Mar 15, 2009

March 15, 2009

Weekly percentage performance for the major indices
Based on last Friday's official settlement...

INDU: 9.0%%
SPX: 10.7%
NDX: 9.8%
COMPQ: 10.6%
RUT: 11.9 %

Well, right on queue with the peak of the negative sentiment in the Investor’s Intelligence survey, the market rallied like a beast beginning Tuesday, with consumer, financials, industrials and energy leading the way while healthcare, utilities and staples lagged. One of the catalysts was a leaked memo from Citigroup CEO Vikram Pandit, which said they were having their best quarter since 2007. Now, compared to their roughly $110 billion loss in 2008, anything would be an improvement. Additionally, there was speculation that the government has finally created a plan to inject capital into the banks and get them to move bad assets off the books, helping to fuel a massive rally in the financial sector. Bill King asked a relevant question: “Why did taxpayers have to rescue Citi for a third time only two weeks ago if Citi is doing so well this year?”

More Market

The market’s rally this week is either a start to a new bull market or another bear market rally. Personally, I have been in the camp that we get a strong bear market rally in March/April, and this rally is setting up in traditional fashion. Remember the last rally, which ended in early January, was up roughly 20% from its intra-day lows. I expect this rally to exceed that, rising 20-25% from the mid-day low of 665, which would push the market to the 800-830 range. As I have mentioned in the past, I began letting my portfolio move to net long as the S&P 500 slid under the 750 level near the end of February, and plan to hold that position until the S&P approaches or breaks 800, at which time I will move back to neutral. A move towards 830-850 will get me net short once again. The market would need to clear the 850ish range, to break the string of lower highs and lower lows and possibly set up for a run to higher levels.

One smart Wall Street executive told me “it’s about time for the shorts to get steam-rolled in this market. I expect the market to top 1000 before running out of steam.”

Mortgage Rescue Plan
The NY Post reported that the Obama administration's $75 billion mortgage rescue plan appears to have been rushed into action and is missing crucial elements that doom it to failure, housing industry insiders tell The Post. The two most obvious things missing from the plan, which hopes to reach 9 million ailing homeowners, is that it doesn't include adequate property appraisals or risk management of the reworked loans, the sources said. Without these safeguards, they said, steadily declining home values will waste taxpayer money by putting homeowners back into over-valued homes with no equity and no free cash to maintain the home. "You're basically turning a nation of homeowners into renters," said one person who works exclusively with foreclosed homeowners. Another source, speaking on the condition of anonymity, poked fun at the Obama administration's requirement that stimulus money must go to "shovel ready" projects to ensure the most immediate effect, calling the mortgage modification plan "not shovel ready."

As you know I have been very bearish on oil since the beginning of 2008, although as recently as last week I lowered my net short position in energy stocks. Last week I was fortunate to speak with a very successful PM who is bullish both short term and long term on oil. Here is his reasoning:

“Today we have a demand for oil of 82-83 million barrels per day, which is 3 million less than production. This compares to a daily surplus of roughly 20 million barrels per day in the 80’s & 90’s and a surplus of 18 million per day in the late 90’s. Globally, we underinvested in industry capex from 1985-2002, at which point annual capex stood at $190 billion. Global capex eventually ramped to $450 billion over the past 7 years, with an expected cutback to $375-400 billion in 2009. Supply demand will get tighter as demand increases. If this recent pull back in oil were a supply issue, it would be bearish, but this is a demand issue and demand always normalizes.” He further stated that consumption will bottom at current levels based upon gasoline consumption, which has picked up in the US over the last month. Additionally, he expects (as do I) that weakness in the dollar will cause inflationary pressures and increase in oil prices.

More Oil

In other oil news, Exxon announced they have made a discovery off the coast of Brazil that may contain 8 billion barrels of recoverable oil. This field could be comparable in size to the Tupi field announced in late 2007, which also was estimated at 8 billion barrels. The fields may require $500 billion in infrastructure investments to extract the crude. Now that’s a stimulus package!

It seems that the airlines have been somewhat quiet in all this economic mess; however, volumes are down (but energy costs have declined also). Last year, with fuel costs soaring, the airlines added surcharges for everything from food to baggage. With the recent declines in fuel costs there has been no reduction in any of the surcharges. UBS says February unit revenue, channel checks, and communication from the airlines suggests weaker revenue trends have carried from February into March. The bank materially lowered their revenue forecast for Q1 and the full year, and also updates their fuel price assumption to the forward curve (lowering annual spot assumption to $1.37/gal from $1.50). The net effect of these changes is negative and should drive American and United to EPS losses in 2009. The bank expects consensus to fall soon but figures the market also anticipates this. The airline stocks are trading at around the same level they were back in July-when fuel prices were at their peak, EPS estimates called for huge losses, and liquidity was a great concern. Also, UBS anticipates announcements of additional capacity cuts as early as next week.

