Sep 28, 2009

Reckless Behavior and Unchecked Excess

Reckless Behavior and Unchecked Excess

September 28, 2009

"Where in the world are you going to find these angels for us to arrange society for us?"..."no other system in the world has lifted so many from poverty as capitalism and free trade"..."is political greed somehow more virtuous than economic greed? If so, where are the examples in history?"-Milton Friedman
Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: -1.6%
SPX: -2.2%
COMPQ: -2.0%
RUT: -3.1%

Not surprisingly, the pullback in the market this week was virtually the mirror image of the run-up as small caps lagged while large cap, defensive stocks held up better. While we have been (overly) cautious for quite some time, the naysayers are out in force, trying to be the first to predict that this may be the long awaited downturn.

I once said that the best investment I have seen over the past 15 years were the hats the hosts on CNBC purchased in the 90’s saying “Dow 10K.” Sure enough, here we are a mere dozen or so years later and those hats have a chance to make yet another appearance on the air as the Dow closed the week at 9665, off from a peak of over 9900 Thursday. The Dow last saw the magic five figures roughly a year ago during its free-fall from just under 12K (after peaking over 14K) to less than 6700 earlier this year. Will the latest surge take it over the magic 10K Mendoza line once again? Possibly, however, we feel that this visit above 10K will be short lived as the market rally appears to be pricing in one of the most amazing economic recoveries in history. Could this be the case? Of course, as even renowned (now former) bear James Grant has finally turned bullish for the first time since the railroads were a growth industry (or so it seems). Jim has been one of the great prognosticators of my Wall Street career, and while he even seems surprised by his newfound bullishness, he would prefer to see a continuation of the deflation we are now seeing as a way to goad consumers back into the spending environment versus the Fed’s prescription of inflation, inflation and inflation.

ISI, which has been on the positive side of the economic and market picture for quite sometime, said this week that “First Call earnings estimates have soared with the rally up almost 56% in the past 13 weeks.”

ISI’s Eric Boucher, an insightful and quick-witted market commentator and marathon junky continued
“How can stocks, bonds, and commodities continue to rise together? My briefest response is ‘money printing’, and a more nuanced version of the same reply describes how risk appetites have been rising due to low interest rates and quantitative easing. Only the most persistent readers are unsatisfied by this explanation. ‘Why?’, or ‘what’s the linkage between the two?’ come the dogged responses, as well as the ever-popular ‘who is doing all the buying?’ In addition to disgruntled shorts and unhappily underweight portfolio managers, the busiest buyers these days are hedge funds and bank proprietary trading desks. They are putting on carry trades, and the latest funding currency of choice is none other than the U.S. dollar”.

Actual Consensus Prior
Leading Indicators 0.6% 0.7% 0.9%
Housing Price Index 0.3% 0.5% 0.1%
Initial Claims 530K 550K 551K
Continuing Claims 6138K 6183K 6261K
Existing Home Sales 5.1m 5.35m 5.24m
Durable Goods Orders -2.4% 0.5% 5.1%
Durables ex-Transports 0.0% 1.0% 1.1%
Michigan Sentiment 73.5 70.5 70.2
New Home Sales 429K 441k 433k

In a surprise to everyone except those who actually watch the housing market, sales of existing homes fell in August. This is the first time sales have fallen in four months, declining 2.7%. The median price declined 12.5% from the prior year period. With the potential of a large number of foreclosures coming onto the market (some are suggesting up to 7 million), combined with the phasing out of the first time buyers’ credit (set to expire in November, but more than likely will be extended), new inventory in the form of increases in building permits, and it would seem the housing market has a chance of heading back towards a bottom. A big issue, of course, is the unavailability of jumbo mortgages.

In a case of “talking up your book” (which we think is bad form for two reasons: 1) you look stupid when you’re wrong and 2) it compromises your reliability to provide an independent viewpoint), Eli Broad, the billionaire home builder, feels that the housing market has bottomed in many areas and its time to start building again. Imagine that-a homebuilder advising its time to start building again?

