Wednesday May 16 was the worst trading session of the year so far on the Australian Securities Exchange (ASX), as the benchmark S&P/ASX 200 Index shed 2.4 percent to take it to its level since Mar. 7.

The ASX 200 is still 2.7 percent to the positive in local price-only terms and has generated a total return–capital gain or loss plus dividends–of 4.6 percent. But factoring in the Australian dollar’s 2.7 percent decline against the US dollar in 2012 the price-only return is negative 0.5 percent, while the total return is 1.3 percent.

The correction for the aussie versus the buck from its Feb. 7 high is now about 8 percent. The ASX 200 met its year-to-date closing peak on May 2–4435.9072–but has sold off hard and fast, a decline of 6.1 percent in exactly two weeks.

Encouragingly, the 20 stocks that comprise the Australian Edge Model Portfolio outperformed on this day of days, declining an average of 2 percent. The 10 Conservative Holdings lost 1.3 percent, while the Aggressive 10 were down 2.7 percent. Standout include Conservative Holdings APA Group (ASX: APA, OTC: APAJF), which was up 0.8 percent on the day, and AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY), which was up 0.5 percent.

APA and AGL–both original members of the AE Portfolio–were two of just 12 stocks in the S&P/ASX 200 Index to post green numbers on Wednesday in Sydney.

Aggressive Holdings Newcrest Mining Ltd (ASX: NCM, OTC: NCMGF, ADR: NCMGY), which shed 4.3 percent, and BHP Billiton Ltd (ASX: BHP, NYSE: BHP), which was off 4 percent, led to the downside.

The Australian dollar, which sank below parity with the US dollar earlier in the week, is actually holding steady just below USD1, even as fear continues to pull people away from assets perceived to bear more risk. At last look the value of the Australian dollar was USD0.9939.

We have more on APA Group and its ongoing attempt to acquire the pipeline and energy infrastructure assets of Hastings Diversified Utilities Fund (ASX: HDF, OTC: None) in the weekly Roundup of significant news on Portfolio Holdings, which is available to Australian Edge subscribers.

As for AGL, the stock stood out to investors probably in anticipation of a positive decision from the Australian Competition and Consumer Commission (ACCC) on its proposed acquisition of the Loy Yan A power station. This decision is expected on May 24, and ratification would provide a significant boost to AGL’s fiscal 2013 earnings.

Newcrest, the No. 3 gold producer in the world, is a relatively low-cost miner that’s been hampered by operational problems at a key mine that are the legacy of the facility’s former owner. Management has issued a series of revisions to fiscal 2012 output guidance, as rainy weather hasn’t helped matters.

But costs remain well under control, particularly in light of the nature of its difficulties and the extent to which it’s had to mitigate issues at the key Lihir mine in Papua, New Guinea. Newcrest, like other gold mining stocks, has lagged the metal dramatically since September 2010. From here the story is about upside, as my AE Co-Editor Roger Conrad noted in the May 2012 issue, because “we can win from either recovering gold prices, an improvement in the mining stock/gold performance spread and/or improved results at Lihir.”

APA and AGL illustrate the point that solid businesses that continue to execute–and the people who own them–will be rewarded by the market. APA is priced to yield a cool, consistent 7 percent-plus, while AGL pays a reliably growing dividend that right now equates to a 4 percent-plus yield on the ASX.

Newcrest’s experience on the ASX shows what can happen to companies seen to be stumbling amid the rising tide of fear. Whatever happens in Greece and Europe–and whatever’s happened to this point–Newcrest remains a profitable company that also pays a reliable, growing dividend. In fact management recommended and the board of directors approved a 20 percent increase in the interim dividend declared Feb. 9, 2012, over the payout for the prior corresponding period.

BHP, for its part, is a great starting point for a discussion of perception, misperception and crappy headline writing, auto-generated or not.

When I awoke this morning at 4:15 a.m. for my 5 a.m. swim I grabbed my BlackBerry, which doubles as my alarm clock, cut the aggravating noise then scanned my e-mail. Courtesy of The Australian–which is good enough to provide news updates directly to my in-box, this “Business Briefing” at 3:27 a.m. my time–I learned via a subject line that “BHP pulls $80bn growth spend.”

The purpose of headlines/subject lines is to grab attention. I get it; I do it. But I like to think my attempts inform at the same time they entertain and/or titillate. The Australian did in fact provide a little extra energy in the form of anxiety as I plowed through my workout this morning, but as I suspected and then learned upon my return and after breakfast with my girls its subject line clearly lacked nuance.

BHP Chairman Jac Nasser did pull in the reins a bit on CEO Marius Klopper’s forecast of an USD80 billion budget to expand its iron ore, coal, energy and base metals divisions over the next five years. What he said to reporters following a lunch meeting in Sydney, according to Reuters, was, “It is all about appropriate allocation of capital. When Marius (Kloppers) talked about the USD80 billion, the environment was different.

“We should pause, take a deep breath and wait and see where the pieces fall around the world.” Although Mr. Nasser replied, “No,” when asked if BHP would spend USD80 billion over the next half-decade, he did not announce a cut in capital spending. He did say, as you and I should expect–demand, really–that BHP was re-thinking its expansion plans “every day.”

BHP’s 4 percent slide in May 16 trade on the ASX in Sydney is akin to Newcrest’s selloff in that it follows a series of negative comments from upper-level decision-makers, in the former’s case about near- and medium-term demand from key markets for its output. But the long-term story remains intact.

As I write in a Sector Spotlight on the company in this month’s Australian Edge:

Motivation for BHP is the inexorable trend toward urbanization sweeping China and other developing Asian economies. By 2030, according to the Population Division of the Dept of Economic and Social Affairs of the United Nations Secretariat, 62 percent of 1.5 billion Chinese will live in big cities, up from 47 percent of 1.4 billion in 2010 and 27 percent of 1.1 billion in 1990. By 2050 urbanization will reach 73 percent.

India, meanwhile, which in 1990 posted an urbanization rate of 25 percent of its 900 million citizens, reached 30 percent of 1.2 billion in 2010. By 2030 it will be 40 percent of 1.5 billion, by 2050 54 percent of 1.6 billion.

A 2009 McKinsey Global Institute study forecast that by 2025 225 Chinese cities will have more than 1 million residents. For comparison’s sake Europe currently has 35 cities of a million or more people.

This has enormous implications for resource consumption. Five billion square meters of road will be paved, and 170 mass-transit systems could be built. Forty billion square meters of floor space will be built by then, in 5 million buildings. And 50,000 of these structures are likely to be skyscrapers.

China is on course to construct the equivalent of 10 New York Cities over the next decade and a half.

This is the transition of emerging economies from investment- to consumption-led growth.

BHP is as well placed as any company in the world to benefit from this transition.

Facebook has easily become the most sought after initial public offering (IPO) of the year and perhaps even of the decade. With investors desperately clamoring for a piece of the IPO action, Facebook announced on Monday that it was upping its IPO price range to $34 to $38 per share from the previous range of $28 to $35 per share. As a result, Facebook’s implied post-IPO valuation will fall somewhere between $93 billion and $104 billion, making it the most highly valued social media company in the world.

Although the company is expected to offer more than 420 million shares in its IPO, that amount may still be insufficient to satisfy initial demand. With large institutional investors such as mutual funds and hedge funds likely to buy a majority of the shares in the offering, only the most well-connected individual investors will have the opportunity to buy shares before they hit the secondary market.

But if you don’t get immediate access to the IPO, don’t feel too bad. Most index funds won’t be taking part in the action either, because of restrictions on how quickly new stocks can be added to their indexes. That can be a disadvantage for exchange-traded fund (ETF) investors who want to tap into Facebook as quickly as possible.

