May 31, 2009

Hello Summer!

Hello Summer!

June 1, 2009

“I never can think of Judas Iscariot without losing my temper. To my mind Judas Iscariot was nothing but a low, mean, premature, Congressman.”-Mark Twain

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

INDU: 2.7%
SPX: 3.6%
COMPQ: 4.9%
RUT: 3.1%

The shortened week after Memorial Day closed with a flurry, helping stocks to finish positive for the month in what has historically been the first month of the weakest six months of the year for the S&P 500, but the 7th of the strongest eight months for the NASDAQ. The past three months has been one of the strongest periods ever, matching the jump seen in late 1998, which makes me pine for Greenspan-NOT!!

Breadth (according to 81% of stocks are above their 50 DMA) is at a level typically associated with market corrections, although this data is far from statistically significant. The last time this many stocks were above their 50DMA was just before the market rolled over in early January. The chart below (courtesy shows that the advance decline line has been rebounding, and is now at levels last seen in September 2008. This chart makes me wonder what people were thinking in January of 2008?

Mortgage rates and treasuries have been rising recently as the yield curve continues to steepen (see chart of 10 year Treasury yield below as well as the Yields section below). While treasury rates are still low on an absolute basis, the direction of the movement is worth watching closely. The most significant positive aspect is the extremely steep yield curve, which benefits the faltering banks. Additionally, a curve this steep could certainly be a precursor to better economic growth in the 9-15 month range. The list of negatives are a bit longer, however, in my mind the three key items to keep in mind are 1) higher rates could be signaling higher inflation down the line; 2) higher borrowing costs for the US government can’t be positive, especially given the trillions that the Treasury must issue to cover the huge budget deficits planned by Team Obama; and 3) ten year Treasuries are often viewed as a proxy for the cost of capital (since so many corporate securities are priced off the 10-year) for the market, and a rising cost of capital results in a lower overall market valuation.

I come from a school that says rising stocks and rising bond yields can’t co-exist for extended periods of time. One of the most famous market crashes ever, 1987, was preceded by months of rising stocks and rising yields. The key difference between 1987 and today was that yields were much higher on an absolute basis in 1987 than they are today.

So where does that leave me? I am still net long about 25%, favoring healthcare, materials (mainly via gold), and consumer stocks. I am still net short industrials and technology (to my detriment). I have also been selling out of the money covered calls on non-core positions as I expect the market to consolidate its recent gains. I plan to move more towards a neutral position, but haven’t been rushing there yet.


As we’ve discussed, first quarter earnings were weak but much better than anticipated, enough to help the market surge off its March 9th low. Scott Chronert from Citi has postulated that second quarter earnings and stock performance will mirror that of the first quarter, with earnings missing elevated expectations and the market rolling over as a result. The S&P 500 as a whole is expected to see earnings decline 35% in the second quarter. Material stocks are expected to see the biggest decline in earnings followed by energy. Technology is expected to see earnings decline by 28%, health care and consumer staples are the only two groups forecast to post a gain.

Consumer confidence came in at 54.9 versus the 42.6 consensus and 40.8 in the prior month. This is a significant jump and somewhat reflected in my VIX comments last week. For more comments, see the Speaking of… and Sentiment sections below.

The Case-Shiller Home Price Index came in at -19%, as reflected in the chart below (S&P). Existing home sales came in slightly ahead of consensus at 4.68 million vs. 4.66 million. New home sales were 352K versus the 360K consensus and 351K last month (revised down from 356K).

Durable goods orders for April rose 1.9% from a March level of 2.1% (that was revised down from a decline of 0.8%) and a consensus estimate of 0.5%. The rise was driven by increases in auto and defense orders. Bookings for non-defense capital goods (ex-aircraft) fell 1.5%. Staying on the downward revision theme, March capital goods orders were revised to a decline of 1.4% after being reported at an increase of 0.4%.

Initial jobless claims came in at 623K.

The US mortgage delinquency rate came in at 9.2% vs. 7.9% last quarter. Subprime delinquencies are horrific at nearly 25%, with prime delinquencies at 6% and rising (see Mortgage Defaults section below).

GDP for the first quarter was revised to a decline of 5.7%, an improvement from the initial reading of -6.1% but weaker than the forecast of -5.5%. A downward revision to personal consumption was offset by a less than expected drop in gross private investment, exports and less of a drag from inventories. Real final sales, which takes out the influence of inventories, was left unchanged at -3.4%.

Chicago PMI, which was expected to be 42 (although many were expecting much higher, actually limped in at 24.9 for May.

Speaking of…
Speaking of consumer confidence, Barry Ritholtz writes: “One of the ironic things about the data is how conclusive it is that sentiment is a contrarian indicator. Mark Hulbert looked at consumer confidence data (via the Conference Board’s index) to its beginning — 1977. He then looked at how markets did over the ensuing periods. His conclusion?

“The biggest monthly jumps in the consumer confidence index were, on average, followed by sub-par returns. Conversely, big drops in the index were typically followed by above-average returns.