A handful of people have asked my view on the first time buyers’ tax credit, and believe it or not this is a program I support. Housing prices have dropped dramatically, and while I am not a supporter of the government directing spending, home ownership is one area which I feel carries a significant benefit beyond the financial advantages that occur during a rising housing market. I feel that increased home ownership helps with employment stability, education, reinvigorating the community, and crime reduction.

The index of U.S. leading economic indicators rose for the fifth straight month, and even though it missed consensus, the rise signals a recovery is bubbling along. We recently discussed that the ECRI Leading Index, a much better indicator than the official government measure, has been positive since the spring.

The gains in stock prices, consumer confidence and homebuilding that are buoying the leading index bolster Federal Chairman Bernanke’s comments that the worst recession since the Great Depression has probably ended. At the same time, rising unemployment and tight credit are still drags on a weak recovery that could easily tip back into recession, as early as the middle of 2010.

Our good friend and small cap strategist Jim Furey of Furey Research Partners has conducted an analysis of the LEI. According to Jim, three of ten indicators are positive year-over-year contributors: money supply, 10-yr/Fed Funds spread, unemployment insurance average weekly initial claims and consumer expectations. Money supply and the 10-yr/Fed Funds spread have been positive in 6 of the prior 7 instances that the LEI turned positive, so it is not surprising they are positive now. Consumer expectations, however, are normally still negative, unlike today's situation, offering a positive divergence from historical tendencies.

Seven of ten indicators remain negative contributors year-over-year -- not unprecedented though building permits and stock prices, which are normally positive when the LEI turns positive, remain down -- a negative divergence from historical trend.

Permits rose 2.7 percent to a 579k annual rate in August. The University of Michigan index of consumer expectations six months from now, considered a proxy for future spending climbed to 69.2, according to a preliminary reading.

FOMC Meeting
The Fed met this week, and said they would keep the benchmark lending rate close to zero for “an extended period”. They discussed the economy and the housing market, saying both had stabilized. Key to their discussions is a plan to discontinue purchasing mortgage backed securities over the next few months. We expect this to phase out sometime early in the spring of 2010.

While the Fed is showing confidence in the economy, they aren’t showing enough confidence to remove the stimulus presently in place. That would signal either 1) the recovery is still very tentative, 2) they don’t believe their own hype, 3) they are receiving political pressure, or 4) they need the accolades that will come with creating another bubble.

Stay tuned.

Credit Conditions
We have often discussed concern over the Fed’s actions and the potential for inflation, longer term. While we still feel this could be an issue in 2011 or 2012, today it is a speck on the horizon, which creates an environment which allows the Fed to “prime the pumps.” Remember that the Fed’s main actions have been to increase the reserves of banks. Typically banks would lend that money, increasing the money supply; however, today the banks have been hoarding this low-cost capital to bolster their balance sheets against non-performing loans. The result is a rapid decline in the velocity of money, and until banks begin lending again the Fed has quite a bit of leeway in their actions.

Money supply actually dropped in the most recent three months by 2.2% (annualized), which many believe could lead to a problem. It is difficult to identify this drop as the Fed stopped publishing M3 some time ago.

The take away? Inflation is on the horizon, but the sun certainly isn’t setting yet. A slack economy with excess capacity in capital production and employment will keep inflation at bay, barring the much discussed (at least in this note) collapse of the dollar.

Increasing Pressure on the Dollar

For many years the Yen has been the currency of choice for the “carry trade”. Now the carry trade has seen a resurgence, but there is a new short vehicle: the US Dollar. The weak dollar and the Federal Reserve's intention to keep its key interest rate close to zero are creating an ideal carry trade, much like that involving the Yen over the past 15 years. "The takeaway point from the Fed meeting is that interest rates in the U.S. will remain low into 2010, leaving the dollar as the perfect funding currency for carry trades," said Kathy Lien, director of currency research at Global Forex Trading.

Fed Unwind
The administration ended its $3 billion “cash-for-clunkers” automobile trade-in program on Aug. 24, and predictably auto sales have collapsed from an annual rate of over 14 million to an estimated 8.8 million (according to Additionally, the Fed is starting to wind down its purchases of Treasury debt, which totaled $285.2 billion between March 25, when the initiative began, and Sept. 16. We expect Treasuries to begin backing up as well, resulting in higher treasury rates as we enter 2010.

