ISM Services: Prior 43.7 / Mkt Expects 45 / Actual 44 … Factory orders: Prior -0.9% / Mkt Expects +0.9% / Actual + 0.7%

Don’t you want to buy high PE’s ?

By Daniel Hauck

June 3 (Bloomberg) — Stocks fell on speculation the rally that sent the MSCI World Index to a five-year high compared with earnings has outpaced the prospects for corporate profits. Russia led the decline.

The MSCI World gauge of 23 developed countries fell for the first time in five days, dropping 0.5 percent at 12:56 p.m. in London. Futures on the Standard & Poor’s 500 Index slipped 0.5 percent, indicating the measure will retreat from a seven-month high, while Russia’s Micex Index slid 3.4 percent. U.S. government bonds that protect investors against inflation showed increased concern that consumer prices will accelerate.

“Markets have run hard, valuations have risen sharply,” Andrew Howell, an emerging-markets strategist at Citigroup Inc. in New York, wrote in a research note. “We do not see major evidence of a pent-up demand for Russian equities among global investors from here.”

Efforts by governments and central banks to end the first global recession since World War II helped push the valuation on the MSCI World index to 18.2 times the average earnings of its 1,655 companies, the most expensive since 2004. The index’s three-month, 45 percent rebound is stoking investor concerns because U.S. profits will decline until the last quarter of this year, according to analyst estimates compiled by Bloomberg.

Australian Economy

A report today that showed Australia’s economy unexpectedly expanded 0.4 percent in the first quarter was the latest sign that interest rate-cuts and stimulus spending may be fueling a recovery. The MSCI Asia Pacific Index climbed 0.4 percent.

The euro fell 0.6 percent against the dollar as reports showed European consumer spending and exports contracted the most in at least 14 years in the first quarter and investment slumped. Gross domestic product shrank 2.5 percent from the fourth quarter, matching an initial estimate and the most since the data were first compiled in 1995, the European Union’s statistics office in Luxembourg said today.

The U.S. dollar also strengthened 1.7 percent against the New Zealand dollar and 1 percent versus the South African rand as the retreat in stocks spurred investors to seek refuge in the greenback.

The ECB will probably hold its main interest rate at a record low of 1 percent tomorrow, according to economists surveyed by Bloomberg News, as it sets out the mechanisms for buying 60 billion euros ($86 billion) of covered bonds, low-risk securities backed by mortgages and public sector loans. ECB council member Ewald Nowotny said in a letter last week that the bank could expand the asset-purchase program beyond that, buying bonds or commercial paper.

Lehman’s Collapse

Some markets are returning to levels before the failure of Lehman Brothers Holdings Inc. in September froze credit. Corporate bonds in euros rallied to the highest since the New York-based firm collapsed in the biggest bankruptcy in history. The pound climbed to more than $1.66 for the first time in seven months as U.K. consumer confidence improved.

NYSE Euronext Chief Executive Officer Duncan Niederauer said today he’s “a lot more confident” the three-month rally in equities is sustainable as trading volume increases.

“At the end of March I was apprehensive because I thought the market had gone up so much so quickly that it didn’t feel like a fundamentally driven rally to me,” Niederauer said in an interview in Amsterdam. “I was nervous that the fundamentals hadn’t really changed and we hadn’t seen enough volume.”

Treasuries, TIPS

Treasuries rose today, with the yield on the 10-year note falling almost four basis points to 3.57 percent, according to BGCantor market data.

Yields declined for a second day after former Federal Reserve Chairman Paul Volcker said yesterday that a full U.S. economic recovery is “years” away and before current Chairman Ben S. Bernanke addresses the House Budget Committee today. The central bank is due to purchase securities today and tomorrow as part of its plan to cap borrowing costs.

The 10-year breakeven rate, the extra yield investors demand to hold notes instead of Treasury Inflation Protected Securities, or TIPS, rose to 2 percent for the second day, the highest level since September.

The collapse of bonds tied to subprime mortgages froze credit markets starting in August 2007 as banks hoarded cash, triggering the global recession and losses at financial firms that have reached almost $1.5 trillion.

