at that time.

So how much will BP PLC's (BP: 49.42 +0.36 +0.73%) Gulf oil spill, which is significantly greater, set it back?

The fact is, it's still impossible to know exactly how much BP will have to cough up to cleanse itself of this crude fiasco without knowing the full extent of the damage caused. But the picture is getting a little bit clearer each day the cleanup effort wears on.

Ian MacDonald, a professor of oceanography at Florida State University, has calculated the amount of oil spilled in the Gulf by BP based on satellite imagery and established models of oil dispersion. He believes that the quantity is already greater than that dumped in Alaska by the Exxon Valdez, the Washington Post reported.

MacDonald estimated last week that 9 million gallons of oil were already in the water, compared with 10.8 million gallons total in the Valdez disaster.

MacDonald acknowledged that the real amount could be different but also said that any comparison to the Valdez spill is misguided because the coastal gulf is far more economically significant than the sparsely populated coast of Alaska.

The type of oil polluting the Gulf is lighter than the heavy crude spilled by the Exxon Valdez. It evaporates more quickly, is easier to burn, and responds better to the use of dispersants, which break up globs of oil and help them sink. But the sheer magnitude of the spill, and the fact that oil continues to gush from the fractured well, adds to the complexity of this cleanup effort.

The oil clean up effort alone is costing BP about $6 million a day, according to the company.

"Whilst difficult to accurately estimate, the cost to the MC252 owners of the efforts to contain the spill and secure the well is currently estimated to be more than $6 million per day," BP said on Tuesday, referring to the Mississippi Canyon block 252.

The latest plan to stifle the oil leak that's pumping about 5,000 barrels of crude into the Gulf of Mexico each day is to drop a 98-ton, 40-foot iron box down onto the broken well. BP also has launched a drilling operation to permanently seal the leaking well 13,000 feet below the ocean floor. Drilling on the relief well is estimated to take some three months.

Lawsuits & Litigation

BP has announced grants of $25 million for states affected by the spill - Louisiana, Alabama, Florida, and Mississippi - but state officials have made it clear they expect more.

"Well, I can tell you we're going to need a ton more," said Florida Governor Charlie Crist.

A lawsuit "is certainly in the realm of possibility," he said.

More than 50 oil spill lawsuits have been filed against BP, Transocean Ltd. (RIG: 65.772 -2.238 -3.29%), Cameron International Corp. (CAM: 35.74 +0.16 +0.45%) and Halliburton Co. (HAL: 27.47 -0.04 -0.15%). Transocean leased BP the collapsed rig, Cameron supplied the blowout prevention equipment on the well, and Haliburton provided cementing services.

Many more lawsuits are expected to pour in, but those involved hope to resolve such litigation quickly.

About 200 lawyers last week descended on a New Orleans hotel to devise a strategy to consolidate as much of the litigation as possible. They have asked a federal judicial panel in Washington to combine thousands of claims into a single multidistrict case, Daniel Becnel, the lawyer who called the meeting, told Bloomberg.

"We're not going to have a long march to trial,"said Becnel. "This could all be over in 90 days."

Most of the suits have been filed by commercial fishermen, shrimpers, property owners, seafood processors and tourism-related businesses. Analysts are unsure how much economic activity will be lost as a result of the disaster.

ExxonMobil was hit with a storm of litigation after its 1989 spill that cost the company $500 million in damages claims. That number was revised down through legal challenges from $5 billion.

Experts at the Harte Research Institute for Gulf of Mexico Studies in Corpus Christi estimated that as much as $1.6 billion of annual economic activity and services - including effects on tourism, fishing and even less tangible services like the storm protection provided by wetlands - could be at risk.

"And that's really only the tip of the iceberg," David Yoskowitz, who holds the endowed chair for socioeconomics at the institute, told the New York Times. "It's still early in the game, and there's a lot of potential downstream impacts, a lot of multiplier impacts."