Loan Losses Worsen
The Financial Times reports that losses on loans at U.S. banks and other lenders rose to $53 billion in the first quarter, almost triple the previous high reached in 2002. Nonbank lenders, particularly hedge funds, hold $1 of every $3 in troubled loans and 47% of all distressed loans. Loans made to media and telecommunications companies were in the worst state. Lending to the financial-services sector was the next worst, followed by loans to property companies.

State Budgets
In response to the state of New York’s $2.1 billion budget deficit, Governor David Paterson has proposed a 2% spending cap on next year’s budget. While this is a step in the right direction, with total federal, state and local government debt now equaling 100% of GDP, wouldn’t it be nice if someone actually rolled back spending? What if a state (or God forbid the Federal government) did what the rest of Americans have been doing-cut back? Why not a 10% cut across the board, or maybe eliminate some of the unnecessary programs that were created during the boom times?

New Improvements in Power Generation
Business Week is reporting that the smart-grid power-distribution system proposed by the Obama administration would have a revolutionary impact on the U.S. economy, possibly bigger than the Internet. The Commerce Department released technical standards for the project to prepare bidders and power companies. Guido Bartels, IBM's general manager for global energy and utilities, said building a smart grid would drive creation of fresh technologies, businesses, industries and jobs.

Interest Rates
From ISI: Historically, the fourth quarter is a good quarter for stocks. The two year note normally rising in this environment is suppressed in part because banks are not lending, choosing to lend to Uncle Sam before making loans. This helps explain why rates are low with the balance sheet of banks still reflecting fear. Loans as a percentage of balance sheet assets are the lowest since 1983. Add no inflation, institutional investors are bearish on bonds, and huge retail demand, the Chinese still managing their peg, and you have recipe for stubbornly low rates.

Another Skeptic
From Josh Rosner, “We haven’t fixed either the banks or the credit markets. Fixing would actually be a fundamental repair-not a patch like we have now. We’ve merely put up scaffolding to make sure when bricks fall off the buildings they do not hit people below.”

We have quoted Josh a number of times, and his predictions have been right on!

Long Short Equity Weightings
I have been receiving a lot of questions recently about our positioning. While I try not to “talk up the book”, much as we’ve discussed over the past few months we have moved to a net neutral position since the S&P 500 has moved over the 1050 mark, which was our target level for that benchmark to begin moving neutral or even net negative. While three months isn’t a long time in the real world, in the market it can sometimes feel like an eternity, especially when the market is surging and you’re somewhat bearish (or vice versa). In addition to the net neutral position, we have recently added a long position in the QID, which is effectively a short on the NASDAQ.

The Banks are Lending, but to Whom?
BBT reports that bank regulators are seriously considering a plan to have healthy banks lend billions of dollars to the FDIC's bank insurance fund, which is rapidly running out of cash amid a wave of bank failures. The plan appeals to banks, because it would forestall yet another across-the-board emergency assessment on them, which could erode $5-10B of their profits. And it appeals to FDIC head Sheila Bair, who bankers say "would take bamboo shoots under her nails" before turning to the Treasury to tap the FDIC's $100B emergency credit line.


Real Estate
The Wall Street Journal reported this week that slow foreclosure processing is creating a pool of homes that will come on the market and drive housing prices down. As of July, mortgage companies had not begun the foreclosure process on 1.2 million loans, according to LPS Applied Analytics. Also, 1.5 million seriously delinquent loans were still caught up in the foreclosure process. Should these homes come on the market in a flood, recovery of the housing market could be hurt severely, analysts said.

Housing Prices
The median price of a single-family home dropped 2.3% in August. The chart below, courtesy, illustrates the US median price of a single-family home over the past 39 years. Not only did housing prices increase at a rapid rate from 1991 to 2005, the rate at which housing prices increased accelerated. Current prices are 30% off their 2005 highs, resulting in home appreciation since 1970 of 4%.