For instance, PowerShares QQQ (NSDQ: QQQ), the most popular Nasdaq index ETF on the market, won’t include the stock for at least three months. In the past, new stocks had to trade for at least a year before they could be added to the Nasdaq. But back in April, that period was shortened to three months, a clear signal that the exchange wants to add the stock as quickly as possible to its benchmark index. Regardless, Facebook won’t find its way into PowerShares QQQ before August or September at the earliest.

Investors will have to wait even longer for Facebook’s inclusion in just about every other technology ETF out there, with Global X Social Media Index ETF (NSDQ: SOCL) the one exception.

The ETF tracks a basket of global companies involved in social networking, file sharing and other web-based media applications. The fund’s top holdings include LinkedIn (NYSE: LNKD), Google (NSDQ: GOOG) and NetEase (NSDQ: NTES).

The ETF’s benchmark is the capitalization-weighted Solactive Social Media Index, which requires a seasoning period of only five trading days before a new company becomes eligible for inclusion. That means Facebook will become the single largest constituent of both that benchmark index and the ETF within a week of its IPO.

With an annual expense ratio of 0.65 percent, Global X Social Media Index ETF is a relatively cheap and quick way for ETF investors to have some exposure to Facebook.

But there is a downside. Despite the fact that social media has been a hot investment topic for the better part of two years now, the ETF has been slow to attract investor attention–only about 40,000 shares change hands daily. While trading volume will probably spike once the Facebook IPO is complete–in fact, volume is already on the rise–low liquidity will likely remain a risk for investors in the ETF for the foreseeable future.

What’s New

In their never-ending quest for yield, investors continue to add high-yield and foreign bonds to their portfolios. Last week, Van Eck rolled out a new fund that allows investors to stretch even further for higher yield.

Market Vectors Emerging Markets High Yield Bond ETF (NYSE: HYEM) tracks a dollar-denominated benchmark comprised of emerging market non-sovereign issuers that are rated below investment grade. So investors get exposure to emerging market high-yield bonds without assuming the additional risk of volatile exchange rates.

And according to data from Standard & Poor’s, these bonds have a lower risk of default than their developed-world peers. Between 1981 and 2011, the annual high-yield default rate in the developed world ran better than 3 percent, compared to a default rate of just 1.6 percent in the emerging market.

The ETF charges a 0.40 percent annual expense ratio and should yield around 8 percent.

The second ETF launched last week came from a new issuer, Arrow Investment Advisors. The fund is also geared toward generating high income from global securities.

Arrow Dow Jones Global Yield ETF (NYSE: GYLD) tracks an index that includes the 150 highest yielding global stocks, bonds and alternative assets, such as master limited partnerships (MLP) and real estate investment trusts (REIT).

The portfolio includes 20 percent allocations to each of five asset classes: global stocks, global sovereign bonds, global corporate bonds, global energy and global real estate. The fund holds 30 equally weighted securities in each of these five asset classes.

The US is heavily weighted in the portfolio at 40 percent of assets, followed by Australia at 7.3 percent, Singapore at 4 percent, and Hungary at 3.3 percent. The US dollar is also the fund’s single largest currency exposure at 56 percent of assets.

Many Investors have become increasingly leery of the BRIC (Brazil, Russia, India and China) nations because of their slowing growth and tight economic links to Europe. But it’s a big world out there, and Andrew Foster, previously a fund manager and chief investment officer at Matthews International Capital Management, is still discovering numerous opportunities in emerging markets. In order to take advantage of investments in regions beyond the Asian focus of his former firm, Foster recently founded Seafarer Capital Partners and is now the lead portfolio manager of Seafarer Overseas Growth and Income (SFGIX).

Ben Shepherd: What’s your view on global growth?

Andrew Foster: Growth around the world is moderating, especially in many of the emerging Asian economies. However, the nature of that moderation is misunderstood and will be for some time. Emerging economies are transitioning to a more sustainable economic model, but that transition has been murky. As a consequence, investors are fearful of such change, and the eurozone’s economic turmoil has compounded the difficulties that large, emerging economies such as China and India are navigating.

But while the growth outlook is tricky, I don’t have particular concerns for the long term. In fact, valuations are quite accommodative of the medium- and long-term investor’s outlook.

Ben:  Can you describe these economic transitions in detail?

Andrew Foster: There are two transitions occurring, one of which is the shift from export-driven economies to consumption-driven economies.

Domestic consumption often gets conflated with consumers, and consumers are quickly conflated with material goods like cars and furniture. These are important areas to monitor if you’re a longer-term investor, but these themes have already received quite a bit of attention. As a result, the valuations in those sectors aren’t very favorable right now.

But I think the more important transition underway is the one from capital-intensive economies to service-oriented economies. Over the last century, the US economy shifted very dramatically from a manufacturing- and production-oriented economy toward a service-based economy. That shift has begun in emerging Asia, as well as some of the other global emerging markets.

These services include industries such as media and entertainment, tourism and leisure, as well as a host of professional services such as legal, accountancy and financial planning; these are industries that are really underpenetrated in most emerging economies.

For instance, health insurance has only recently begun to be offered in Singapore. Health maintenance organizations and health insurance just doesn’t exist in the region. That’s a basic consumer service that is largely untapped in one of the richest nations in the world. So I think the shift from external-production economies toward internal-service economies that focus more on intangibles and services, rather than consumables, is an important trend to watch.

Ben: Is the slowdown in global growth a natural consequence of that transition?

Andrew Foster: The shift among emerging economies to a new growth model is part of the story, but the slowdown has also been exacerbated by the eurozone’s debt crisis. Europe is a key export market for most emerging economies, so the Continent’s economic woes are taking a toll.

But I still believe that growth in emerging markets will be relatively robust, even if it’s not at the 10 percent to 11 percent rate that people have grown accustomed to from China, or the 7 percent to 8 percent rate that people look for from India. Growth will moderate, but it will also become more sustainable.

Ben: What countries are most attractive right now?

Andrew Foster: Vietnam is well positioned. Some investors are concerned that its growth model isn’t very healthy, since the state sector is not particularly well managed and creates distortions in the economy. But the private sector is vibrant and growing quite rapidly.

China and some of the other more developed emerging markets in Asia have been shifting their manufacturing bases to lower-cost economies. Vietnam stands to gain much of that business. Meanwhile, on the domestic front, Vietnam continues to make sound regulatory changes, even if those changes haven’t always pleased the market. For example, some investors are worried about heavy-handed regulations on Vietnam’s banking sector, but those concerns are misplaced. The regulators are acting in quite a benign way to promote medium- to long-term growth by forcing some consolidation among the banks and clamping down on certain speculative activities.

There’s also a lot to be excited about in Malaysia. Some interesting economies and sub-industries have begun to spring up there. For example, Malaysia has a growing medical equipment sector, and a number of burgeoning financial services industries. With regard to the latter, Malaysia has a leading global position in Islamic finance, predominantly serving Southeast Asia. These are intriguing niches where Malaysia has managed to secure a foothold and become quite competitive. On the other hand, the economy as a whole does have a fair bit of export sensitivity, and that could be problematic during a global downturn.

South Korea is another market that offers opportunity. Samsung Electronics (Korea: 005930, OTC: SSNLF) and Hyundai Motor (Korea: 005380, OTC: HYMTF) have become strong enough to practically dominate their industries. South Korea also has some very competitive and well-managed companies that are incredibly cash generative, but have yet to see their valuations rise to reflect their underlying fundamentals. Those stories are lost behind the excitement over the country’s export competitiveness.