At least 10 wildlife preserves in Louisiana and Mississippi - which nurture the region's $1.8 billion seafood industry - are at risk, as are billions of dollars in revenue from outdoor recreation, sport fishing, and beach tourism.

Fishing has been shut down in federal waters from the Mississippi River to the Florida Panhandle, leaving boats idle in the middle of the prime spring season. A special season to allow boats to gather shrimp before it got coated in oil closed last Tuesday.

Analysts estimate that the Louisiana fishing industry could sustain $2.5 billion in losses, while Florida could lose $3 billion in tourism income. The total cost to the region could be $8 billion-$12 billion, according to estimates.

Federal laws enacted after the Exxon spill require the "responsible party" to pay for all the costs associated with the cleanup. And while there is a $75 million cap on economic damages such as lost earnings and damage to local resources, U.S. lawmakers are seeking to raise that cap to $10 billion.

"[BP] says it'll pay for this mess. Baloney," said U.S. Sen. Bill Nelson, D-FL. "They're not going to want to pay anymore than what the law says they have to, which is why we can't let them off the hook"

U.S. Sen. Bill Nelson has filed a bill that would increase oil companies' liability to $10 billion and put them on the hook for lost business revenues.

BP chief executive Tony Hayward - who promised to pay "all legitimate claims" privately balked at committing to paying all claims for economic damage caused by the company's oil spill, said Nelson.

"When I said 'Will you be responsible for the economic damages?' he said, "That's something we'll have to work out in the future,'" Nelson said.

Buy, Sell or Hold?

BP stock plunged more than 15% to an intraday low of about $47 a share on May 3, from about $60 on April 20. However, the stock appears to have bottomed out, as it surged a little more than 4% about May 3 to its current value of $49.06.

That bump was largely the result of a call by some analysts that the company had been oversold by panicked shareholders. Bernstein analyst Neil McMahon wrote in a note to clients that BP's decline seemed "extreme" relative to the potential worst cost scenario of about $12.5 billion.

What's more, is that BP - with a price-to-earnings (P/E) ratio of 7.7 - is trading at a significant discount to other big oil firms. Chevron Corp. (CVX: 79.21 +2.11 +2.74%) is trading at 11.71 times earnings and Exxon has P/E ratio of 14.50. BP's dividend yield stands at relatively rich 6.86%, as well.

BP has lost roughly $30 billion in market value since April 20.

Still, investors beware: The full extent of the impact the oil spill will have on BP's other operations or its earnings are still largely undetermined. The same can be said for Transocean, whose stock has plunged about 22% since April 20.

Additionally, the prospects for offshore drilling as a whole have been put at risk.

"This will be a financial calamity for many firms, not just BP and its partners and service providers. Their liabilities are immense and must not be underestimated," said David Kotok, chairman and chief investment officer of Cumberland Advisors, which does not own BP shares.

Indeed, the energy sector as a whole has come under selling pressure as well, as traders fret over potential changes to U.S. offshore drilling policy. But that's not all. The price of crude oil has dropped precipitously in the wake of Europe's debt crisis, stumbling to $75.14 a barrel Friday from above $86 a barrel in early April.

If Europe sidesteps a full-fledged debt contagion, and the price of oil rebounds, there's a good chance the sector will bounce back. But it will still have to wrestle with the potential political fallout from a BP backlash.

President Obama lifted a ban on offshore drilling, opening up large portions of the East Coast and Gulf of Mexico to new development. But now the administration appears to be backing off.

"All he has said is that he's not going to continue the moratorium on drilling," White House senior advisor David Axelrod told ABC's "Good Morning America." No domestic drilling in new areas is going to go forward until there is an adequate review of what's happened here and of what is being proposed elsewhere."

That moratorium had been put in place after a disastrous oil spill off the coast of California sparked a public backlash against offshore drilling and drove lawmakers to action.