The starkest patterns in the data, however, were between monthly changes in the consumer confidence index and how the stock market had performed in prior months. When the stock market is going up, their confidence rises too — and vice versa. So, given the stock market’s impressive rally over the last couple of months, it was entirely to be expected that consumer confidence would rise smartly.

In other words, focusing on consumer confidence tells us more about how the stock market has performed in recent weeks than it does about the future.”

As JFK said “those who look only to the past or present are certain to miss the future.”

Best Investment Ever (revisited)

In September I suggested that the best investment ever had been those “Dow 10,000” hats that all the anchors on CNBC were wearing back in 1999. The Dow has crossed that new Mendoza line so many times that they must be getting dizzy flipping those hats on and off. Now with the Dow approaching 8500, the Dow 10K birds are beginning to chirp and I’m sure the talking heads are dusting off their derbies once again.

Personally, I like my “Gold 1K” hat.

Bank of America

From Bank of America (BAC) has won some support for bank stocks ahead of the opening bell by announcing that it has raised almost $26 billion in capital since the government announced the results of its bank stress tests. Bank of America's efforts thus far have included a $13.5 billion common stock offering last week, and the partial sale of its China Construction Bank holding. Bank of America still needs to raise more capital in order to achieve the $33.9 billion capital buffer that the Fed deemed sufficient.

All I can say is the list of leading stocks this week included enormous moves by all of BAC’s preferred issues.

Mortgage Defaults
From Peter Boockvar “An example that the more the US government gets involved in cleaning up the economic mess, the longer it will last, aka Japan, Fitch is forecasting that between 65-75% of mortgage loans that are modified will re-default after 12 months. An example of the damage that can be done to a family by artificially modifying a loan for one who should be renting and re-defaults in 12 months and thus prolongs the agony and delays the inevitable, is the money that a family spends each month on a mortgage during the initial 12 months after modification that can be used for renting at a lower monthly price, with money leftover. It’s not the same as owning one’s own home but it improves the financial health of the family. The foreclosure process however painful also more quickly clears markets and brings out demand.”

As I mentioned earlier, the 2-10 year treasury spread is at a record high.
This is great for banks since they can borrow cheap and lend expensive. However, this steep curve can be bad for mortgages since it causes rates to increase.

From ISI: “Spreads are tightening not because the cost of capital is falling rather because rates are moving up. A consequence of this price action is tight mortgage spreads (a primary Fed goal), but higher mortgage rates. Refi applications have rolled over, perhaps in response to the back up in rates.”

The last two times the yield curve was anywhere near this steep was September 1992 and 2003, and both periods were followed by rallies in the bank stocks.

End of Recession?
From The Big Picture: 1) Conference Board’s Leading Economic Indicators: Historically, when we see the LEIs jump a full point (to 99 in April), that is a positive sign for the end of a recession. David Rosenberg, now Chief Economist & Strategist at Glusking Sheff, notes that going back to 1960, “the only times we have seen increases of this magnitude in recessions were at the very tail end of the downturns.” However, he warns that “even if the LEI has bottomed, it typically takes another six months for the recession to come to an end and that lag time has been known to be as long as 10 months.” Given the severity of this downturn relative to prior recessions, we are likely to be on the longer end of the range.

2) ECRI LEIs: The Economic Cycle Research Institute (ECRI) leading index has risen to -11.5% — that has been a significant point in past recessions. On average, it takes five months from the time this index hit -11.5% until we reach the end point of a recession. Again, the average can be misleading, and the range is what matters. In the past, the minimum was one month and the maximum was 12 months. Again, given the depth of this recession, and then credit destruction it has had, expect the longer end of the range.”

From David Rosenberg: “The last time that there were more equity market bulls (36%) than bears (31%) was back in October 2007 when the market was hitting its peak. This metric works like a charm because in March, at the market lows, the gap between the bears (53%) and the bulls (20%) in the other direction was the largest spread since July 2008 (and the second largest gap on record).”

Exxon Mobil Corp.'s top executive said he suspects the recent $10 a barrel jump in oil prices was due partly to investors anticipating a recovery, but that it was "too early to call" whether the U.S. economy had turned a corner. Speaking to reporters after the Exxon annual shareholder meeting, Chairman and Chief Executive Officer Rex Tillerson said that oil-market fundamentals hadn't changed much since the beginning of the year. He stated that “there has been no significant change in demand” and “there’s been little to no change in inventories”. He further speculated that much of the move may be driven by currency fluctuations (i.e. a declining dollar, see chart below).

From ISI: “prices "at the pump" in the US are now up $.75 per gallon (or 45%) from the start of the year. Each penny rise at the pump equates to $1.4 billion in consumer expenditures, annualized, meaning the rise this year equates to $105 billion in additional expenditures. Crude oil costs make up the largest component of retail prices which has raised a question about just how much the "financialization" of crude is costing consumers.”

The Wall Street Journal is reporting that Arthur Samberg, among the best-known hedge-fund managers, is closing down his firm amid an ongoing investigation into possible insider trading.

I’ll have to disagree with Gordon Gekko, greed is NOT good.