There’s been a bifurcation in the market’s opinion about whether to favor companies that produce impressive top-line growth, but whose cash flows are not nearly as strong, or companies that produce strong cash flows, but have more moderate growth. That’s created a situation where investors interested in South Korea can still find defensive, undervalued names with attractive yields.

Thailand deserves attention too. We’re reasonably positive about Thailand’s political outlook, as well as the country’s recovery after last year’s floods. The economy seems to be picking up momentum after a difficult 2011, and we’ve been excited to see many Thai companies that had suffered serious setbacks regain lost ground. There’s reason to be optimistic about Thailand in that context.

Mexico also has a robust economy. It does have linkages to Europe, and there has been concern about the narcotics wars there. Despite those issues, the economy has been surprisingly stable and productive. And there are Mexican companies that offer attractive dividend yields and have healthy, unlevered balance sheets.

Ben: Do demographic trends influence your investment strategy?

Andrew Foster: Demographics can be a helpful analytical tool, but they don’t play a huge role in our investment process. Demographics only become real destiny when a society becomes very rigid about immigration and internal labor mobility. That’s a big issue in Japan, where labor mobility and immigration are fairly static. Japan’s demographics have become its destiny, and therefore its economy has been in a protracted decline.

Elsewhere in Asia, even in China, the markets are open, so even with challenging demographics, there are still enough levers they can pull to help correct the situation.

Ben: Are there any countries that should be avoided?

Andrew Foster: If Europe has a messy unwind, the financial markets will swoon, and that will have a global impact. Individual economies and financial markets are increasingly integrated at a global level, and that makes it much more difficult to escape a crisis.

That said, China will bear the brunt of the economic stresses that emerge from Europe since its integration with the eurozone is quite high. China would be hit harder than many other economies.

Ben: How should investors position themselves if Europe’s debt crisis worsens?

Andrew Foster: Although I think the eurozone will eventually unravel, and the currency will no longer exist in its present form within about five years or less, I don’t believe there will be a messy unwinds culminating with a short, sharp catastrophe.

Even so, investors interested in bolstering their portfolios against this scenario should take a look at the tremendous growth in the fixed-income markets in many emerging economies.

The valuation argument for equities in some of the smaller emerging markets is also fairly pronounced.

Outside the BRICs, there are equities that offer substantial dividend yields, even though they’re only paying out 20 percent to 30 percent of earnings. Low payout ratios provide an ample cushion for a company to sustain its dividend, even if earnings come under stress.

Such companies often have very little balance sheet leverage, so there’s not much debt to create a financial concern. Yet the equities that offer these yields aren’t particularly expensive because their prices have already been beaten down by investors concerned about waning economic growth.

Ben: Can you give a few examples of these companies?

Andrew Foster: In South Korea, Samsung Fire & Marine Insurance Co (Korea: 000815) and S-Oil Corp’s (Korea: 010955) preferred shares offer attractive yields, and their underlying companies boast solid balance sheets. They yield 5.25 percent and 8 percent, respectively, despite the fact that payout ratios for both companies are well below 50 percent.

Kimberly-Clark de Mexico (Other OTC: KCDMF.PK) is one of our larger holdings in Mexico. It’s an affiliate of Kimberly-Clark Corp (NYSE: KMB) via both economic and ownership arrangements, but it’s basically independently managed in Mexico. It offers a stable 3.5 percent dividend yield, but it does have a leveraged balance sheet. Although the company carries more debt than the two aforementioned South Korean names, management does place a high premium on paying a consistent dividend.

Ben: What’s your best piece of advice for investors over the next year?

Andrew Foster: Invest in the emerging markets on a diversified basis, and don’t be slavishly oriented toward the BRICs. Valuations are your friend, especially if you focus on income-generating equities. There may be some shocks that still emerge, however, so make sure you’re prepared to endure the ensuing volatility. And if the market does get bumpy, try to stay invested and even invest a bit more during down periods, as those offer the best opportunities to build a strong portfolio.

Besides bad teeth, the British have a reputation for lack of emotion (i.e., a stiff upper lip), courteousness, and playing by the rules. So it may surprise you to learn that most of the biggest financial scandals of the past decade have occurred in London or under London-based supervision:

1995: Nicholas Leeson – U.K.-based Barings Bank (Singapore office)

2007: Jerome Kerviel – Societe Generale (Paris office, but used London-based clearing and brokerage arm to make fraudulent trades).

2008: Joseph Cassano – American International Group (London office)

2010: Fabrice Tourre – Goldman Sachs (London office)

2011: Kweku Adoboli – UBS (London office)

2012: “London whale” Bruno Iksil – JP Morgan Chase (London office)

The infamous role played by London in these scandals is due to lax regulation by the Financial Services Authority (Britain’s version of the SEC) and the fact that the credit derivatives market originated in London.

JP Morgan Loses $2.3 Billion on “Hedge” Trade

The latest trading scandal involves JP Morgan Chase’s (NYSE: JPM) London office, which has lost $2.3 billion on an alleged credit-derivative “hedge” of Euro-denominated debt securities, with another $1 billion of losses likely to materialize before the position is completely unwound. Unlike the other scandals, this errant trade had the full approval of upper management, which in some ways is even scarier because JP Morgan is the largest bank in the U.S. The possibility that the risk managers of a “too big to fail” institution are incompetent makes the call for government regulation very compelling. How a hedge – which is meant to reduce the risk of loss – actually increased losses remains a mystery. But it’s also a mystery how such a huge trading loss could occur under the management supervision of CEO Jamie Dimon, who had until last week a deity-like reputation on Wall Street.

On Friday May 11^th when the news hit, JP Morgan’s stock nosedived 9.3% — its largest one-day percentage decline since last August during the market panic over S&P’s credit downgrade of U.S. debt. The stock decline wiped out $14.4 billion of JP Morgan’s market cap, which seems excessive given only a $2.3 billion trading loss, but investors are now worried about a lot more than the trading loss itself. Confidence in CEO Jamie Dimon management competence has been shaken to the core, as well as his ability to influence bank regulatory policy in Washington. Fitch Ratings downgraded JP Morgan’s credit rating to A+ from AA-, stating:

JP Morgan CEO Jame Dimon Ignored Risk Warnings

How could Dimon have let this happen under his watch?  Just last month, when rumors first started circulating that JP Morgan trader Bruno Iksil (nicknamed. the “London Whale” and “Voldemort”) had amassed a huge position of $100 billion in credit default swaps, Dimon and CFO Douglas Braunstein showed utter ignorance of the risk. During the bank’s first-quarter conference call, CFO Braunstein described the firm’s London-based Chief Investment Office (CIO) as low-risk:

We have more liabilities, $1.1 trillion of deposits, than we have loans, approximately $720 billion. And we take that differential and we invest it, and that portfolio today is approximately $360 billion. We invest those dollars in very high-grade, low-risk securities in order to hedge the interest rate risk of the firm.

The result of all of that is we also need to manage the stress loss associated with that portfolio and — so we have put on positions to manage for a significant stress event in credit. We’ve had that position on for many years, and the activities that have been reported in the paper are basically part of managing that stress loss position, which we moderate and change over time, depending upon our views as to what the risks are for our stress loss from credit.

All of those decisions are made on a very long-term basis. They’re done to keep the company effectively balanced from a risk standpoint. We are very comfortable with our positions as they are held today. And I would add that all of those positions are fully transparent to the regulators. They review them, have access to them at any point in time, get the information on those positions on a regular and recurring basis as part of our normalized reporting.