EE Times reports amid the IC downturn and a slump in lithography, Gartner Inc. has cut its capital spending forecast again. Worldwide capital equipment spending is forecast to total $16.9 billion in 2009, a 45.2 percent decline from $30.8 billion from 2008, according to Gartner (Stamford, Conn.). Gartner has worldwide capital equipment spending reaching $20.3 billion in 2010, a 20.1 percent increase from 2009. ''The dramatic crisis in world economics that came to light late in the third quarter and fully engulfed the fourth quarter of 2008 slowed capital spending in all segments of the semiconductor market,'' said Klaus Rinnen, an analyst with Gartner. ''The overspending on memory in the past three years, combined with a retrenching consumer market, presents little potential for any upside until 2010.'' This is the fourth time Gartner has cut its forecast in recent times. In October, Gartner projected that chip capital spending would decline 25.2 percent in 2008 and 12.8 percent in 2009. Then, in December, the firm said semiconductor equipment spending would decline 30.6 percent in 2008 and another 31.7 percent in 2009. Semiconductor equipment spending was projected to decline by 34.1 percent in 2009, according to a revised forecast by Gartner in January.

Gartner also recently cut its IC forecast. Worldwide semiconductor revenue is forecast to reach $194.5 billion in 2009, a 24.1 percent decline from 2008 revenue. Now, it appears that the market is much worse than expected amid the current and horrible downturn.

There is a proposal in Congress to raise taxes on stock trades to pay for the Wall Street bailout. Capital gains tax increases, dividend tax increases and now tax increases on trading-will there by anyplace left for the average investor to make any money or will we all be doomed to the soup kitchen line?

Bear Market End

From Merrill, er Bank of America, oh, what the heck, just give me a toaster with that new account:

“The timing for the end of the bear market is still October. As economists, trying to time the bottom comes down to trying to time the end of the recession because history teaches us that bear markets end roughly 60% of the way into the recession. Our in-house compass is now telling us that we are roughly 45% of the way through, which means without getting into too much detail, the timing of the end of the bear market, based on the economy, is still around October. That hasn’t changed.”

Moral Hazard
“American International Group Inc., the insurer that got four bailouts from the federal government, has been the subject of complaints from rivals who say the firm is under-pricing commercial coverage,” a regulator said. Competitors have said AIG was able to charge lower rates after getting government help, said New York Insurance Superintendent Eric Dinallo in an interview with Bloomberg Television today. Insurers including Hartford Financial Services Group Inc. have also applied for capital from the federal government, seeking to join more than 500 financial institutions that have received about $300 billion in government funds. Other insurers have complained that government aid gives a competitive advantage to the weakest firms at the expense of those that don’t need extra capital.

China Problems

In past issues I have discussed concerns with the Chinese holding massive ($1 trillion) amounts of US Treasuries. Last week Chinese Premier Wen Jiabao highlighted concerns about their huge US holdings. “We have lent a huge amount of money to the US, so of course we are concerned about the safety of our assets,” Jiabao said. According to the Financial Times, an unnamed Chinese official said “We hate you guys. Once you start issuing $1 trillion to $2 trillion, we know the dollar is going to depreciate.”

Jim Furey of Furey Research Partners put together the chart below, which shows that the rate of decline in commodity pricing historically as occurred near the end of a recession.

More Problems for the Decoupling Theory

There are a few brave souls still clinging to the decoupling theory, the one that posits China and a few other lucky countries can grow unscathed while the rest of the world stumbles. This theory has been thrown another curveball over the past week as China announced that exports, the key driver to their economic growth, had plummeted by 26% last month (their imports fell by a comparable percentage). Their gaping trade surplus, which was $39 billion in January, fell to under $5 billion in February.

Overall economic reports this past week continued to be soft, although there weren’t any dramatic misses to scare the markets.

Advanced retail sales for February came in at -.1% vs. a -.5% expectation. Excluding autos, retail sales were +.7% vs. -.1% expectation and 1.6% in January. Retail sales were a bit better overall, possibly as a result of the bump from lower gasoline prices (see the chart in my note last week

Consumer net worth was down $16.5 trillion, over 25%.

Wholesale inventories declined 0.7% vs. a -1.0% estimate. Business inventories fell 1.1% vs. a -1% expectation.

Mortgage applications were up 11.3% vs. a decline the prior month of 12.6%. Lower rates and a renewed interest among lenders to advertise better rates led to a surge in new applications. Let’s see if the banks will actually lend the money.

Initial jobless claims continued in the mid 600K range, coming in at 654K vs. expectations of 644K. Continuing claims now stand at 5.3 million.

The University of Michigan consumer confidence index was 56.6 vs. 55.0 and flat w/ last month (56.3).

The trade balance was -$36 billion vs. an expectation of -$38 billion. Total trade with the world is down 25% YTD vs. last year.