California Governor Arnold Schwarzenegger has already withdrawn his support for new offshore drilling in his state.

"You turn on the television and see this enormous disaster," said Schwarzenegger. "You say to yourself, 'Why would we want to take on that kind of risk?'"

Still, offshore drilling enjoys widespread support among many lawmakers.

"Depending on how bad the spill proves and how serious the public reaction is, we believe the most likely potential implications are" slower progress approving new leases and a smaller chance of lifting the moratorium on drilling in the eastern Gulf of Mexico, said Goldman Sachs Group Inc. (GS: 145.10 +2.11 +1.48%) in a research note.

 

68 Bank Failures So Far In 2010

Bank failures continue unabated as U.S. regulators on Friday closed down four more banks in Florida, Minnesota, Arizona and California, pushing up U.S. bank failures to 68 so far in 2010. This compares to a total number of bank failures of 140 in 2009, 25 in 2008 and only 3 in 2007.
 
Although the economy is showing signs of a gradual recovery with large financial institutions stabilizing, tumbling home prices, soaring loan defaults and a high unemployment rate continue to take their toll on small banks.

While we expect the economic recovery to gain momentum soon, there remain lingering concerns in the banking industry. Failure of both residential and commercial real estate loans as a result of the credit crisis has primarily hurt banks. As the industry tolerates bad loans made during the credit explosion, the trouble in the banking system goes even deeper, increasing the possibility of more bank failures.
 
The failed banks are:
 
Bonifay, Florida-based The Bank of Bonifay with total assets of $242.9 million and total deposits of $230.2 million.
 
Champlin, Minnesota-based Access Bank with $32.0 million in total assets and $32.0 million in total deposits.
 
Mesa, Arizona-based Towne Bank, a subsidiary of Towne Bancorp (TWNE: 0.00 N/A N/A), with $120.2 million in assets and $113.2 million in deposits.
 
San Diego, California-based 1st Pacific Bank with total assets of $335.8 million and deposits of $291.2 million.
 
These bank failures will deal another blow to the Federal Deposit Insurance Corporation's (FDIC) fund meant for protecting customer accounts, as it has been appointed receiver for these banks.
 
When a bank fails, FDIC reimburses customers for their deposits of up to $250,000 per account. The outbreak of bank failures has significantly stretched the regulator's deposit insurance fund.
 
However, the FDIC has about $66 billion in cash and securities available in reserve to cover losses arising from bank failures. Also, the FDIC has access to the Treasury Department's credit line of up to $500 billion.
 
The four failed banks together would cost the FDIC's Deposit Insurance Fund about $213.7 million.
 
The Bank of Bonifay is expected to cost the deposit insurance fund about $78.7 million, Access Bank will cost about $5.5 million, Towne Bank will cost about $41.8 million and 1st Pacific Bank will cost around $87.7 million.
 
Lake City Florida-based First Federal Bank will assume the assets and deposits of The Bank of Bonifay.
 
Prinsburg, Minnesota-based PrinsBank will buy the assets and deposits of Access Bank.
 
Tucson, Arizona-based Commerce Bank of Arizona agreed to buy all of the deposits and assets of Towne Bank.
 
Los Angeles, California based City National Bank, a subsidiary of City National (CYN: 59.6644 +1.9544 +3.39%), will assume all of the deposits and assets of 1st Pacific Bank.
 
In the fourth quarter of 2009, the number of banks on the FDIC's list of problem institutions grew to 702 from 552 in the third quarter. This is the highest since the savings and loan crisis in the early 1990's.

Increasing loan losses on commercial real estate are expected to cause hundreds more bank failures in the next few years. The FDIC anticipates bank failures to cost about $100 billion over the next three years.