Credit markets unlocked as the U.S. Treasury said it would finance as much as $1 trillion in purchases of distressed assets, the Federal Reserve pledged to buy more than $1 trillion of bonds and the Federal Deposit Insurance Corp. agreed to guarantee corporate debt.

The Libor-OIS spread, which measures banks’ reluctance to lend, narrowed to 44 basis points, or 0.44 percentage point today, the lowest level in almost 16 months, from a record 364 basis points in October following Lehman’s failure.

U.S. Job Reports

U.S. reports this week may show unemployment is still increasing. ADP Employer Services probably will say companies cut an estimated 525,000 jobs in May following 491,000 in April, according to 28 economists surveyed by Bloomberg.

Labor Department data on June 5 may show that the unemployment rate climbed to 9.2 percent in May, the highest level since September 1983, according to the median of 73 estimates in a Bloomberg News survey.

Russian stocks dropped the most in nine days after Citigroup’s Howell downgraded the shares to “underweight” from “overweight,” citing a “huge run” since March that made valuations less attractive. The Micex trades at 7.2 times reported profits, almost double the price-to-earnings ratio of three months ago, according to data compiled by Bloomberg.

‘Like the 1970s’

U.S. futures slid, indicating the S&P 500 may drop for the first time in five days, after Credit Suisse Group AG cut the firm’s allocation on U.S. stocks to its 60 percent benchmark level from “overweight.” The bank maintained a year-end estimate of 920 for the S&P 500, which closed yesterday at 944.74.

“We remain concerned about the economic backdrop,” London-based global equity strategist Andrew Garthwaite wrote in a note today. “We believe we are in a range trading market like the 1970s.”

Higher bond yields have “undermined” the valuation of equities, Garthwaite said. Bond investors have driven up the yield on the benchmark 10-year Treasury note, which helps set rates on everything from mortgages to corporate bonds, to as high as 3.75 percent last week from the record low of 2.035 percent in December.

Stocks in play

Today’s highlights: ADCT, JOYG, MTL, SAI, SNDA, TOL, & WSM

Or mismanaged…

By David Epstein

If only there were a stimulus edition of Quicken. With billions of stimulus dollars flowing into the economy, some via historically unprecedented avenues, accounting mistakes were inevitable. And, given the magnitude of the stimulus plan, some of the typos and slip-ups were bound to involve astronomical sums of money. Last month, there was the whole $250-checks-being-sent-to-thousands-of-dead-people [1] thing. Then, last week, we noted that the Labor Department had slipped a footnote onto Recovery.gov [2] that corrected by $10 billion [3] the amount of stimulus money that the department had put in the unemployment trust fund. This week, ProPublica received a copy of a section of California’s corrected application [4] for State Fiscal Stabilization money that fixes an accounting error worth $2.3 billion.

The State Fiscal Stabilization Fund is a $53.6 billion pot created by the stimulus bill. Most of the money is earmarked for education, and to receive the money, a state has to assure the federal government that it will spend at least as much on public K-12 and higher education in 2009 and 2010 as it did in the 2006 fiscal year.

When California submitted its original application [5] for $4.875 billion in stabilization funds on April 15, it showed 2006 figures of $34.905 billion for K-12 funding and $5.435 billion for public higher education. Last month, after Californians voted down various budget measures, Gov. Arnold Schwarzenegger submitted a budget that includes $4.7 billion in cuts to schools [6] over the next two years. The plan made it painfully obvious that California might have trouble topping the 2006 figures in its application, potentially jeopardizing its right to money from the stabilization program. That’s where the accounting error comes in.

Going over their numbers, officials in California realized that they had counted more than $2 billion in “settle-up” funds, which were guaranteed to schools in 2006 but not actually spent until the following year. Settle-up funds are owed to schools that have not yet received all the money they are entitled to under California’s Proposition 98, which promises that 40 percent of the state’s general fund be spent on schools.