Note that Fed Funds rates fell to 1% in 2003 (thanks Mr. Greenspan), leading to another Greenspan led bubble!

Health Care Reform
CBS news reports that 59% of Americans are confused by the health care reform proposals, slightly less than the percentage of Congress who is also confused by the issue. Approximately 45% approve of the plan, up from 39% last week, after the President put on his full court press of public relations supporting, but not explaining his plan. Ironically, less than 1/3 of respondents feel each party has taken a stance on the reforms because of the good it will do for the country.

Amazingly, 55% of respondents feel the President is puffing up the results of his health care plan, which makes us question President Lincoln’s comment that you can only fool some of the people some of the time…

Health Care Reform and Ted Kennedy
Paul Kirk Jr., a long time Kennedy associate, was named to replace the Senator until an interim election can be scheduled in January. While the placement of Mr. Kirk (seems like there should be a guy named Spock as well) is controversial, the reality is this could give President Obama his best chance of passing health care reform. I would anticipate a major push by the White House for this reform to come to vote before the January election.

Clean it up!!
We usually try to keep the commentary very clean in this note, and even edited a quote from President Bush last week. However, this quote from Barry Ritholtz was accurate, even though it’s a bit blunt. Sorry to those who are offended:

“If the Fed is Wall Street’s bitch, then Congress is the Street’s whore.”

I don’t anticipate publishing next week as we (my wife and I) will be in Napa next weekend for an annual get away. Although some of you have informed me of the potential brain cell loss associated with too much wine consumption, I must, of course, remind you of the philosophical (and scientific) viewpoint of one of our favorite commentators on life, Cliff Clavin. As you may recall, Cliff has been credited (erroneously), with the following quote:

"A herd of buffalo can only move as fast as the slowest buffalo. When the herd is hunted, the slow and weak at the back are killed first. The speed and health of the herd keeps improving by the regular killing of the weakest members. In the same way, the human brain can only operate as fast as its slowest brain cells. Excessive intake of alcohol, as we know, kills brain cells. 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."

So even though I’ll miss next week, I should be smarter when I return.

Have a great week. Cheers.


“There’s going to be a flood of bank-owned homes listed for sale at some point.”-John Burns, real-estate consultant

Ned W. Brines
O (562) 430-3232

Sep 20, 2009

Small Caps Continue to Lead

Small Caps Continue to Lead

September 21, 2009

“Extensive participation in the impersonal, transaction-oriented capital market does not seem to me an intrinsic part of commercial banking.”-Paul Volcker

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

INDU: 2.2%
SPX: 2.5%
COMPQ: 2.5%
RUT: 4.1%

The market continued its torrid upward pace, rising once again as the momentum in the market outweighed lingering and justifiable fears about the economy. Much has been made about whether this is a bear market rally (we fall into this camp) or a bona fide new bull. Many ask how the market can continue to go up and ignore the weak economy. One plausible answer we have laid out in prior notes is that while the economy isn’t yet on sound footing, it is showing some signs of improvement, which when combined with better than expected corporate earnings, is enough of a positive to bounce the market from an oversold low. The question we have been struggling with since June is how far will this market bounce? So far the market has moved up for much longer than we anticipated, and is now once again outside our beginning of the year estimated trading range of 840-1020 (S&P 500 1068)

In a speech this week Fed Chairman Ben Bernanke stated that the recession was probably over. The cynic in me wants to remember the underestimation Mr. Bernanke has made at every stage of the financial crisis and cringe when I hear pronouncements such as this. Technically, he may be correct. We certainly could see positive economic growth this quarter, however, the level of economic activity is far from the most recent peak, and this is why the early part of the recovery doesn’t feel good. A proxy for how far things have fallen is the drop in S&P 500 earnings, which can be seen in the chart below courtesy of While they have bounced slightly, they still have a long way to go to achieve their prior peak. Employment, economic activity, housing, and consumer balance sheets face a similar hurdle.

Regarding Mr. Bernanke, Barry Ritholtz commented
“Recall it was Mr. Bernanke who described the sub-prime situation as “Contained;” it was he who believed Housing would not spill over to the broader economy; and it was he who somehow thought the Bear Stearns situation was a one-off.