The failure of Washington Mutual in 2008 was the largest in U.S. banking history. It was acquired by JPMorgan Chase (JPM: 42.045 +1.285 +3.15%). The other major acquirers of failed institutions since 2008 include Fifth Third Bancorp (FITB: 14.15 +0.84 +6.31%), U.S. Bancorp (USB: 26.16 +1.01 +4.02%), Zions Bancorp (ZION: 27.445 +1.8751 +7.33%), SunTrust Banks (STI: 28.70 +1.24 +4.52%), PNC Financial (PNC: 67.2725 +3.1325 +4.88%), BB&T Corporation (BBT: 33.54 +1.30 +4.03%) and Regions Financial (RF: 8.44 +0.45 +5.63%).

We expect loan losses on the commercial real estate portfolio to remain high for banks that hold large amounts of high-risk loans.

 

Hercules Tech Weakens A Bit

Hercules Technology Growth Capital Inc.'s (HTGC: 9.41 +0.10 +1.07%) first-quarter change in net assets of 16 cents per share was slightly short of the Zacks Consensus Estimate of 19 cents. However, this compares favorably with the change in net assets of 14 cents in the prior-year quarter.

Results for the reported quarter benefited primarily from a 22.3% year-over-year decrease in operating expenses. However, the lower-than-expected expenses were more than offset by a 38.8% decrease in top line. Hercules ended the quarter with a much stronger balance sheet and high level of liquidity.
 
Total investment income for the reported quarter came in at $12.5 million, down 38.8% from $20.5 million in the prior-year quarter. Both interest and fees decreased compared to the year-ago quarter.
 
Total operating expenses were $6.9 million for the reported quarter, down 22.3% from $8.9 million in the year-ago quarter. This decrease is primarily attributable to lower compensation expense related to bonus accrual. On a year-over-year basis, interest expense decreased 35.9% to $2.0 million and loan fees decreased 68.5% to $0.3 million.
 
Net investment income (before investment gains and losses) for the reported quarter came in at $5.6 million or 16 cents per share, compared with $11.6 million or 35 cents in the year-ago quarter. The decrease was primarily attributable to lower fees and lower interest earned.
 
The fair value of Hercules' total investment portfolio was approximately $380.0 million as on March 31, 2010, compared to $370.4 million as on December 31, 2009. The company funded and restructured approximately $87.0 million to new and existing portfolio companies during the reported quarter.
 
Net Asset Value
 
As on March 31, 2010, Hercules' net asset value was $10.11 per share, compared to $10.29 as on December 31, 2009. This decrease in net asset value was due primarily to the company's issuance of long term management incentives in the form of restricted stock.
 
Dividend Update
 
Concurrent with the earnings release, Hercules declared a quarterly dividend of 20 cents per share. The dividend will be paid on June 18, 2010 to shareholders of record as on May 12, 2010. This would represent the company's nineteenth consecutive dividend payment since its initial public offering.
 
Share Repurchase Update
 
During the reported quarter, the board of Hercules authorized the repurchase of common shares worth $35 million. The company repurchased 25,125 common shares at a total cost of approximately $234,000 as of March 31, 2010.
 
Hercules is a well capitalized specialty finance company providing debt and equity growth capital to technology and life science companies at all stages of development. As with the gradual recovery of the overall economic condition many technology companies are surpassing others with respect to earnings, Hercules has started experiencing growth with improvement in valuations within its portfolio companies.

High-FrHigh-Frequency Trading - The Latest Worry For StockInvestorsequency Trading - The Latest Worry For Stock Investors

 

Back on April 14, U.S. stocks advanced for the fifth day in a row, causing the U.S. Standard & Poor's 500 Index (SPY: 111.26 -1.682 -1.49%) to close above the 1,200 level for the first time in more than 18 months.

Traders said that a growing confidence in the strength of the U.S. rebound was a key rally catalyst.

But Money Morning's Shah Gilani was worried.

In fact, in a column published in Money Morning the next day, the retired hedge-fund manager and Money Morning contributing editor warned that traders were overlooking a key point. According to Gilani, so-called "high-frequency trading" was responsible for much of the stock-market volume that investors have been seeing of late - meaning "real" volume was actually much lower.

