Jul 6, 2009

Bye Bye Bernie

Bye Bye Bernie

July 6th, 2009

“Capitalism is the legitimate racket of the ruling class.” - Al Capone 1899-1947

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

INDU: -1.9%
SPX: -2.5%
COMPQ: -2.3%
RUT: -3.1%

Market participants celebrated the 4th of July and the end of the second quarter this week. I can imagine that most investors will say a sad farewell to the second quarter of 2009, because the sledding looks a bit more difficult as we move forward. After rising for nearly three months, the market just experienced its third consecutive weekly decline. While the decline from the recent high is barely enough to mention, just more than 5%, investors should take note that the easy money, if there is such a thing, has been made. Further market increases will require improvements in earnings and true improvements in the economy, neither of which seems imminent.

The trade this past week resembled the more defensive trading we experienced pre-March 9th. Treasuries rallied again, utilities and consumer were the best performing sectors (see chart below, courtesy of www.finviz.com), oil fell, and the dollar strengthened (slightly). It is too early to call this action a trend, but risk taking over the past few weeks has definitely moderated.

Trading strength within the sectors seems to be breaking down. According to Bespoke Investment Group, 45% of stocks in the S&P 500 are above their 50 day moving average. Energy stocks have fared the worst with only 8% of the stocks in the sector above their 50 DMA. Industrials are the next worst, with technology, consumer staples, health care and utilities still above 50%.

A negative factor to watch is the head and shoulders formation that appears to be forming on the major indices. A head and shoulders formation is considered one of the strongest and most negative technical patterns in the market. Using the Dow as an example, a significant break below 8300 would violate the neckline of this pattern and could lead to further significant declines.

The chart below, courtesy of The Big Picture and the Chartstore.com, shows the inflation adjusted return of the S&P 500 since 1870. The chart shows three secular bear markets, with the current market represented the potential fourth secular bear. The chart points out what we have been discussing with you since October, that as this market continues to unfold we will experience a series of rallies and declines in what we have termed a range bound market (even though the range has been wider than we anticipated year to date).


Actual Consensus Prior
Consumer Confidence 49.3 55.3 54.9
Case-Shiller Home Prices -18.12% -18.75% -18.70%
Chicago PMI 39.9 39.0 34.9
Construction Spending -0.8% -0.5% 0.8%
ISM Index 44.8 44.9 42.8
Pending Home Sales 0.1% 0.0% 7.1%
Crude Inventories -3.66m -3.87m
Auto Sales 3.3m
ADP Employment Change -473K -394K -485K
Nonfarm Payrolls -467K -367K -322K
Unemployment Rate 9.5% 9.6% 9.4%
Hourly Earnings 0.0% 0.1% 0.1%
Average Workweek 33.0 33.1 33.1
Initial Claims 614K 615K 630K
Factory Orders 1.2% 0.9% 0.5%

It was a busy week for economic releases. The overall pattern of releases was mixed versus consensus. Consumer confidence, nonfarm payrolls (see chart below courtesy www.chartoftheday.com), the ISM Index, construction spending, and the average workweek were weaker than expected. The Case Shiller Home Price Index was slightly better than expected, as were pending home sales, the unemployment rate, and factory orders.

According to David Rosenberg, the Consumer Confidence measure is consistent with an economy “knee-deep in recession.” For comparison, the index was at 84.9 at the end of the 1991 recession and 81.1 when the 1982 recession ended.

Last week I discussed the impact of government stimulus on income. Rosenberg calculated that the combination of tax reduction and increased benefits totaled $121 billion (annualized) for April, and resulted in a $1 billion increase in consumer spending. For May the Obama stimulus totaled $163 billion (annualized) and consumer spending increased $25 billion.

Bernie Madoff pled guilty to running the biggest Ponzi scheme in history. Some optimistic defense attorneys and relatives were speculating he would get 12 years, but he landed a 150-year sentence. As a 71 year old, I’m guessing he won’t be out before he unleashes his mortal coils.

Personally, I say good riddance. Operators such as this decimate their investors and make the operating environment more expensive for those of us running legitimate firms.

This week Hong Kong and China announced an agreement to settle trade between the two in Yuan for transactions beginning in July. While this won’t have a major impact on the dollar in the short run, it could be the beginning of China asserting their influence on Asian trade by positioning their currency as the primary unit for trade in that region of the world.