CEO Dimon followed up by saying that press reports of Iksil’s huge credit default swap positions were exaggerating the risks being taken in the CIO portfolio:

It’s a complete tempest in a teapot. Every bank has a major portfolio. In those portfolios, you make investments that you think are wise, that offset your exposures. Obviously, it’s a big portfolio. We’re a large company and we try to run it. It’s sophisticated, well, obviously, a complex thing. But at the end of the day, it’s our job to invest that portfolio wisely and intelligently.

In hindsight, Dimon and Braunstein’s assurances were complete garbage and make them look like fools. After news of the $2.3 billion trading loss broke, Dimon held another conference call and this time his story was completely different from the one he told a month earlier:

The synthetic credit portfolio was a strategy to hedge the Firm’s overall credit exposure, which is our largest risk overall. We’re reducing that hedge. But in hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored. The portfolio has proven to be riskier, more volatile and less effective an economic hedge than we thought.

These were grievous mistakes, they were self inflicted, we were accountable and we happened to violate our own standards and principles by how we want to operate the company. This is not how we want to run a business.

In an interview with Meet the Press, Dimon went further, saying the trade was “sloppy and stupid” and JP Morgan’s management “made a terrible egregious mistake.”

Heads Roll at JP Morgan But CEO Jamie Dimon Keeps His Job

The trade was authorized by former Chief Investment Officer Ina Drew, a 30-year veteran and highest-paid woman at the firm, who resigned on Monday. Also expected to resign this week are: (1)  Achilles Macris, head of the London trading desk, (2) Javier Martin-Artajo, one of Macris’ chief lieutenants, and (3) Iksil, the Frenchman who actually placed the ill-fated trades.

Conspicuously absent from the list of terminated employees is CEO Dimon. Since he is ultimately responsible for all management decisions, shouldn’t he be held accountable and resign? After all, while Dimon was not directly involved in formulating the specific trades at issue, he created the atmosphere of risk that allowed the egregious mistake to be made. Dimon has been a zealous critic of Ben Bernanke and the Federal Reserve for its efforts to regulate bank trading activities. At an April dinner party in Dallas, Dimon rudely characterized calls by former Fed Chairman Paul Volcker and Dallas Fed president Richard Fisher for stricter bank regulation as “infantile.” In JP Morgan’s annual report (pp. 35-36), Dimon harshly criticized both the Volcker Rule – which will curtail the proprietary trading of investment banks – as well as derivatives rules, which require that credit default swaps be cleared on a public exchange. Dimon ranted: “Let’s not destroy the world’s best capital markets” and warned that such rules will “severely inhibit American banks’ ability to compete and serve clients.”

Even after the $2.3 billion loss became public, Dimon refused to admit that the trade violated the Volcker Rule, stating in the May 10^th conference call (page 12) that:

We need to have the ability to hedge in a CIO type position and that Volcker allows that. This trading may not have violated the Volcker rule.

Under the Volcker rule – which won’t go into effect until July 2014 because the Fed hasn’t written definitions yet – “market-making” activities for clients as well as the “hedging” of an investment bank’s securities portfolio are exempt from restriction. But for Dimon to claim that a hedge that lost $2.3 billion is okay under the unwritten Volcker Rule is absurd. According to unnamed sources within JP Morgan, the hedge started off as a safe, risk-reducing insurance play that guarded against European bond defaults, but then was modified into a dangerous “hedge of the hedge” that actually made a huge bet on stronger European economic growth. The JP Morgan official admitted that the trade:

morphed into something we should not be doing. We don’t think where it ended up would be consistent with the Volcker Rule.

JP Morgan CEO Jamie Dimon Should Resign

Why couldn’t Dimon have been as honest as this unnamed JP Morgan official and conceded the illegality of the trade? Perhaps Dimon’s reluctance is based on the fact that he encouraged Ina Drew ‘s Chief Investment Office to do more than hedge the firm’s portfolio exposure; Dimon wanted the CIO to be a profit center for the firm. Profit generation requires enhancing vanilla hedges with risky side bets, which were called “icing” on the hedging cake. This pursuit of “icing” is a form of proprietary trading prohibited by the Volcker Rule. Former CIO Drew made $14 million in salary and bonus last year. Pure hedgers don’t make that kind of money. Thanks to Dimon, Drew was given strong financial incentives to take risks with firm capital to generate as much “icing” as possible on trading hedges.

Bottom line: How can anyone trust Dimon anymore?

MIT economics professor Simon Johnson doesn’t trust Dimon anymore and says that Dimon should be forced to “resign in disgrace.” Similarly, Massachusetts Senate candidate Elizabeth Warren – who exaggerated her Native American heritage in order to get appointed to a tenured law professorship at Harvard – says that Dimon should also be forced to resign from his position as a director of the New York Federal Reserve Board because it is a “position of trust.” I’ll let the irony of Warren’s statement about trust go unchallenged and just agree with her that Dimon’s regulatory advice should no longer be welcome at the Fed.

In October 2009, a book came out entitled Last Man Standing: The Ascent of Jamie Dimon and JP Morgan Chase, which extolled the virtues of Dimon as a financial risk manager during the 2008 global financial crisis. Dimon has now fallen and he cannot get up. His reputation is ruined, just like that of former MF Global CEO Jon Corzine. For the sake of JP Morgan shareholders and the financial industry at large, Dimon should take responsibility for his encouragement of excessive risk-taking and follow Ina Drew out the door.

I’m saddened that at JP Morgan’s annual meeting today, shareholders approved Dimon’s $23 million pay package and also allowed him to remain Chairman of the Board in addition to his CEO position. Something is wrong with corporate governance in the United States when CEOs are never punished. More now than ever, it’s time to regulate the investment banking psychopaths who prove over and over again that they put personal profit ahead of the public good.

When Scott Thompson arrived at Yahoo! Inc. (NasdaqGS: YHOO) after a successful term as head of eBay’s (NasdaqGS: EBAY) PayPal unit in January, there was a sense that the company might finally be finding its footing.

It had been a long time coming, too: Yahoo Inc. had endured a long period of turmoil that started in 2008 when the company turned down a $31-a-share takeover offer from Microsoft Corp. (NasdaqGS: MSFT).

In May 2010, Chinese e-commerce company Alibaba, in which Yahoo owns a 40% stake, transferred its Alipay subsidiary to another Chinese company 100% owned by Alibaba chairman Jack Ma. Alipay represented $1.7 billion of Yahoo’s valuation at the time, but the company was never informed of the transfer. Yahoo and Alibaba later negotiated a settlement in which Alibaba would retain a 37.5% stake in Alipay’s equity value, but it was still a major loss for Yahoo.

How Things Went From Bad to Worse at Yahoo! Inc.

All this led up to the firing of former CEO Carol Bartz in September 2011. And if that wasn’t enough, the company seemed to be hurtling toward a messy and expensive proxy fight with hedge fund Third Point, run by activist investor Daniel Loeb, which owns 5.8% of Yahoo Inc.

That dispute centered around the company’s rejection of Third Point’s nominees to the Yahoo board (one of which was Loeb himself) in March 2012 in favor of its own nominees. At the time, Yahoo! Inc. backed up its decision by saying that “other candidates were more qualified for the position,” and “that appointing Mr. Loeb to the Board is not in the best interest of the Company and its shareholders.”

The conflict got even uglier two weeks ago, when Loeb accused Thompson of padding his resume by claiming to have a computer science degree that he didn’t, in fact, have. Thompson later admitted to the inaccuracy.

Desperate to get a handle on the situation, Yahoo struck an independent committee to look into Thompson’s credentials. That provoked a harsh response from Loeb: “It seems farcical to us,” he wrote in a May 9 letter to the board, “that the board will most likely spend more time deliberating over whether Mr. Thompson should be fired than it did properly vetting whether he should have been hired.”