The accounting fix lowered the education funding bar that California must meet to receive SFSF funds. “This technical adjustment was made to ensure that we treat all funds consistently across fiscal years in our State Fiscal Stabilization Fund application,” says Kathryn Gaither, California’s undersecretary of education. “We’re continuing to work with the federal government, and we expect to hear final word on our revised application soon.” According to John White, a spokesman for the federal Department of Education, no state has had its SFSF application [7] turned down thus far, so it’s a good bet that California’s revised application will be accepted.

Based on its revised application (which also includes community college funding that was left out on the first go-round), California is still aiming for the funding figures in its original application but now has the wiggle room to deal with the deep and unavoidable cuts that are looming. “It frees up $2 billion in the terms of the ‘maintenance of effort’ requirement in the application,” says Carol Bingham, director of the state Education Department’s fiscal policy division, “so the 2009 and 2010 figures can be dropped down if they need to.”

Does this signal risk or risk aversion ?

By Kristina Cooke

NEW YORK (Reuters) – The flagship U.S. program to revive consumer and small business lending picked up pace in June, showing investors have grown more comfortable with taking part in the government initiative and appetite for risk has increased across all markets.

The lending facility is a crucial part of the Federal Reserve’s and Treasury’s efforts to lower borrowing costs for consumers for everything from student loans to a new car, which had skyrocketed after credit markets froze last year.

In June, investor demand for Fed loans rose to about $11.5 billion, up 8 percent from May and up 145 percent from the first round in March.

The Term Asset-Backed Securities Loan Facility (TALF) — announced with much fanfare in November — had some trouble getting out of the starting block in March and April.

New York Fed President William Dudley said in April that the program had initially suffered from some investors’ worry that they could become subject to the same heated scrutiny on their pay as banks that received bailout money. Investors said they were also initially put off by complex paperwork.

In March and April “issues related to the Customer Agreement kept many participants on the sidelines. By May, many of the issues had been resolved,” said Brian Loo, portfolio manager at Metropolitan West Asset Management in Los Angeles.

He said the three-year, non-recourse funding offered by the TALF was attractive to investors.

Some economists had feared the program would not gain enough traction to be effective — a worry that has since been soothed.

Investor interest was broader than in previous rounds, with loans for premium finance and servicing advances requested for the first time.

But demand was still clustered around auto and credit card ABS, at the heart of the consumer lending problem. Investors requested $6.2 billion for credit card TALF loans and $3.3 billion for auto TALF loans.

In this first phase of the program, the Fed lends money to investors against newly issued asset-backed securities as collateral.

Earlier, a primary dealer said U.S. consumer finance debt issuers, including Citigroup (C.N) and Ford Motor Co (F.N), sold as much as $16.5 billion in bonds eligible for this round of the Fed’s program.

“Auto and credit cards are the biggest categories of consumer credit, and that’s what the program is hoping to tackle,” said Michael Feroli, economist at JP Morgan in New York.

Asset-backed securities spreads have tightened sharply since the program was announced in November.

Consumer ABS issuance plummeted in the fourth quarter of 2008 to $4 billion from $50 billion in previous quarters, but issuance has picked up since with help of deals supported by Fed loans, and stronger conditions are luring investors back into the market, traders and analysts said.

The total amount of loans requested in the first four rounds of the Fed’s program is about $28.5 billion — still only 14 percent of the $200 billion the Fed said it could lend for the program’s initial phase. The Fed has said the program could grow to $1 trillion.

The next phase starts in mid-June when applications for newly issued commercial mortgage-backed securities are due. In July, the lifeline will be expanded to older, so-called legacy commercial mortgage backed securities, as part of a comprehensive government plan to remove so-called toxic assets from banks’ balance sheets.

If things do go awry how will the EU stick together ?

By JOELLEN PERRY

German Chancellor Angela Merkel, in a rare public rebuke of central banks, suggested the European Central Bank and its counterparts in the U.S. and Britain have gone too far in fighting the financial crisis and may be laying the groundwork for another financial blowup.