The bottom line: Gilani believed that U.S. stocks were highly vulnerable to a deep downdraft.

That vulnerability introduced itself to investors in a big way on Thursday, playing a huge role in a whipsaw-trading day that sent the Dow Jones Industrial Average screaming into a near-1,000-point nosedive at one point late in the day.

"I warned that high-frequency traders (HFT) were responsible for too much of the volume we've been seeing. I noted that, if they exited (turned their program-driven automated trading systems) the market, liquidity would dry up and exacerbate any downdraft," Gilani said in an interview today (Friday). "I also warned that HFT - by the very nature of the complexities of how it works, could misfire and muck up some or all of the major exchanges. Guess what: That's exactly what happened to cause the big spike down yesterday."

Anatomy of a Downdraft

The U.S. stock market went on a wild ride Thursday, with the Dow Jones Industrial Average plunging nearly 1,000 points late in the afternoon. That plunge sent the Dow down to 9,869.62 at about 2:40 p.m. EDT - its first time below the 10,000 level since November 2009.

The Dow retraced some of its steps and ended up closing at 10,517 - down 350.97 points, or 3.2 % on the day. The Nasdaq Composite Index closed at 2,319, down 82.65 points, or 3.4%, and the Standard & Poor's 500 Index closed at 1,127, down 37.85 points, or 3.2%.

The Dow lost another 141 points today (Friday), to close at 10,379.60. For the week, the Dow dropped 772 points, or 5.7%, its worst one-week showing since October 2008.

The downdraft started because of concerns that the Greek debt situation was making the leap from crisis to contagion, and might be infecting the finances of other European countries.

But stocks soon were down much more than was warranted by the now-well-known crisis among the "PIGS" (Portugal, Ireland (and/or Italy), Greece and Spain) in euro land.

Just before 3 p.m. Thursday, the Dow was down bout 180 points.

Then the index literally fell right off a cliff. It dropped more than 900 points, then retraced its steps by several hundred points - in a mere 20 minutes. Volume skyrocketed to its highest levels in more than a year, and some stocks underwent a nightmarish plunge.

According to a Newsweek.com report, shares of Accenture PLC (ACN: 40.32 -0.77 -1.87%) dived from $41 all the way down to a penny a share, and then back to $35 - in a less than five minutes.

Shares of The Proctor & Gamble Co. (PG: 60.31 -0.44 -0.72%) crashed from about $60 down to $48 - only to then zoom up past the $60 level, again in just a few minutes. That's more than can be logically explained by today's news that the Consumer Product Safety Commission is investigating reports of severe rashes caused by two new lines of Pampers diapers - which are made by P&G.

In the postmortems that started Thursday night, HFT is being identified as the chief suspect behind the near tragedy. Computer-driven trading algorithms now account for nearly 70% of all U.S. stock market volume.

A Chicago-based market observer and HFT expert told Newsweek that rumors are circling about a computer glitch hitting one of the automated trading systems operated by a Citigroup Inc. (C: 4.00 -0.04 -0.99%) unit. The system is said to have essentially gone "haywire."

"This is why quality control is so essential on these automated systems," the market observer, who asked to remain anonymous, told Newsweek.

Other rumors - including the story of the now-fabled "fat-finger discount" - are making the rounds, too. In this particular rumor, human error is said to have been the culprit. In this scenario, a trader or trader's assistant allegedly typed "billion" instead of "million" into a sell order.

"When you tell a computer to do something - no matter how irrational - it doesn't ask: 'Are you sure?' It doesn't say: 'That's insane.' It simply executes the order," the Newsweek account states.

An Earlier Warning

Gilani's warning about the perils of high-frequency trading wasn't the only time Money Morning has cautioned readers about the potential pitfalls of this high-tech trading strategy.