Housing & Unemployment
Reader Jon Fisher, former CEO of software startup Bharosa (which was sold to Oracle) and now a professor at the University of San Francisco, writes that the three biggest housing start declines (72-75), (78-81), and (05-09) have resulted in a V shaped recovery closely followed by an unemployment cap. Jon’s chart can showing this can be found at His blog can be found at

More Auto Woes
Visteon, which was once the parts making unit of Ford but is now independent (spun in 2000), filed for bankruptcy this week. The company has over $5 billion in debt and hasn’t been profitable since 2000. The list of parts makers filing for bankruptcy is over 40, with Visteon and Delphi (former GM parts unit) being the largest. Ford has committed to provide operating capital during the reorganization.

Banking Problems
About a fifth of U.S. banks are in trouble, and more "problem banks" are likely, the Federal Deposit Insurance Corp (“FDIC”) said. The 8,200 FDIC-insured banks saw their collective income plunge more than 60% year on year. "The first-quarter results are telling us that the banking industry still faces tremendous challenges and that, going forward, asset quality remains a major concern," FDIC Chairwoman Sheila Bair said. "Bank failures continued to mount, and they will continue to do so."

Ms Bair also stated that the $27 billion FDIC fund was in danger of running empty by the end of the year. That means higher fees for those banks remaining solvent.

Bullpen Problems
Can anyone please find a closer for the Angels? The daily demolition of that bullpen is horrific. Can we get Frankie or Percie back?

Business Week is reporting that the US is facing a severe chance of stagflation due to the gaping deficits that are being projected and an anticipated collapse of the dollar. Interest rates are rising, pushing mortgage and other rates up as well.

Glad they are finally on board with our expectations.

Semiconductor Demand
Gartner revised its 2009 revenue growth estimate for the semiconductor industry to -22.4% from -24.1% and 2010 to 10.6% from 7.5%. The two primary reasons for the 2009 revision change were the actual number for 4Q08 came in lower than their estimate, which resulted in a 1Q09 sequential decline of 15.7% versus a previous forecast of a 17% decline and PC sales were not as bad as the previous forecast (4.9% sequential growth versus the previous forecast of a 1% decline). Looking at the aggregate forecast for 2009 shows the change had a positive variance of $3.5 billion or 1.8%.

Global Warming
I hesitated before adding this chart because I know it will tick off a number of you, but then I thought it would be fun to get this argument going again. The chart below is courtesy of Bob Bronson, who has collected data from NOAA and NASA, which are calling for an 11 year cycle of global cooling. The chart shows weather data for the earth over the past 3000 years or so, and shows that recent weather isn’t out of line with historical averages. The study can be found at

OK-let me have it!

Commercial Real Estate
Bloomberg reported that Starbucks, among others, has been taking advantage of the weakness in real estate by pushing their rent factors down by as much as 25%. Vacancy rates have been rising as retailers and restaurants close their doors, pushing commercial property values down over 20% in the past year. Mall and shopping center vacancies have risen to 9.5%, the highest level in over 10 years.

Anecdotally, I know of a retail franchise operator who has been acquiring other franchisees and immediately negotiating new leases down 25-50% from their current levels.

Are you kidding me?
We haven’t posted an ‘are you kidding me” for a few weeks, but here’s a great lesson in hypocrisy from the Associated Press: While Gov. Rick Perry is criticizing Washington bailouts, state lawmakers are planning to use $11 million in federal stimulus money to help rebuild the badly burned Texas Governor’s Mansion. The mansion was burned in an arson fire last summer. Perry has railed against federal bailouts and what he called the free-spending, power-hungry ways of Washington. In January, he said Texas was endangered by Uncle Sam’s “audacity.”

People in glass houses just shouldn’t.

I expect the coming summer months to be anything but quiet as more comes out of Washington and all eyes are on second quarter earnings. As always I appreciate your feedback and comments. The notes have been pouring in lately, thanks for all the great flow.

Have a successful week.


“The content of your character is your choice. Day by day, what you do is who you become.”-Heraclitus (Greek philosopher)

"Well ya see, Norm, it's like this: A herd of buffalo can only move as fast as the slowest buffalo. And when the herd is hunted, it is the slowest and weakest ones at the back that are killed first. This natural selection is good for the herd as a whole, because the general speed and health of the whole group keeps improving by the regular killing of the weakest members. In much the same way, the human brain can only operate as fast as the slowest brain cells. Excessive intake of alcohol, as we all know, kills brain cells, but naturally it attacks the slowest and weakest brain cells first. In this way, regular consumption of beer eliminates the weaker brain cells, making the brain a faster and more efficient machine. That's why you always feel smarter after a few beers." Cliff Clavin-Cheers

Come on, how many of you have read a financial piece which quotes Mark Twain, Heraclitus, JFK, and Cliff Clavin in the same note? Actually, the Cliff quote is an urban legend known as “The Buffalo Theory”, he never actually said that, but it made me laugh so I included it anyway.

Ned W. Brines
O (562) 430-3232

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