“I view with great skepticism the powers of the Fed, for example, and also how, within Europe, the Bank of England has carved out its own small line,” Ms. Merkel said in a speech in Berlin. “We must return together to an independent central-bank policy and to a policy of reason, otherwise we will be in exactly the same situation in 10 years’ time.”

Ms. Merkel also said the ECB “bowed somewhat to international pressure” when it said last month it plans to buy €60 billion ($85 billion) in corporate bonds — a move that is modest in comparison to asset-buying by its counterparts, the U.S. Federal Reserve and Bank of England. Details are to be unveiled by the ECB’s president, Jean-Claude Trichet, Thursday.
[Angela Merkel]

Angela Merkel

The public criticism is unusual — and not only because German politicians rarely talk harshly about central banks in public. When politicians around the world do criticize their central banks, they almost always gripe that they are too tightfisted.

The conservative German leader’s comments came as Europe’s statistical agency reported that unemployment in the 16 countries that share the euro rose to 9.2% in April — the highest level since September 1999 and still below the 11.5% that the European Commission forecasts for 2010.

However, the economic straits of countries within the euro zone vary widely. Germany’s unemployment rate of 7.7%, for instance, contrasts with 18.8% in Spain, where a collapse in the construction industry that was driving the economy has pushed unemployment to the highest in the euro zone.

It isn’t clear what triggered Ms. Merkel’s remarks, which came in a prepared speech. The ECB has been markedly less aggressive than the Fed or the Bank of England, particularly in moving beyond cuts in short-term interest rates to buy bonds to boost economic activity. However, German officials traditionally have been on the more conservative end of the central bankers’ spectrum, partly because the country’s hyperinflation of the 1920s is seared into people’s memories.

The ECB, the Fed and the Bank of England are increasingly vulnerable to criticism because they have played such a prominent role and crossed so many traditional lines in the past several months — even though they do appear to have steered their economies away from a repeat of the Great Depression. Neither the ECB, the Fed nor the Bank of England had any comment on Ms. Merkel’s remarks.

Her tough comments about the extent to which the central banks are intervening in the economy also come amid attacks on her by some in her conservative base for putting €1.5 billion of taxpayer money into a deal to shield Opel from parent company General Motors Corp.’s bankruptcy-protection filing.

Ms. Merkel’s critique jibes with statements from Axel Weber, the head of Germany’s central bank and a member of the ECB’s 22-person Governing Council. He has warned that too-loose monetary policy could fuel future inflation. Mr. Weber was among the body’s most vocal skeptics on asset purchases before the bond-buying program, reservations that were also shared by Jürgen Stark, another German on the ECB council. In a May 12 speech, Mr. Weber warned that overly generous monetary policy had helped build asset-price bubbles in the past.

In contrast, Athanasios Orphanides, the former Fed economist who now heads the Cypriot central bank, has been a vocal proponent of aggressive ECB policy. And many private-sector economists contend the ECB’s response to the global recession has been too cautious. The ECB cut its key rate to a record low of 1% in May. Mr. Trichet hasn’t ruled out further cuts, but most economists expect the central bank to stand pat Thursday and foresee the rate remaining at 1% for the rest of this year. The Fed cut its analogous rate nearly to zero in December and has said it will keep it there for some time.

Although the administration of President Barack Obama has carefully avoided criticizing the Fed, Republicans and Democrats in Congress have questioned the wisdom of the Fed’s power and its governance as they contemplate far-reaching changes to the nation’s financial regulatory structure. The senior Republican on the Senate Banking Committee, Richard Shelby of Alabama, recently asserted that “an inherent web of conflicts is built into the DNA of the Fed as it now exists,” a reference to commercial bankers’ role in overseeing the Fed’s 12 regional banks.

Some private economists — and a few inside the Fed — say the Fed’s aggressiveness is increasing the risks of an outbreak of inflation and creating the unwelcome perception that it will bail out big financial institutions when they take big risks that turn out badly.
—Nicholas Winning in London and Jon Hilsenrath in Washington contributed to this article.