Back in mid-August, Money Morning's Martin Hutchinson, a former U.K. and U.S. merchant banker, characterized HFT as "Wall Street's new rent-seeking trick."

"When the U.S. economy is facing collapse and merger and acquisition volume is way down, it seems odd that investment banks like Goldman had record quarters," Hutchinson said. "Well, here's the secret: [Wall Street investment banks] have found a new way to skim more of the cream off the top of U.S. economic activity. It's called "High-Frequency Trading."

According to the Newsweek report, institutional traders "load complex trading algorithms into supercomputers, hook them up to stock exchanges, and then trade vast amounts of stocks at warp speeds, literally millions of shares in a matter of milliseconds. With each trade, the codes gobble up about one tenth of a penny. Eventually, a few billion pennies add up to serious money."

That gives institutions a massive - even insurmountable - advantage over other investors, experts such as Money Morning's Hutchinson says.

"HFT computer servers are able to beat other computers because they are located at the exchanges. They take crucial advantage of the finite speed of light and switching systems to front-run the market," he explained. "They also gain information on orders and market movements more quickly than the market as a whole. They operate not only on the New York Stock Exchange (NYSE), but also on the electronic trading exchanges such as the NYSE hybrid market."

Hutchinson described the cast of characters that make up the population of high-frequency traders. They include:

The "liquidity-rebate traders," who take advantage of volume rebates of about 0.25 cents per share offered by exchanges to brokers who post orders, which is supposed to provide liquidity to the market. When they spot a large order they fill parts of it, then re-offer the shares at the same price, collecting the exchange fee for providing liquidity to the market.
The "predatory-algorithmic traders" - also known as "predatory-algo players," who take advantage of the institutional computers that chop up large orders into many small ones. They go to the institutional trader who wants to buy and make him bid up the price of shares by fooling its computer, placing small buy orders that they withdraw. Eventually the "predatory-algo" shorts the stock at the higher price it has reached, making the institution pay up for its shares.
The "automated-market makers," who "ping" stocks to identify large reserve-book orders by issuing an order very quickly, then withdrawing it. By doing this, they obtain information on a large buyer's limits. They use this to buy shares elsewhere and on-sell them to the institution.
And the "program traders," who buy large numbers of stocks at the same time to fool institutional computers into triggering large orders. By doing this, they trigger sharp market moves.
Possible Solutions to HFT-Induced Fallout

Money Morning's Hutchinson says that "this toxic trading has caused volume to explode, especially in NYSE-listed stocks. The number of quote changes has also exploded and short-term volatility has shot up. NYSE specialists now account for only around 25% of trading volume, instead of 80% as in the past."
This has major ramifications for all investors, Hutchinson says.

"The bottom line for us ordinary market participants is that insiders are using computers to game the system, extracting billions of dollars from the rest of the market," he said. "While it is illegal to trade on insider knowledge about company financials, these people are trading on insider knowledge about market order flow. That's how Goldman Sachs (GS: 142.99 +0.67 +0.47%) and the other biggest houses make so much from trading. By doing so they are rent-seeking, not providing value to the market."

According to Hutchinson, there are two solid solutions - ideally, the Securities and Exchange Commission (SEC) would employ both.

First, the SEC could introduce a rule that all orders must be exposed for a full second. That will reduce the volume of HFT, but still wouldn't truly protect non-computerized outsiders, he said.

The second, and better, solution would be to introduce a small "Tobin tax" on all share transactions. It could be tiny; maybe 0.1 cents per share. (The SEC would also need to ban "exchange rebates" to traders).

"Such a tax would make the worst HFT types unprofitable, without imposing significant costs on retail investors," Hutchinson says. "It would also provide funds to help run the vast apparatus of regulation and control that seems to be necessary to run a modern financial system. Goldman Sachs and other financial institutions of its ilk have imposed huge costs on the U.S. public with their 'too-big-to-fail' status. Now they are adding to the problem by scooping out money from the stock market through HFT. It's about time the government imposed some taxes to stop the worst of these scams and recover the public some of its money."