Thompson Exits Yahoo! Inc.; Loeb Wins Big

What, then, to make of the events of this past weekend? In a Mother’s day press release, Yahoo! Inc. announced that Thompson had left the company, and that Ross Levinsohn, former head of Yahoo’s Americas division, would take over as interim CEO. And in a major win for Loeb, the company relented and allowed three of Third Point’s nominees, including Loeb himself, to join the board.

The exact circumstances of Thompson’s departure weren’t immediately clear, and were further clouded by reports on Monday that the former CEO had told his colleagues at Yahoo that he was suffering from thyroid cancer.

Analysts See the Clock Ticking on a Yahoo! Inc. Turnaround

Still unclear is where the company goes from here. Thompson had begun a restructuring, including laying off 2,000 workers and focusing on media and advertising, but the company didn’t say whether it planned to continue down that path.

At TheStreet.com, Charles Ciaccia thought new CEO Levinsohn should look to none other than legendary investor Warren Buffett for ideas on how to turn Yahoo around. Ciaccia wrote:

“When Buffett took over Berkshire Hathaway in 1962, it was a struggling New England textile firm, but thanks to purchasing businesses outside of textiles (namely insurance and savvy investing from Buffett), Berkshire transformed itself. Yahoo could do something similar, albeit focused on the technology space.”

According to Ciaccia, step one would be a renewed push to unlock some of the company’s value, which mainly consists of its stakes in Alibaba and Yahoo! Japan, and slowing share buybacks to conserve cash. It would then use these funds to buy high-growth businesses, utilizing Loeb’s skill at investing in undervalued companies.

What Yahoo Really Needs? “Another Steve Jobs”

Taking the less optimistic view was Forbes.com contributor Erika Morphy, who thought that after all these years of turmoil, Yahoo is simply too far gone for a turnaround.

But if the company is to rise again, she thinks it needs someone in the mold of another business titan, Steve Jobs, someone who “can turn Yahoo around through sheer force of intellect, will, personality and imagination.”

But who would be willing to take on such a task? In Morphy’s view, “no one in his or her right mind, that’s who.”

Valuable Asian Assets Aren’t Enough to Drive Yahoo’s Renaissance

In the end, though Yahoo’s Asian assets are valuable, it’s hard to see how a company with so many internal struggles will be able to compete in the cutthroat Internet business in the long term, especially when it’s up against dominant companies like Google (NasdaqGS: GOOG). and social networks like Facebook.

The stock has more or less been moving sideways at around $15 since late 2008. That reflects the ongoing internal instability at the company. And given the events of the past few weeks, it’s hard to see how it’s going to break out of that range anytime soon. 

People continue to miss significant opportunities to maximize their Social Security retirement benefits. The problem is especially acute among married couples who don’t consider the long-term effects or don’t know the interaction between personal retirement benefits, spousal benefits, and survivor benefits. It’s a once-in-a-lifetime decision, but the benefits or drawbacks of the decision will last your lifetime and beyond.

For a single person, delaying SS benefits generally is a winner. Your benefits increase by 8% for each year you delay through age 70. These days, it’s tough to find a return like that elsewhere. Plus, SS benefits are indexed for inflation and lifetime guaranteed.

Married couples have more options and considerations. It’s worth the time to consider the choices and make the best one. You’ll accrue the benefits every month for the rest of your life, and even beyond when your spouse survives you.

A spouse can receive retirement benefits based on either his or her own working record or 50% of the normal benefits earned by the other spouse, whichever is higher. The latter are known as spousal benefits. But the benefits will be reduced if this spouse claims benefits before normal retirement age (age 66 for people retiring today). In addition, you can claim spousal benefits only if your spouse already has filed for his or her retirement benefits.

Survivor benefits are 100% of what the deceased spouse was receiving at his or her death. An advantage of survivor benefits is that they aren’t reduced when the surviving spouse began receiving retirement benefits before his or her normal retirement age. So a spouse can begin benefits at age 62 without affecting survivor benefits. (A surviving spouse receives the higher of his or her earned benefits or the survivors’ benefits, but not both.)

Those are the basic rules. Let’s look at some nuances and strategies you should consider to maximize the family benefits. To keep it simple, I’ll assume the wife’s earned benefit is less than the husband’s and that they’re both the same age.

Collect now, collect more later. Let’s say the wife begins receiving her retirement benefits at age 62. She would have been entitled to $1,600 per month at age 66 but receives 25% less, or $1,200 monthly, at age 62. The husband plans to wait until age 70 to begin receiving his benefits to maximize the benefits and also maximize his wife’s survivor benefits.

The husband has another option. After reaching full retirement age (age 66 for people retiring now) he can file a restricted claim. That is, he files only to claim the spousal benefits of 50% of his wife’s benefit. He would receive half of what his wife would have received at her full retirement age. That’s $800 (half of $1,600) per month.

Then, at age 70 he can file to claim his own retirement benefits. He won’t be treated as having filed for retirement benefits early and will receive the full bonus for waiting until age 70.

Claim and suspend. Remember a spouse qualifies to receive the spousal benefit of half the other spouse’s earned benefits only if the other spouse already has filed to receive retirement benefits. In this case, the husband wants to wait until age 70 to begin his benefits, but there’s a way he can receive the advantage of waiting until age 70 and still allow his wife to claim a spousal benefit of 50% of his earned benefit. He can claim and suspend. That means at age 66 or later he can file for his SS retirement benefits, and then he can immediately file to suspend his payments. His wife still can receive her spousal benefit based on his earned benefits. When he reaches age 70, he ends the suspension and begins receiving benefits based on his current age.

There are special rules for those many of those receiving federal and state pensions, but for most people these are the rules and strategies.

I think most people should have a couple of goals for their SS benefits. When you’re married, a major goal should be to maximize the survivor benefits available to the lower-earning spouse. Survivor benefits are a form of life insurance that pays an inflation-adjusted annuity. That means the higher-earning spouse should delay beginning benefits until age 70.

Another goal should be to maximize lifetime cash flow. For unmarried people, that means delaying the receipt of SS benefits as long as possible, preferably to age 70. Even if that means spending from your nest egg first, it’s usually a good idea. That’s because each year you wait to begin SS benefits increases the benefits by 8%, and those benefits are indexed for inflation and guaranteed for life.

For married couples, the higher-earning spouse can maximize his lifetime benefits and his spouse’s survivor benefits by delaying retirement benefits until age 70. At the same time he can increase the family’s cash flow by either filing to receive a spousal benefit based on his wife’s earned benefits or claiming and suspending his benefits so his wife can receive 50% of his earned benefit.

Divorced persons have some special considerations. You can receive retirement benefits based on your ex-spouse’s earnings record when the two of you were married for at least 10 years; you’re at least 62 years old and unmarried; and is entitled to a benefit based on your own record but those benefits would be less than those as a divorced spouse. When you have been divorced at least two years, you can apply for divorced spouse benefits even when the other ex-spouse hasn’t applied for retirement benefits. The receipt of benefits by a divorced spouse doesn’t affect the amounts paid to the other spouse and any current spouse. So, three people can receive benefits at the same time based on one earnings record. A divorced spouse’s benefit is 50% of the other spouse’s full retirement benefit if the divorced spouse doesn’t apply for benefits until reaching his or her full retirement age.

When your former spouse passes away, you still might be eligible for divorced spouse survivor benefits.

You can find more details about these and other aspects of Social Security retirement benefits in my report Secrets to Boosting Social Security Benefits and in my book, Personal Finance for Seniors for Dummies (with Eric Tyson). Also, the Social Security web site has details on these rules and offers some free calculators you can use to see results for different options. Making the right choice for Social Security benefits can generate more cash than all the investment decisions you’re likely to make over the next couple of decades.