Unemployment in four states is now over 10% (Michigan 11.6%, S. Carolina 10.4%, California at 10.1%, and Rhode Island at 10.3%). In another of many understatements coming from the bureaucrats, Bernanke said that unemployment of 10% for a period of time is “certainly well within the realm of possibility.” On the upside (I think), it may take over 100K additional government jobs to administer the new $787B economic stimulus package.

ISI reports that their company surveys of retailers, auto dealers and homebuilders are still bad but not as bad as the end of the year. Back end companies (temporary employment, real estate, construction, technology, manufacturing, trucking, capital goods and shipping) continue to deteriorate.

Financial Conditions Watch
According to Bloomberg’s monthly Financial Conditions Watch report, the recovery in financial conditions experienced in late 2008 and the early portion of 2009 is beginning to lose traction. The report notes that the Fed has been unable to push real market interest lower-in fact they have risen by almost 700bps during the crisis since spreads have widened much more dramatically than the decrease in the Fed Funds rate (see chart below).

Additionally, improvements in the Libor-OIS spread and the TED spread have reversed over recent weeks. The overall improvement in credit conditions, as measured by Bloomberg’s Financial Conditions Index, can be seen in the chart below.

Congress approved a $410 billion to boost spending and will fund thousands of congressional pet projects, aka earmarks. I think my favorite is the $1.8 million for swine order and manure management research in Iowa.

Kudos to Senator David Vitter of Louisiana, who proposed eliminating the practice of giving member of Congress an automatic annual salary increase. He called the practice “offensive” at a time when constituents are struggling. According to Bloomberg, the majority in the Senate defeated this measure.

Big 3
Ford announced a contract agreement with their labor union that should save the carmaker $375 million this year. Ford is the only member of the Big 3 not to have requested or received a government loan. GM’s stock actually soared this week from $1.45 to $2.72 as the company announced they may not have to feed at the public soup kitchen line this month.

Life Insurers
From Scott Patterson and Leslie Scism in Thursday’s Wall Street Journal:

“This is as strong an argument for receivership/recapitalization as I’ve seen. The otherwise healthy life Insurance business is getting dragged through the muck by the collapsing banking and brokerage industries.”

“The tumbling financial markets are dragging down the life-insurance industry, an important cog in the U.S. economy, as mounting losses weaken the companies’ capital and erode investor confidence.

A dozen life insurers have pending applications for aid from the government’s $700 billion Troubled Asset Relief Program, and the industry is expecting an answer to its request for a bank-style bailout in the coming weeks. The government so far hasn’t said whether insurers will be eligible for the program.

Life insurers have taken a beating in recent weeks. The Dow Jones Wilshire U.S. Life Insurance Index has fallen 59% since the beginning of the year, leaving it down 82% since its May 2007 all-time high. The Dow Jones Industrial Average has lost 21% year to date, off 51% since its October 2007 record.”

Where’s the Gratitude?

After all the billions of dollars that have been pumped into the financial system, primarily to benefit Goldman Sachs (see prior notes at, you would think they could show some gratitude to the populace that is funding their bonuses by saying something nice. Instead, Goldman reduced their global GDP forecast to -1%. Now, if I were cynical (and I am), I’d say they might have held off on that negative outlook until they were done milking the US government for aid. Wait, they are done (at least for now), at least as long as there is a cap on executive pay associated with more handouts.

Speaking of Goldman, AIG finally released their use of bailout proceeds. It seems that $105 billion of the $165 billion in federal aid received by AIG has been paid to states, banks and brokerages. Who was the leading benefactor of that government handout? That favored step-child of the treasury-Goldman Sachs, which pulled in a cool $12.9 billion.

The Coolest Invention

Scientific America reported that scientists at the University of California Berkley invented the world’s smallest radio. It seems they were able to use a nanotube to create a single celled radio the size of a virus. A typical radio has four key parts: antenna, tuner, amplifier, and demodulator. The carbon nanotube provided all four functions, and only requires a small electrical charge (battery) and speaker to operate. The applications for this technology are limitless-think of hearing aids, radio-controlled chemotherapy delivery, and espionage to name just a few applications. To witness the radio working, click on

Did anyone notice the #6 seed become the winner of the Pac-10 basketball tournament? It’s time for March Madness, one of the greatest sporting events in all of athletics!

The power of the market rally was impressive, and posting the first positive week in the market in 2 ½ months certainly has encouraged a lot of discussion (once again) about whether we’ve seen the bottom of this market or not. I’m not convinced we’ve seen the bottom yet, but I am going to cautiously approach this bounce as yet another bear market bounce-anticipating this one will have even more power than the last. As always, I encourage you to use the strength to lighten up on weaker holdings.

Have a great week, and as always let me know if you’d like to be removed from the list. I appreciate all your comments and referrals.


Ned W. Brines
O (562) 430-3232

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