Even now, the Federal Reserve Chairman said the recession was “very likely over” as consumers showed some of the first tangible signs of spending again. Never mind that all this retail activity has been driven by government subsidies.

Now, as an investor, you do want to be mindful of the Fed Chief’s economic views, particularly how they pertain to his interest rate policies. The Fed has made it clear rates are staying low for the foreseeable future, so this becomes a non-issue in this context.

But his economic forecasts? Don’t bother.

Note that I have not been a particularly harsh critic of the Fed Chair. While he may not be Paul Volcker, he is also (thankfully) not Alan Greenspan. And we could have done much worse than having a student of the Great Depression, who is also an out-of-the-box thinker as Fed Chief.

But as a prognosticator? He is no better than his predecessor.”

The charts below, courtesy of Bespoke Investment Group, show a potential overbought condition in the financial, industrial and materials space. Note the oversold condition of all three groups in March 2009, and also the overbought condition near the end of last year. Investors have run these groups hard into the bear market rallies we have experienced so far. More recently the retail and technology stocks have also been strong, but haven’t entered the overbought area suggested in these charts.


Actual Consensus Prior
Core PPI 02.$ 0.1% -0.1%
PPI 1.7% 0.8% -0.9%
Retail Sales 2.7% 1.9% -0.2%
Retail Sales ex-auto 1.1% 0.4% -0.5%
Core CPI 0.1% 0.1% 0.1%
CPI 0.4% 0.3% 0.1%
Capacity Utilization 69.6% 69.0% 69.0%
Building Permits 579K 583K 564K
Housing Starts 598K 298K 589K
Initial Claims 545K 557K 557K
Continuing Claims 6230K 6100K 6101K
Philadelphia Fed 14.1 8.0 4.2

From Peter Boockvar:
Aug Retail Sales were much better than expected. Including clunkers, sales were up 2.7% vs. expectations of a gain of 1.9%. Ex clunkers, sales were up 1.1%, .7% more than expected and ex clunkers and gasoline stations, sales were up .6% vs. the estimates of flat. Sales for auto/parts were up 10.6% and gasoline station sales rose 5.1%. There were also gains seen in clothing, sporting goods, electronics, dept stores, on line retailing and restaurant/bars. Furniture and Building Materials were the only 2 categories that saw declines. Bottom line, the report is a pleasant surprise ex auto sales as there was a fear that the clunker plan would steal sales from other categories. There were tax holidays and the Labor Day calendar shift that helped to boost sales and the same store sales data for Aug seen 2 weeks ago were better than expected. With the clunker plan now over, we’ll see what impact overall it will have in the Sept data next month.

The Sept Empire Fed manufacturing survey was 18.9, almost 4 points more than expected, up from 12.1 in Aug and it reached its highest level since Nov ‘07 when it was at 25. New Orders rose to 19.8, up almost 6.5 points from Aug. Shipments though moderated by 9 points after jumps in July and Aug. Backlogs remained negative still but rose almost 5 points. Employment stayed sluggish, falling about 1 point to -8.3 but Aug saw a big improvement from July. Prices Paid rose almost 7 points and Prices Received, while still negative, rose 9 points and both are at Nov ‘08 highs. For those looking for a boost in inventories didn’t get it as it fell almost 3 points and this category will be a key focus as we look at all the manufacturing surveys. The 6 month outlook rose 4 points to the highest since Nov ‘04. Net-net, manufacturing is a key component of the 2nd half recovery theme and today’s number confirms that improvement in the NY metro area.

Aug PPI rose 1.7%, .9% more than expected while the core rate was up .2%, .1% more than estimates. The y/o/y headline decline of 4.3% was the smallest since April as we begin to cycle thru the big drops in commodity prices and start to capture the bounce back. An 8% rise in energy prices was the main catalyst for the headline upside surprise. Food prices rose .4%. Helping to boost the core was a .7% price gain in passenger cars and an .8% rise in light trucks. The lack of supply and clunker demand gave auto makers pricing power. Inflation in the pipeline, as measured by intermediate goods, rose smartly, up 1.8% headline and .6% ex f&f and rose 3.8% headline and 6% at the core in the first stage of production, thus adding evidence that the disinflation trends over the past year has run its course.