Investment Banks
According to the London Times, Morgan Stanley forecast that as many as 40 firms across Europe will launch initial public offerings during the next two years, while city bankers are looking forward to about $20 billion in new issuance. About 146 IPOs are in the global pipeline, according to data from Thomson Reuters. "The IPO [float] market is open. Investors are interested in companies new to the markets," said Lisa Carnoy, global head of equity capital markets at Bank of America Merrill Lynch.

Amazingly, less than a year after it appeared the investment banks could only survive with government support, it could now be time to own their stocks again.

Schnitzer Steel (SCHN) got thwacked last week after reporting a third- quarter loss of 5 cents a share. Analysts surveyed by Bloomberg had estimated the company earned 16 cents a share, on average. On its earnings call, the company said that for its Metals Recycling business near-term demand for ferrous scrap appears to have improved in Q4 (Aug) relative to Q3 (May). As a result, average ferrous selling prices are expected to increase this quarter. Nonferrous prices are also expected to improve. Volumes are expected to increase by 100-200,000 tons over Q3. Margins in Q4 are expected to improve, although the supply of raw materials is expected to continue to put pressure on metal spreads. The company thinks demand will strengthen and inventory destocking is over. For the Auto Parts business they expect higher prices, improved parts sales and higher car volumes are expected to result in increased revenue. In the Steel Manufacturing business, weak demand in the construction markets is expected to continue through Q4. As a result, although prices are expected to increase from the low point at the end of May, average prices are expected to be slightly lower than in Q3. Higher production volumes are expected to result in higher margins.

Federal Spending
The website www.usaspending.gov. shows where your federal tax dollars are being spent. The chart below comes from the site. The two largest pieces (44% and 41%) are contracts and grants.

Good News for College Savings Plans

The National Association of Independent Colleges and Universities announced the results of their annual tuition survey, and for once the results are encouraging. US private colleges anticipate fees and tuition rising 4.3% for the upcoming school year. While most businesses would kill for a 4% plus price increase in this economic environment, for these universities this represents the smallest annual increase in about 40 years.

The rubber should meet the road when the carnage from the performance of university endowment funds gets factored into the universities’ new business plans later this year.

Real Estate
The Office of Thrift Supervision reported that the delinquency rate on prime mortgages, those 60 days or more past due, rose to 2.9% of the total loans outstanding (as of March 31) versus 1.1% last year. Prime mortgages account for 65% of total US mortgages outstanding.

Mortgage applications fell last week by 19% to 445K versus 550K the prior week. The Mortgage Bankers Association said that their refinancing gauge declined 30% to the lowest level since late 2008. The association attributed the declines to the rise in mortgage rates, which moved above 5% in June for the first time since early in the year.

Government Pressure on Another Industry
The for profit education sector (ESI, APOL, DV, COCO, CPLA, LOPE, LINC, etc) was volatile this week on the back of a report by website Inside Higher Ed. In the report they cited plans by the Obama administration to provide $9 billion to community colleges to fund free online programs. Creating a federally subsidized competitor to the for profit education companies is negative for their profitability by stifling enrollment growth and putting pressure on pricing.

Auto Sales
Ford, Honda and Nissan reported June sales that were slightly better than anticipated. GM, Toyota and Chrysler each reported sales that were less than forecast. Auto sales in the US have fallen for 20 consecutive months, and recently have dipped below 10 million per month.

Dow Theory
The rollover in the major indices has been accompanied by weakness in the Dow Transports. According to Dow Theory, a strong transport tape is required to support a market breakout. The transports have been weak, thus we haven’t had confirmation in past month of a new bull market. According to Richard Russell, there has been no change from bear to bull.

Are You Kidding Me?
Edward Liddy, the CEO of AIG, said this week that “we believe there is an excellent chance that we can repay the government.” AIG has taken $180 billion in government aid as their revenues have plummeted since the crisis has unfolded. The bulk of the government aid has gone to bail out AIG’s creditors and counterparties. How they plan on paying this back is anyone’s guess, but this could go down as one of the most ridiculous comments of this financial crisis.

Favorite Video
This isn’t my quote, but I read the sports page first because I like celebrating man’s accomplishments. I read the headlines last because they focus on man’s failures.

On my site this week I have embedded one of my all time favorite videos, celebrating what man can do. It is a highlight of the past 100 years of sports, created by ESPN. I especially like the shots of Walter Payton, whom I met many years ago. Walter was one of the NFL’s all time greats, and an amazingly nice guy who was taken from this earth much too early.

Take a look at the video, I hope you enjoy it

This week trading should get back to normal after the holiday shortened week. Earnings should pick up this week, and we should get a better view on retail sales around mid week.

Have a great week.


“The nice thing about being senile is you can hide your own Easter eggs.”

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