February 1, 2009
“If all the economists in the world were laid end to end, they still wouldn’t reach a conclusion”-George Bernard Shaw
Weekly percentage performance for the major indices
Calculated from last Friday's official settlement...
I had an annual dinner last week with a handful of friends from Business School. The conversation (and the meal) was great, and I enjoyed learning how my much smarter classmates have been fairing during these rough economic times. A senior investment banker friend made two comments which stuck with me during the meal. The first was how his firm plans major layoffs, which they will time just before bonus payments to avoid having to pay the newly unemployed for their work during 2008. That’s cold! The second comment was that he really felt last week’s note wasn’t my best because “it wasn’t as funny as usual.” As I always remind you, I’m trying, however, I only comment on what I see and sometimes it’s difficult to find humor in this economy, despite the stupid comments that keep coming out of Washington, Wall Street, and Main Street.
Tonight’s Super Bowl was a lot like the past year in the market-lot’s of records and firsts (100 yard plays, safeties, six-time champions, 39 year old quarterbacks, one team’s first title game in 60 years, youngest coach to win a Super Bowl, etc). There were a lot of people not planning on watching tonight’s game (hello, Boston), and to those I say too bad. Outside of the Patriot-Panther game five years ago, tonight’s game was probably the best Super Bowl I’ve seen. Although there were too many penalties, there were so many amazing individual performances (and of course the great finish) that I marvel at what great athletes these guys truly are. How about a 100 yard interception return for a touchdown? What about Larry Fitzgerald, almost a footnote in the game until the fourth quarter, then showing how amazing he is with two great touchdown catches? And what can you say about Santonio Holmes? Was that an unbelievable catch with triple coverage, fully laid out, on his toes?!!!
Looking at the economics, the game generated roughly $150 million for the local economy, 22% less than last year’s game between the Giants and the Patriots. Long time and well-respected Goldman analyst Anthony Noto is now the CFO of the NFL (I’ve included him on this week’s list), and is facing the first downturn in the league since George Clooney played without a facemask. In a sign of the times, the league has reduced its payroll by 150 employees, and even cut prices on some tickets for this year’s big game. The advertising slate looked full; however, I didn’t see any big zinger, funny ads as in prior years. The only auto ads I saw were from Mitsubishi and Hyundai. Thankfully the Big 3 weren’t taking my tax dollars and spending them to encourage me to buy their product! I may be wrong, but GoDaddy.com seemed to be one of the big spenders of the evening. I’m not sure of the exact numbers, but I have been hearing $3 million (+) for a 30 second spot, of which there were 60 or so.
The Super Bowl stock market indicator says that when an original NFL team wins the Super Bowl, stocks should deliver a positive performance. This year both teams were original NFL teams, but the indicator should get a real challenge for 2009. The Super Bowl indicator stands in contrast to the Trader’s Almanac January Barometer I discussed a few weeks ago, which suggests that the direction of the market for the year is determined by how the market trades in January. This year, January was the worst for the S&P 500 ever, and according to Barron’s the worst for the Dow in 113 years. Although I’m leaning towards a flattish year (see my year end note), I’d say that the January Barometer will hold more sway than the Super Bowl indicator this year.
Stimulus or Politics?
The House of Representatives passed an $819 billion stimulus plan with zero Republican votes. This package is equivalent to 25% of the entire federal budget. The plan includes payroll tax cuts, jobless benefits, education programs, aid to the states, and infrastructure projects. Even in this time of economic crisis, the political infighting continued. The Republicans fought to eliminate cheap condoms for Medicaid recipients, and the Democrats pushed hard to give the National Endowment for the Arts additional funding. The CBO estimates that $526 billion (less than 2/3) will actually get into the economy by the end of 2010, estimating a 1.2-3.5% boost to GDP by Q4 2010. A provision related to my tariff discussions of the past few weeks was included, requiring all iron and steel used in construction projects funded by the bill to be produced in the US. The Senate has not yet voted on their version of stimulus, but should address it this week.
Both houses are motivated to get something done before they take their winter recess on February 13th. I doubt any of them wants to go home to their constituents without some type of plan to discuss.
With a few exceptions, most earnings reports had these comments: 1) we were surprised how quickly demand for our products declined; 2) even though we have zero visibility, we are lowering (or eliminating) our guidance for 2009; and 3) we are reducing our headcount by xx% in the face of declining demand.