Unemployment rose in 27 states in August, with California and Nevada reaching record levels of unemployment at 12.3% and 13.2% respectively. Michigan continues to have the highest unemployment rate at 15.2%. It is interesting to note that over 50% of the job creation came from the state of Texas, which claims to be the freest market state in the union.

ECRI reports that
“a weekly gauge of future U.S. economic growth hit a year-high in the latest week, sending its yearly growth rate to an all-time high that points to a more vigorous recovery than consensus has shown.”

"The rise in WLI growth to a record high reinforces our earlier forecast that at least the early stage of the current economic recovery will be more vigorous than the last two," said ECRI Managing Director Lakshman Achuthan.

Retail Sales
Retail sales jumped in August by 2.7%, the biggest jump in three years. As expected, auto sales showed the biggest jump in eight years, rising 11% on the Cash for Clunkers program. The real bright spot in the report was that 11 of 13 categories showed increases. Excluding autos the gain was the biggest in six months.

David Rosenberg of Gluskin Sheff also notes that seasonal factors used by Commerce were the most aggressive in five years and helped give the data bit of a boost — in fact, one-quarter of that 2.7% gain came just from the more generous-than-usual seasonal factor.

According to the Financial Time the Japanese yen rose to a seven-month high against the U.S. dollar after Japanese Finance Minister Hirohisa Fujii assured markets that the government will not intervene to slow the currency's rise. The yen was at 90.16 against the dollar, its strongest level since early February. Fujii said the government, led by the Democratic Party of Japan, opposes currency intervention as a policy.

Commercial Real Estate

From Bridgewater Associates:
“At the headline level, there are $3.5 trillion in commercial real estate loans outstanding, with more than $1.0 trillion coming due in the next three years. The average loan outstanding has a loan-to-value of 100% versus 65-70% at origination, and our expected losses on those loans are about $700 billion (including construction & development loans) through the cycle. The three big holders of these loans are banks with 52% (two-thirds of which are held by regional or small banks), CMBS & other securitized products with 21%, and insurance companies with 10%. We have just begun to experience the problems. This month Colonial Bank and Guaranty Bank, with a combined $40 billion in assets, failed largely due to their commercial real estate exposure.”

Household Net Worth Increasing

Household wealth in the U.S. increased by $2 trillion in the second quarter, bringing an end to the biggest slump on record. Net worth for households and non-profit groups climbed to $53.1 trillion from $51.1 trillion in the first quarter, marking the first gain since the third quarter of 2007, according to the Federal Reserve’s Flow of Funds report. The government began keeping quarterly records in 1952.

The advance reflected the biggest quarterly jump in stock prices since 1998 and the first increase in home values in more than two years. Together with increased savings and less debt, the gain in wealth is part of the mending process consumers will undergo in coming years before spending can gain speed.

Best Buy reported EPS less than consensus on above consensus revenues. The company guided both measures above consensus for the full year. Comps were down 3.9% versus the decline of 6.2% in the prior quarter. As we discussed last week, the company feels that the late back to school season will help September comps. Strength was noted in notebooks, phones and flat panel TVs.

Better revenue on lower gross margins is the prescription we laid out for Best Buy when Circuit City closed up. Best Buy has become the walk-in electronics store of choice, however, price discovery has become so efficient because of information availability on the internet, and competition has increased from Wal-Mart and the club stores to the point that Best Buy has been unable to raise prices in spite of the Circuit City closure.

Are you kidding me?

According to Bloomberg, former Federal Reserve Chairman Alan Greenspan warned that Congress might slow the Fed's attempts to exit from supporting the economy with stimulus measures. "It's the politics in the United States that worries me, whether the Congress will basically feel comfortable" with the Fed ending stimulus measures, Greenspan said. The U.S. must reduce its debt and take measures against inflation, Greenspan said.