The 200-DMA Is The Key

It's hard to believe but it has only been 10 trading days when on Wednesday April, 28, the S&P Index closed at 1191 and I wrote a remarkably tame and soothing "Nothing Warrants Wholesale Liquidation …… Yet".

In that piece, I assured you that the market's action, up to then, was far from issuing an unequivocal "all-cash" alarm because at that point of the Index's moving averages were generally favorably aligned . They were all arranged in bullish mode with the 50- above the 100- which was above the 200- and at the bottom was the 300-day moving average. Finally and perhaps most convincingly, the Index itself was still above them all.

But everything has changed in the ensuing 10 trading days. The market and its Index swiftly penetrated what should have been supporting moving averages creating extensive damage. Most of the blame was attributed to the European Sovereign Debt mess, the Gulf oil spill, Congressional action on financial institution regulation and, as a coupe de grace, a breakdown of processes and procedures in electronic financial markets on Thursday (which still can't be adequately explained). Compare the chart in that April 28th post with yesterday's below:

What wasn't clear 10 days again was how fast the correction would be. On the one hand, most failed to anticipate the decline in any way and suffered severe damage to their portfolios. As I outlined in my game plain I liquidated as various dominoes fell but failed to act quickly enough, wounding up at only a 35% cash position (I had hoped to be 50% if the market did drop as far as it did). On the other hand, the panic style swiftness creates a perfect situation for a bounce of sorts.

Market history has many precedents that offer some perspective on what to look forward to and what further actions to take. The key unlocking this view is the fact that the Index twice crossed the 200-day moving average on an intra-day basis. If Monday again turns into a liquidation day, then the Index will likely close below the 200-DMA, not an insignificant event.

The 200-day moving average is a crucial milestone for both individual and institutional market timers. As the market was bottoming in 2009, the Index crossed above the 200-DMA in July providing a highly anticipated signal that the recovery was solid and reliable. The Index crossing below its 200-DMA at the end of 2007, likewise signaled that a significant decline was immanent.

If it actually happens, the cross under will still be an unreliable bear market indicator because it will occur when the moving averages are still arrayed in a bullish alignment. When the Index has similarly crossed under the 200-DMA in the past, it stayed below anywhere from a day to at most 10 trading days (in fact there have been 81 of these "cross unders" since 1963). All but one was followed by the Index moving back above the 200-day moving average. For how long and for how much? That's where the unpredictability comes in.

The bottom line is that there's a high probability that those who missed out on the opportunity to become more risk averse by selling stock and increasing cash will have a second chance soon. Some will describe the move up as the end of the correction and the time to again buy stocks that have been marked down significantly. For the time being, I'm going to take a more conservative tack and look at it as an opportunity that passed me by.

The Bull has been injured and his forward momentum has been damaged. It will take time to either heal and resume it's climb (which I not only hope but currently anticipate will happen during the summer in line with the mid-term election market pattern) or be mauled by the Bear whose momentum will pull the market further down. Right now, we just can't tell which way it will go.

U.S. Stock Markets Post Largest Weekly Losses Since March 2009 AsEurope Panics

DailyMarkets.com (New York) - U.S. stock markets had a poor performance last week on the back of the debt crisis in Greece. Both the Dow and the S&P 500 index posted the largest weekly losses since March 2009. For the week, the S&P 500 fell 6.4% to 1,110.86, and the Dow slid 5.7% to 10,380.43, the lowest level since February. After a stellar first-quarter showing, both indices have now erased their gains for the year. The Dow is now down 0.5% for the year, while the S&P 500 is now down 0.4% year-to-date. The Chicago Board Options Exchange Volatility Index, also known as the VIX (^VIX: 40.95 +8.15 +24.85%), jumped a whopping 86% to 40.95 - the largest weekly increase ever in its 20-year history.