American Express- “Our fourth quarter results reflect an operating environment that was among the harshest we have seen in decades... Nevertheless, we met our near term goals - staying liquid, staying profitable, and investing selectively to strengthen our competitive position over the longer term... We remain cautious about the economic outlook through 2009, and card member spending to remain soft with past-due loans and write-offs rising from current levels."
I guess people are staying home to watch movies because Netflix beat both earnings and revenues. These results make sense when you consider the performance of Wal-Mart during 2008, which held up remarkably well as people moved towards the discount chains to save money. Now NFLX is benefiting from a reduction in entertainment spending combined with the ongoing shift away from video rental stores.
IBM announced more job cuts. Texas Instruments missed estimates and guided down, yet the stock went up. Q-Logic also missed as tech stocks in general reported horrid numbers.
McKesson beat numbers and guided earnings higher as healthcare stocks continued showing relatively better results.
Amazon.com beats revenue and earnings estimates on stronger book sales and upside to the sales of Kendle, their electronic book reader.
ISI is estimating that US pension plans were underfunded by 29% as of 2008 year-end. If Aa corporate interest rates remain flat at 6% at 2009 year-end, ISI estimates that the S&P 500 must increase to approximately 1250 by year-end to bring pension underfunding to a more manageable 15%. Just as a reminder, the S&P now stands at 825, so 1250 would represent an increase of 51% from Friday’s close. I have discussed this issue in the past (http://weeklymarketnotes.blogspot.com), and expect continued pension problems to arise, resulting in earnings pressure on top of the pressures being created by weak sales.
Be very careful of your companies with defined benefit plans!
Surprise! GDP was down 3.8%, better than the -5.5% consensus, but that was still the biggest decline since 1982. An inventory buildup cushioned the decline, which otherwise would have been -5.1%. Consumer spending, which was down 3.8% in Q3, was down 3.5% in the December quarter for the first consecutive declines of greater than 3% since record keeping began in 1947. Prices rose 0.6% ex-food and fuel, and declined 0.1% including those items. Home construction slumped 24% in the quarter, while purchases of equipment and software dropped 28%. Nominal GDP (ex-inflation) was down 4.1%, the worst since 1958.
South Korean exports were down 33%, the worst since record keeping began in 1957 and almost 2x December’s decline of 18%. Exports to Korea’s largest trade partner, China, declined by 32% during the first half of January, shipments to the US were down 22%, 47% to the EU, and 36% to Latin America.
Home prices were down 18% in November in spite of government efforts to prop up this market (see Mortgages and Housing below for more comments on housing).
ABC consumer confidence was down to -54.
Durable goods orders were softer than expected, coming in at -2.6% vs. a -2.0% consensus. Ex-transports they were -3.6% vs. -2.7%.
Initial jobless claims were 588K vs. 575K consensus as the unemployment rate surged over 7%. The chart below shows the weekly initial jobless claims since 1999.
I have discussed some thawing within the credit markets over the past few weeks, but the big test is $245 billion of commercial paper purchased by the Federal Reserve in October beginning to mature this week. If the companies can roll that debt over it may indicate we are actually seeing an improvement in liquidity beyond that funded by our tax dollars. The chart below shows that there are still fears in this market, represented by the large spread in rates between top tier and second tier issuers.
There has been much speculation about the second part of the bank bailout and what might happen. Some are anticipating a bailout announcement early next week that would include a proposal from FDIC Chairman Sheila Bair (who also wants to run the program) to create a “bad bank” that would take all the toxic loans from the banks onto it’s balance sheet (that bank, by the way, is funded by all of us taxpayers). If the government owns these loans, it gives them the ability to rewrite the mortgages that have created a large piece of the banking problem. Given that 80% of mortgages that have received relief have gone back into default, I’d say the government isn’t viewing this as a prudent investment of our tax dollars but instead an expensive form of social policy.
This over-commitment by the Fed and our government may be contributing to the weakness in the treasury market, which has seen 30 year rates back up significantly from 2.5% just before the year end to 3.6% as of Friday. Remember that I have been a proponent of higher interest rates, inflation and gold prices over the next few years; however, it appears the markets may be starting to recognize the inflationary impact of the Fed’s actions in spite of the current demand void we are experiencing today. The chart below shows gold’s performance (represented by the GLD, the gold ETF which is priced at 1/10th the price of an ounce of gold), which has increased by 5.5% this year.
Remember that inflation and high rates are the great killers of equity returns.