What about that comment about US politics bothering him? I thought the Fed was supposed to be independent?

Who’s Buying Stocks?

From David Rosenberg:
“While some pundits will boil it down to abundant liquidity, a term they can seldom adequately define. If it’s a case of an endless stream of cheap money, we are reminded of Japan where rates were microscopic for years and the Nikkei certainly did enjoy no fewer than four 50% rallies and over 420,000 rally points in a market that is still more than 70% lower today than it was two decades ago. Liquidity and technicals can certainly touch off whippy tradable rallies, but they don’t take you all the way to a sustainable bull market. Only positive economic and balance sheet fundamentals can do that.”

A survey by the Boston Consulting Group found that the rapid loss of wealth in North America through the economic crisis pushed Europe to the top of the list as the world's richest region. The consulting firm said the wealth of North Americans, according to assets under management, plummeted 21.8%, the most severe drop anywhere during the downturn. At the same time, the value of Europeans' assets declined only 5.8%, the company said.

I wonder how the Administration will pay for all these new spending priorities without the wealth of the American taxpayer to kick around?

It should be no surprise that newspapers’ share of US advertising dollars has been dropping significantly since peaking at 37% in 1949. First television, then direct mail, and now the internet have all taken a bite out of the papers. Help wanted and classified ad sales have plummeted along with readership over recent years as online options (think EBay, Craig’s List,, and blogs) have chipped away at the share of traditional media (see chart below courtesy Pali Research). Now social media threatens to blow the lid off of online ad spending. Social networks such as Facebook (an estimated 100 million users) are growing exponentially, and users are recommending products, sharing ideas, and most importantly spending hours a day on the sites. The companies themselves are attempting to increase the utility of the sites to encourage users to be online all day long, without barraging them with advertising and other revenue generating techniques. The success of social media entering the advertising space could drive the final nail into the coffin of the newspapers.

Protectionism 101

In past notes we have discussed the risk of protectionism and how the Smoot Hartley tariff act prolonged the Great Depression. In response to a recent WTO ruling, the Obama administration announced a 35% tariff on the $1.8 billion of automobile tires being imported from China. The Chinese responded by saying they will begin dumping tires and will probe subsidies on chicken and autos from the US. The US had the option to not act on this ruling, however, since the complaint was filed by the United Steelworkers union, a major Obama financial backer, the administration was stuck between a rock and a hard place.

More Bank Closures

Corus Bank, heavily laden with commercial real estate loans, failed last week, bringing the total number of banks that have been closed this year to 94, the most bank failures in the last 15 years combined.

National Debt

From Jon Fisher (
“The annual interest on the current public debt is ~$329B, which was the total debt circa 1970. That’s the annual profits generated by the top ~75 Fortune 500 companies (combined) assuming a zero versus negative contribution by the ones losing money. The President of the United States should not be called a liar on television but maybe the President of the United States should also pass on borrowing another trillion dollars this week.”

According to ISI the total government debt, the Feds and the locals as a percentage of GDP, hit a record 68% in the 2nd Q.


The economic calendar is light this week as the quarter enters its last two weeks. News flow should be fairly light with the exception of the typical slew of investment conferences and field trips. Companies are generally in their quiet period, so outside of mergers & acquisitions and pre-announcements, there should be very little corporate news flow impacting the markets.

Have a great week.


“If bullsh… was currency,” he said straight-faced, “Joe Biden would be a billionaire.” Everyone in the room burst out laughing.—George Bush, as related by former speech writer Matt Latimer

Ned W. Brines
O (562) 430-3232

Sep 13, 2009

Approaching the Last Quarter of the Decade

Approaching the Last Quarter of the Decade

September 13, 2009

“How do you turn an industry that costs $700 million annually into one that eats $6 billion? Nationalize it, as Congress did airport screening after September 11, 2001.”—Becky Akers, Author of TSA: Taxes Spent Absurdly

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

INDU: 1.7%
SPX: 2.6%
COMPQ: 3.1%
RUT: 4.1%

The market rallied in a rather ho-hum holiday shortened week. It’s seems strange to refer to a 2.6% gain in the market as ho-hum, but given the fireworks in the market over the past 18 months, it truly was a mundane week.