While we all like to analyze individual stocks and invest in those we think can beat the market, it is sometimes wise (and certainly less time-consuming) to hedge your bets and achieve instant diversification through a mutual fund. Closed-end funds (CEFs) are actively managed mutual funds that trade on stock exchanges.

They’re called “closed” because they don’t accept new investment dollars or redeem existing investment dollars – the investment capital is fixed at the time of the initial public offering (IPO). The only way to invest in CEFs after their IPO is by purchasing shares on a stock exchange.

Exception: CEFs may periodically conduct “rights offerings” that permit current stockholders to purchase additional fund shares directly from the fund.

CEFs don’t permit investors to cash out at the fund’s net asset value (NAV) — the per share value of the fund if you were to add up the dollar values of all the individual securities in its portfolio and divide by the number of shares outstanding. Instead, shareholders must sell their shares to other investors on an exchange. Thus, share prices are subject to the psychological whims of investors, and shares often trade at wild deviations from the fund’s NAV.

Only Invest in CEFs Trading at a Discount

If you wait until a CEF trades below its NAV, you are setting yourself up for a double benefit. Not only can you gain from the capital appreciation of the securities held by the CEF, but you also can profit if the price of the CEF itself moves up toward its NAV. Of course, nothing says that the discount at which a CEF trades can’t widen even further, so you should look at the discount’s 52-week average to make sure the discount hasn’t historically been much greater. A good place to check out a CEF’s 52-week average discount is www.cefconnect.com.

The key to successfully investing in CEFs is to buy them when they are selling at a discount to NAV. Of course, as with stocks, it’s important to investigate why they’re “on sale” — and find out if you’re really getting a bargain. Some CEFs trade at a discount because investors lack confidence in the management team, there is a large unrealized tax liability, or the fund employs high-risk leverage, so it is important to do your due diligence, just as you would with any investment. In other words, a CEF trading at a discount to NAV does not automatically mean that it is a bargain.

Stay Away from CEFs Trading at Premium

In contrast, a CEF trading at a premium to NAV is almost never a good investment. Premiums exist due to investor speculation or confidence in the investment prowess of the manager. For example, bond funds managed by PIMCO often trade at a premium because investors respect PIMCO’s bond trading prowess. I once shorted a PIMCO CEF trading at a double-digit premium only to find it expand to an even greater premium. I didn’t enjoy that experience, so I am hesitant to short CEFs trading at a premium (especially any managed by PIMCO), but I still won’t buy them either.

Investing Daily’s Ben Shepherd is not a fan of CEFs for a couple of reasons:

Closed-end funds are burdened with two significant disadvantages.

The most obvious problem is pricing. Regardless of the quality of the bonds making up a closed-end fund, because shares trade just like any other stock, they often change hands at substantial premiums or discounts to their net asset value (NAV). Unless you’re engaging in a bit of arbitrage or making a speculative bet on the recovery of specific areas of the bond market, that’s a disadvantage to investors.

There’s also the issue of leverage. Closed-end funds have a long history of issuing preferred shares and auction rate securities (ARS) in order to juice the returns they offer investors. That can be attractive in bull markets, with positive returns amplified by the leverage. But in down markets plunging share prices are just as exaggerated. And closed-end funds aren’t always as transparent on this issue as they should be.

Focus on CEFs with Low Expense Ratios

Another important factor to consider is the CEF’s expense ratio, which includes management and marketing fees. Fund performance is uncertain, but fund expenses are predetermined, so investing only in CEFs with modest fees is a smart way to reduce your risk. Theoretically, CEFs should have lower expenses than open-ended funds because CEF managers have a captive investment base and don’t have to worry about redemptions — which can add to trading costs. In reality, I have found many CEFs charge exorbitant fees either because their fund’s asset size is too small – thus forcing a higher percentage of fixed costs to be absorbed per investment dollar — or because they unethically take advantage of the captive investment base, knowing that redemptions are impossible.

Buying CEFs at Their IPO is a No No

Never buy a CEF at the time of its initial public offering (IPO). Brokers often tout CEF IPOs as “commission-free,” but what they don’t say is that the offering price includes an embedded sales charge, resulting in a price that is around 5% higher than the fund’s NAV. For example, many CEF IPOs are offered at a price of $20 with an initial NAV of between $19.00 and $19.10. Buying $19 worth of assets for $20 is not a smart way to invest, especially since academic studies have shown that the typical CEF loses 8% of its value in its first 100 days of trading and 12.6% in the first five months.

A 2004 study by Thomas J. Herzfeld Advisors drew this conclusion about CEF IPOs:

Investors in IPOs of closed-end funds rarely make money just after the offering: In fact almost all investors wind up underwater over the short term. But there is often a lot of money to be made by buying the new issues three to six months after launch for two reasons: There is usually a lack of research on these issues and many are dumped for tax losses toward the end of the calendar year.

List of CEFs Worth Considering

Below is a list of CEFs that pay at least a 5% annual dividend, are trading at a discount to NAV of at least 8%, and charge no more than 1.25% of assets in non-leveraged management expenses. They are not recommendations, but merely a starting point for further research.

Source: www.cefconnect.com

*As of May 11, 2012. **As of Dec. 31, 2011. ***May include capital gains or return of capital.

The surest way to turn a small loss into a big one is to become obsessed with a falling stock. That’s why I’m adamantly opposed to “averaging down” when a stock drops.

There’s no such thing as perfect information in the stock market. The more times you double down, the more you’re at risk to events beyond your knowledge and control–and the more in danger you’ll be of succumbing to emotions that will cloud your judgment.

At least that’s been my experience as an investor. The irony is real crack-ups at companies are thankfully rare birds. In the vast majority of cases, a falling stock will catch itself by finding a value point, and then recover either as market conditions improve or the company gets its act together.

From the fall of Lehman Brothers in September 2008 to the market bottom in March 2009, even Southern Company (NYSE: SO) and Wisconsin Energy (NYSE: WEC)–considered the gold standard of the steady electric utility industry–lost 28 percent and 20 percent, respectively. The Philadelphia Utility Index that I track in Utility Forecaster lost a blood-curdling 35 percent.

Ironically, of the 100 plus electric and gas utility companies I track in Utility Forecaster, only one company cut its dividend over those six months. That was the former Constellation Energy, which eventually doubled off its post-dividend cut low and is now part of Exelon (NYSE: EXC).

Clearly, it would have been a horrible idea to bail out of these utility companies in late 2008 or early 2009, including Constellation. But the fact that prices fell so far so fast clearly shows that many people abandoned the sector, believing that the market action presaged disaster for the companies and their dividends. Sadly, they locked in losses and were forced to buy back in at higher prices, if they came back at all.

We got a minor taste of 2008-style downward volatility in mid-2010 and again in the summer of 2011. Each time, investors inferred that falling prices were the harbinger of doom for the underlying companies and their dividends. They were right in a few cases. But the vast majority of stocks–including all of the utilities–kept paying their dividends, and in many cases increased them. Then when market conditions turned more favorable, the stocks recovered in full, and often ascended to new heights.

Of course, there was plenty of smoke at the bottom. But the only fire at these companies was fueled by their profit growth, and eventually it ignited robust shareholder returns. The only investors who got burned were those who fled when things looked their worst.

History rarely repeats itself in precisely the same manner. But as emotion rules the stock market at least near term, past is often prologue. Lately, the conventional wisdom seems to be the stock market is on the verge of disaster, possibly an even worse debacle than 2008. As a result, investors are as skittish as I’ve ever seen.