On Thursday May 6th, the Dow tumbled almost 1,000 points or 9.2% intraday before paring its losses. That was the steepest drop since the stock market crash of 1987, and it wiped off US$700 billion from U.S. markets in just eight minutes. Waves of electronic selling in Accenture (ACN: 40.32 -0.77 -1.87%), Exelon (EXC: 41.54 -0.32 -0.76%) and Philip Morris (PM: 46.42 -0.58 -1.23%) caused losses of more than 90% to cents before rebounding within minutes. Almost 1.3 billion shares traded on U.S. markets in a 10-minute period beginning at 2:40 p.m., six times the average. This surge in volume, coupled with a slowdown in trading on the NYSE, caused volatility to spike as sell orders were routed to other smaller exchanges that had few if any buyers.

Apple (AAPL: 235.86 -10.39 -4.22%) shares fell 9.7% to $235.86, its largest weekly loss since October 2008, after Nokia, the world's biggest maker of mobile phones, filed a patent-infringement lawsuit over the smartphone technology in iPhone and iPad. This fifth lawsuit was the latest in a series of lawsuits and counter-lawsuits between the two technology companies in the past year. Dow Chemical (DOW: 25.50 -1.18 -4.42%), the biggest U.S. chemical maker, fell 17% to $25.50, the most since January 2009.

Next week, Walt Disney (DIS: 33.41 -0.60 -1.76%), the world's largest media company, and Cisco Systems (CSCO: 24.71 -0.778 -3.05%), the world's biggest maker of computer networking equipment will report quarterly earnings, along with retailers such as Macy's (M: 21.94 -0.48 -2.14%), Nordstrom (JWN: 40.06 -0.50 -1.23%), J.C. Penney (JCP: 27.61 -0.49 -1.74%) and Whole Foods Market (WFMI: 36.68 -1.41 -3.70%).

In forex trading, the Euro fell 4.1% against the US dollar, the largest weekly loss since October 24, 2008, to 1.2755 on concerns the ECB may not be able to handle the Greek crisis on its own. However, the Euro rallied 1.1% on Friday, its first gain in a week, on speculation that the European Central Bank (ECB) may come to the aid of banks threatened by Greece's crisis in an effort to halt contagion. USD/JPY fell 2.4% to 91.59 for the week, the biggest drop since February, from 93.85.

The British pound hit a 13-month low of 1.4477 against the US dollar as Conservative David Cameron failed to win a majority in the House of Commons, leading to concerns that the U.K. would be unable to manage its fiscal deficit. For the week it fell 3.1% to 1.4795, from 1.5274.

 

Current U.S. Stock Market Following The 2003-07 Pattern?

History says we should test the lows at some point in the next few weeks. The fact that we ended well off the lows does muddy the picture at bit, as most "crash" days have ended at or close to the lows of the day. So perhaps this time will be different.

I'm going to point to an interesting parallel that I've been watching.

I've noted that the first and second leg of this bull roughly followed the same pattern as the 03-07 market. The correction following the second leg copied the 04 correction if not in duration in magnitude.

I've speculated that this bull would bypass the middle phase of a "normal" bull and move straight into the final phase.

In 06 the final phase began with a 7 month runaway move. We certainly saw a runaway move out of the February 5th bottom. I must admit I thought it would last a bit longer than 2 1/2 months but I guess we shouldn't be surprised as everything has been unfolding much faster during this bull.

In 07 the runaway move ended with the mini-crash in February. Thursday certainly qualifies as a mini-crash. So we are still following the 03-07 template. If the pattern holds then we should expect a recovery soon and a final surge higher into an ending blow off top.

From there we should roll over into the next leg down in the secular bear market.

Not that I want to buy into a secular bear market, but sometime in the next couple of weeks we should get a intermediate buying opportunity…unless this time is different and we just continue higher from here.