The house has drafted legislation to regulate the credit-default swap (CDS) market. CDS are derivative securities which act as insurance against a bond issuer defaulting. The prices of these derivatives move up and down based upon the perceived risk in the market place of various bonds and issuers. If an issuer defaults or otherwise fails to adhere to their debt agreements, the owner of the CDS is paid the face value of the bond, typically by a third party such as AIG (now you understand why AIG was in such big trouble-many of their issuer bonds were facing technical default, and Goldman was exposed to a ton of the AIG underwritten CDS). The market has evolved to one in which people trade the CDS without owning the underlying bonds, and the house is hoping the legislation will help control this speculation. While good in theory, in my view this only opens the door to other, less well-understood forms of speculation. Creating an exchange for these securities might make more sense. An exchange would at least increase the transparency (Wall Street speak for “seeing what the heck is going on”) into these securities.
Mortgages & Housing
The Wall street journal reported that the mortgage weakness has spread to the jumbo market, with 7% of jumbo prime loans now over 90 days delinquent versus 2.5% a year ago. Florida has the highest rate of delinquencies with roughly 17%, while California is slightly above the average at 8%.
From The Big Picture: “New Home Sales fell last in December 2008 to the lowest level on record — a seasonally adjusted annual rate of 331,000. Month over month, the drop was 14.7% (±13.9%), and year over year, the collapse was an astounding 44.8% (±10.8%) below December 2007. If we take the raw sales data (NSA), the level of home sales in 2008 was 482,000, the lowest since 412,000 in 1982, the WSJ reported.
Other data points:▪ The median sales price of new houses sold in December 2008 was $206,500. The average sales price was $246,900.▪ Seasonally adjusted estimate of new houses for sale = $357,000, a supply of 12.9 months at the current sales rate.▪ This inventory to sales ratio is a new all time high dating back to at least 1963.▪ 482,000 new homes were sold in 2008, a decrease of 37.8% (±2.7%) below the 2007’s 776,000.”
J.P. Morgan reported that more than 55% of borrowers with option ARMs are underwater, i.e., they owe more than their homes are worth. Unfortunately it looks as though housing’s problems will continue as unemployment rises and the economy falters.
Even More Loans
Jim Furey, the former small cap strategist at Lehman Brothers and proprietor of Furey Research Partners (www.fureyresearch.com), commented on the recent weakness in bank lending.
”Yesterday’s Wall Street Journal shouted page one headline: “Lending Drops at Big US Banks.” The article’s tone indicated declining loan balances was a bad thing and unexpected. To the contrary, every single recession has experienced a decline in Commercial & Industrial (C& I) loans. This recession will be no different, TARP or no TARP. We have been waiting for the decline to occur in this recession to indicate the end of the recession is nearer.”
He continued “Our point? Declining C&I loans is bullish. Forcing banks to loan money into the teeth of a recession would be throwing good money after bad.”
Thanks Jim. Check out his website for more information, it is full of Jim’s very rigorous quantitative work.
New Medical Disorder
Investment-deficit disorder is a phrase from this weekend’s NY Times to describe our national preoccupation with current consumption and lack of investment
I added a link to Jeremy Grantham’s 4th Quarter Letter on my site (http://weeklymarketnotes.blogspot.com). Jeremy is a great investor with a wonderful long term track record and is also a terrific writer. The note is long, but I encourage you to read it. BTW-this is the first time I’ve ever seen the word “obstreperous” in a financial note.
Those pirates are at it again, this time stealing a German ship w/ Bahamas flag. Apparently unsatisfied with the fall in oil prices, they have stolen a tanker of liquefied petroleum gas. This is the third vessel hijacked off Somalia this month. Last year there were 43 in all, 10 in November alone. I may not know anything about navigating a ship, but I do know that I would make every effort to avoid the coast of Somalia.
Quote(s) of the Week
Two quotes this week.
“If you want to raise a crop for one year, plant corn. If you want to raise a crop for decades, plant trees. If you want to raise a crop for centuries, raise men. If you want to plant a crop for eternities, raise democracies.”-Cal Schenck
“The difference between genius and stupidity is that genius has its limits”-anonymous
January is over, and I continue to recommend fading the market when it rallies and adding to strong positions when the market is weak. I continue to believe we are far from finished with this economic downturn, and that we won’t experience a robust, lasting rally for many years. Buy and hold will be a very difficult way to make money in this environment. If you must be invested, a disciplined strategy designed to take advantage of the markets volatility is prudent. Personally, I am still about 5% net long, but somewhat underinvested at 50% long, 45% short.
Have a great week. Good luck in February, which according to the Hirsch team is the worst month of the market’s best six months (November-April).
As I write this the Hang Seng is down 3%.
Ned W. Brines
o (562) 430-3232