Buyers flock to familiar names for safety, pushing them ever higher and well above fair value. Meanwhile, any stock that weakens, for whatever reason, is treated as toxic. Normal daily volatility can suddenly turn into a wave of selling, which then invites more selling, as 2008-wary investors panic and throw in the towel.

To be sure, economic conditions are far from perfect now. And there are plenty of catalysts for an overall market correction of 10 percent to 15 percent, as my colleague Elliott Gue is forecasting. In fact, it would be a very rare year indeed if we didn’t see that kind of action at least once.

On a company level, subpar conditions mean there’s also higher-than-normal potential for individual crack-ups. The massive decline in North American natural gas prices this year is still filtering through a wide range of industries, many of which aren’t involved in the actual production of gas. So far, there have thankfully been few real disasters in earnings, but that possibility remains for later this year as fallout spreads.

Europe’s economic weakness and turbulent credit markets have wreaked havoc on companies there, even those providing essential services like electricity. Investment-grade US companies are borrowing at record-low rates, but the less creditworthy face somewhat more difficult conditions. And still other companies are challenged by competition and erratic regulation.

However, we’ve been living under these same conditions of sluggish economic growth and uncertain credit markets now for the better part of three years. Company managements are well aware conditions can shift to the negative, and as first-quarter conference calls indicate, most are preparing for the worst case by pursuing conservative financial and operating policies.

In other words, dividend-paying stocks are going to remain volatile for the rest of 2012 and probably well beyond. But the number of true company crack-ups is going to be small. And that means the vast majority of stocks that fall in the coming months are going to recover, no matter how panicked investors become in the meantime.

Here’s how to spot and deal with crack-ups as they occur, so you can minimize losses and stay in the game for powerful total returns from the majority that may bend but won’t break.

• Never average down on a falling stock, unless you’re systematically reinvesting dividends through a dividend reinvestment plan. This ensures your loss will never be more than your initial investment, and almost surely a lot less.
• Don’t sell unless the company’s numbers show the business is weakening enough to threaten the dividend. In this market, stocks sell off in anticipation of nasty developments whether they occur or not. Consequently, odds are the stock will already have lost some ground by the time real trouble appears. But this will save you from bailing out of a good company at a bad price, which is ultimately the greater danger.
• The payout ratio is the single most important gauge of dividend safety, but only if you have the right measure of profits for the company in question. Master limited partnerships (MLP), real estate investment trusts (REIT) and many of the former Canadian income trusts pay dividends from cash flow, called alternately “distributable cash flow,” “funds from operations” or some variant. Earnings per share (EPS) is entirely irrelevant.
• To calculate a payout ratio, divide the quarterly dividend by the most recent quarter’s relevant measure of profit. Lower percentages are always best, though some businesses such as pipelines generate reliable cash flow for companies to pay out substantially all income.
• Ignore headline earnings releases. These are generated by computer and convey essentially useless information.
• Do your own digging. Don’t take someone’s word that a company you own is cracking up, particularly if it’s a television personality. They’re trying to attract viewership, so hyperbole will always trump insightful analysis. If you don’t want to review the earnings release or read the conference call yourself, find a trusted resource that will pore over such data for you.
• Don’t rely on broad-based data sources such as those offered by major brokerages to find payout ratios for your company. These are universally based on headline EPS, which is rarely accurate for corporations that use EPS as their gauge for paying dividends. They’re going to be wildly misleading for MLPs or any company paying dividends via cash flow.

I calculate payout ratios by hand for all the 200-plus companies in Utility Forecaster. The next set of data will be presented in the “How They Rate” table of the June issue, which will be available at www.UtilityForecaster.com on Jun. 2.

The normally obscure US trade finance entity known as the Export-Import Bank has garnered attention recently from politicians and pundits over the manner in which its policies potentially distort the marketplace. The timing of this debate had been driven by the reauthorization of the institution’s lending authority, which was set to expire at the end of May and effectively cap its financing ability at $100 billion.

On Wednesday, the US House of Representatives passed legislation to boost the institution’s lending authority over each of the next three years, initially by 20 percent to $120 billion in 2012 and ultimately by 40 percent to $140 billion in 2012.

Like many investors, I’d prefer our policymakers to err on the side of free enterprise. But the fact is that America’s vaunted free-market system is more of a hybrid of market-based actors and government enablers. While our government isn’t known for being particularly adept at picking winners and losers (ahem, Solyndra), if “Uncle Sugar” is favoring particular firms with its largesse, it behooves us as investors to consider whether those firms merit our consideration. After all, if a firm is shrewdly using the government’s coffers to its advantage, that should ultimately aid its bottom line–especially when it’s already a well-established firm, as opposed to a tiny renewable energy startup (cough, Beacon Power).

The Export-Import Bank (ExIm Bank) is an independent federal agency that provides export credit to foreign buyers of American goods via loans at below-market rates. Additionally, it provides loan guarantees to banks that agree to lend at favorable rates to a US company’s end buyers in foreign countries. The ExIm Bank is self-sustaining, which means that the fees it collects more than offset its expenditures. Since 1990, the bank has returned $4.9 billion to the US Treasury in excess of what was appropriated for its operating costs. Of course, the US taxpayer would still be on the hook to bail it out in the event it suffered financial distress.

Despite Its Small Business Mandate, the ExIm Bank Favors the Big Boys

Although only a subset of House Republicans voted against the bank’s reauthorization earlier this week, it has faced criticism from members on both sides of the aisle. In the past, Democrats have inveighed against the bank for providing “corporate welfare” to large firms that already have myriad sources of private sector financing. To that end, since 2002, Congress has mandated that at least 20 percent of the bank’s annual financing be steered toward small businesses.

Although the ExIm Bank touts the fact that over 85 percent of its transactions facilitated small business exports, the cumulative dollar amount involved in these deals is dwarfed by similar deals made on behalf of giant firms such as Boeing (NYSE: BA) and General Electric (NYSE: GE).

To be sure, small business financings have averaged 21.7 percent of the ExIm Bank’s total lending authorization over the past five years, with the dollar amount of transaction volume rising to just over $6 billion for fiscal-year 2011 from $3.4 billion in 2007. By contrast, Boeing alone secured $11.7 billion in long-term loan guarantees for buyers of its commercial aircraft, which accounted for 75.5 percent of the ExIm Bank’s $15.5 billion in total long-term loan guarantees.

The United Kingdom’s Inmarsat (LSE: ISAT.L) also received a $700 million long-term loan to finance the purchase of Boeing’s satellite technology. That loan accounted for 11.1 percent of the ExIm Bank’s $6.3 billion in long-term loans.

In sum, Boeing’s foreign trading partners received financing that accounted for 37.9 percent of the ExIm Bank’s $32.7 billion in 2011 funding authorizations.

From a taxpayer perspective, that’s a tremendous amount of exposure to a single firm. But from an investor perspective, one can’t help but marvel at Boeing’s ability to singlehandedly dominate a government agency.

Boeing’s Chief Competitor Is Also Heavily Subsidized

Critics contend that subsidizing Boeing’s sales to overseas buyers puts other US companies at a disadvantage, particular a US airline industry whose purchase of commercial aircraft from Boeing is not subsidized in the manner of its foreign competitors. Indeed, Delta Air Lines (NYSE: DAL) says that had it been eligible for such subsidies, it could have saved $100 million a year in financing costs.

Of course, supporters of ExIm Bank policies note that Airbus, a subsidiary of the European Aeronautic Defence and Space Company (NYX: EADS) and Boeing’s primary competitor, receives even larger subsidies than Boeing. Although it can be difficult to determine the extent to which foreign firms are subsidized, the World Trade Organization recently found that Boeing’s subsidies from the US government were greatly exceeded by the subsidies Airbus received from European nations.

That suggests that any potential advantage Boeing receives from the ExIm Bank’s financings could be more than offset by the fact that its chief competitor is even more heavily subsidized. Nevertheless, Boeing outperformed the S&P 500 by 2.2 percentage points annually over the trailing 10-year period

That Was the Winner, Here Are the Losers

After Boeing, General Electric (NYSE: GE) is the next major beneficiary of the ExIm Bank’s attentions. The conglomerate’s foreign buyers received $255 million in long-term loan guarantees and $1 billion in long-term loans, the latter of which accounted for 15.9 percent of the ExIm Bank’s total long-term loans last year. GE shareholders have lagged the S&P 500 by a substantial 5.7 percentage points annually over the trailing 10-year period.

Although Boeing’s shares have performed well, it may be ill-advised to build a portfolio based on which firms the ExIm Bank tends to favor. That’s further underscored by the fact that last year the ExIm Bank financed deals for at least three troubled companies, two of which have already filed for bankruptcy.

The aforementioned Solyndra was involved in a deal where a foreign buyer received a $10.3 million long-term loan guarantee from the ExIm Bank in mid-February last year, a little more than six months before the solar panel manufacturer filed for bankruptcy.

And Hawker Beechcraft Corp, which manufactures business jets and is owned by a consortium that includes Goldman Sachs (NYSE: GS) and Onex Corp (Toronto: OCX.TO), was involved in deals that included $83.7 million in long-term loans and a $7.8 million long-term loan guarantee. The firm filed for Chapter 11 bankruptcy protection late last week.

Finally, beleaguered solar panel maker First Solar’s (NasdaqGS: FSLR) foreign trading partners received $447.6 million in long-term loan guarantees and $100.1 million in long-term loans. The firm now trades toward the bottom of its 52-week range, down roughly 89 percent from its 52-week high.

Although Boeing remains a clear winner, the results for some of these other firms are dismal. Sadly, the government’s ability to “pick winners and losers” may reside solely in its ability to confer advantage, and not in its ability to tip us to a portfolio of market-beating investments.

It’s still way too early to call an end to this sell-off; check out my table below.

The market is vulnerable to summer sell-offs even in years when stocks generally perform well. For example, the market rallied an impressive 21 percent back in 1999 but saw a vicious 13 percent correction that lasted from mid-July until mid October. And while 2010 brought a more than 15 percent gain in the S&P 500, that move was punctuated by a more than 17 percent downturn from late April through early July.

In years when the market generally performs poorly such as 2001 and 2002, the May to September period often takes the form of acceleration in the pace of selling. These can be even more painful events: the S&P 500 plummeted nearly 35 percent between March and July 2002 before putting in a historic bottom late in the year.

In 2008, the market didn’t see a definitive summertime correction because stocks steadily marched lower that year, seeing only a modest year-end rally before resuming their downtrend in early 2009.

The average summertime correction in years when the market generally rallies is 11 percent and the average duration of the downturn is just under 3 months. Unless the economic data deteriorates further, I’m looking for a pullback of roughly average duration and severity this summer. Such a move would see the S&P 500 re-test the 1,270 to 1,280 support area and find a bottom at some point over the summer.

From a fundamental perspective, my call for a pullback in the broader market averages has been predicated on a number of potential downside catalysts. Here’s an updated outlook on a few of the more important:

Seasonality

The warmer-than-normal winter threw off the government’s seasonal adjustments to key data series such as jobless claims, construction activity and consumer spending. As a result, the data was artificially strong over the winter months and is now weakening as seasonal tailwinds fade. This seasonal effect has panned out as I expected; the weaker-than-expected March and April employment reports have been a significant driver of the broader market sell-off.

That said, US economic data hasn’t softened to the same degree it did in 2010 and 2011 so far this year. In fact, this week the four-week moving average of jobless claims has fallen to 379,000, down from 384,500 a week earlier. If jobless claims numbers continue to trend down over the next few weeks, it would be a sign the seasonality hangover is already abating.

I’ll also continue to watch the Citigroup US Economic Surprise Index, a measure of how economic data compares to consensus expectations (see chart below). Currently, this index stands at minus 24.3, an indication that economic data has actually been broadly below expectations over the past month.

Source: Bloomberg

That said, the Citigroup Surprise Index has not collapsed as quickly it did one year ago. We’re seeing an economic soft patch but the slowdown doesn’t appear to be as dramatic as was the case one year ago.

Of course, I will continue to monitor the incoming economic data in May and June. If we see further deterioration, I might need to increase my expectations as to the length and severity of the broader market correction.

Gasoline Prices

The surge in crude oil and gasoline prices in the first part of 2012 was a major risk. A spike in oil was one factor that contributed to the summertime economic soft patch in 2011 and there was a risk of a similar retrenchment in 2012.

However, crude oil prices have now declined significantly, whether you look at the US West Texas Intermediate (WTI) benchmark or Brent. In fact, crude oil and retail gasoline prices in the US are now actually lower than they were one year ago; the energy price headwinds that looked formidable two months ago have abated.

Political Uncertainty

Political uncertainty surrounding the French and Greek elections over the past few weeks and the US presidential election this coming November remain a major obstacle for global markets this summer.

In France, socialist Francois Hollande beat incumbent center-right candidate Nicolas Sarkozy. Hollande’s rhetoric suggests that he’s opposed to many of the fiscal austerity measures imposed by the Sarkozy government. This may also mean that the relationship between France and Germany’s generally pro-austerity Chancellor Angela Merkel is less cozy than was the case with Sarkozy at the helm.

To date, I’m not seeing many signs of stress in the European sovereign credit markets as a result of the French elections, but I will continue to watch the spread between the yield on French and German 10-year government bonds closely (see below).

Source: Bloomberg

A spike in French yields relative to those of Germany would indicate market concerns that Hollande’s government plans to abandon austerity and fiscal discipline.

In the US, the looming question remains the future of fiscal policy after the November elections. The nation faces major tax hikes in 2013, because the tax cuts put in place during the George W. Bush administration are due to expire unless Congress and the president agree to another 11^th-hour extension. Moreover, last summer Congress and President Obama agreed to a number of automatic spending cuts as part of the debt ceiling compromise. Those spending cuts would go into effect in 2013 if Congress and the President can’t agree to delay these measures.

If all of the planned tax increases and spending cuts go into effect, it would represent the largest fiscal contraction in the US since World War II and would almost certainly push the fragile US economy back into recession. I seriously doubt the government will allow this to happen, but it’s a material risk and there’s not likely to be much clarity on fiscal policy until after the November elections.

Interestingly, Cisco’s CEO John Chambers remarked during the company’s recent quarterly conference call that one of the main reasons its customers are holding back on technology spending is uncertainty about US fiscal and monetary policy after November.

Europe

Europe is in a recession and economic trends on the Continent continue to deteriorate. Only the German economy is showing any real resilience and the outlook for fiscally challenged economies such as Italy and Spain remains grim.

Spanish 10-year government bond yields have spiked to around the 6 percent danger zone, while Italian bonds are yielding close to 5.5 percent, only marginally better. A spike in Italian and Spanish yields back to 6.5 percent or so would likely catalyze a more severe sell-off in global stock markets just as it did last summer.

All told, the market continues to face several major risks this summer and I’d expect to see the risk-off trade gain momentum over the next two months, taking the S&P 500 back under 1,300. However, the risks this summer appear to be less severe than was the case one year ago, so I’m looking for a milder sell-off.