Market leadership has definitely shifted, with the IME sectors (industrial, materials and energy) once again taking center stage. The weak dollar combined with strength in China is driving these mid/late cycle sectors higher. Transport stocks were strong, led by Fed Ex and UPS after the former raised guidance for the upcoming quarter.


Actual Consensus Prior
Consumer Credit -21.6 bil -4.0 bil -15.5 bil
Initial Claims 550K 560K 576K
Continuing Claims 6.1 mil 6.2 mil 6.25 mil
Trade Balance -32.0 bil -27.3 bil -27.5 bil
Michigan Consumer Sentiment 70.2 67.5 65.7
Wholesale Inventories -1.4% -1.0% -2.1%
Treasury Budget -139.5 bil -111.9 bil

The big drop in consumer borrowing (see chart below, year over year growth of consumer credit courtesy of means that business and government spending will lead any type of strength in this quarter’s GDP report. Again, Cash for Clunkers probably pulled some demand from future quarters into this quarter, strengthening reported GDP at the expense of future quarterly growth. Without continued strength in business spending or a pickup in consumer spending, we are set up for a potential double dip recession.

The September Michigan Consumer Sentiment index (see chart blow courtesy came in strong at 70.2 versus consensus of 67.5. Given the index tends to be highly correlated with the tone of media reports and stock market performance, it’s not surprising that the index was up given the positive economic chatter coming from the press recently. The key to economic recovery hinges on this improved sentiment leading to an uptick in consumer spending, which doesn’t seem likely anytime soon given the unemployment picture and the drop in consumer borrowing.

“Consumer spending remained soft in most districts,” the Fed said in its Beige Book report. The central bank said 11 of its 12 regional banks reported signs of a stable or improving economy in July and August. Manufacturing showed “modest improvements” in most regions, the Fed said. Companies were “cautiously optimistic,” with New York among three districts reporting expectations of “modest growth later this year or early 2010.”

The government’s “cash for clunkers” program increased spending and had an impact on payrolls. General Motors Co. last month called back 1,350 union workers, its biggest one-time increase in jobs since 2006, as it boosted second-half production in part because of the trade-in program.

Health Care
This week the President came out firing with both guns in a push to get health care reform passed as the cornerstone of his domestic economic policy. I listened to six or seven post speech responses by Democratic lawmakers, and was struck by both their inability to grasp the plan and their reluctance to explain how the plan would financed without adding to the budget deficit. Some of the suggestions were tax increases on the wealthy, fees on existing plans and “immoral” insurers, eliminating billions in waste and fraud in Medicare and Medicaid, and $100-$200 billion in improved efficiencies.

The last two I find entertaining. If there is billions in waste and fraud in the two big health care systems we are already running, why haven’t we been able to eliminate them over the past 45 years? The other, improved efficiencies, isn’t exactly a strength of government programs, and this one will be especially challenging with 53 new bureaucracies being created.

Wall Street-Business as Usual
We all know the Street has been busy issuing paper like crazy, with 2009 going down as a record year for corporate debt issuance. Contacts at Merrill Lynch tell me they have done 102 deals since April alone.

Profits on the Street should be big this year, as long as the markets hold up.


Satya Pradhuman at Cirrus Research notes “risk taking has reached speculative levels (+35% as measured by their Cirrus Risk Score (CRX)). In just three months, this reading has jumped well north of +1 standard deviation, based on readings dating to 1980.”

CRX has reached these levels only three times: Sept. 1999 (height of the Tech bubble), August 2003 and Sept. 1980. History shows that such optimism portends a heightened risk of disappointment in the coming months and quarters. When CRX and estimate revisions reached these levels in the past, value sensitivity has out-earned the benchmark by 10%-13% per annum, while higher quality companies generated excess returns of approximately 8% per annum.

Gold topped $1000 this week as concerns about the dollar continue. Peter Bockvar wrote that the CFTC reported the net speculative long position in gold rose to an all time record high, up 22% on the week. The chart below, courtesy of, shows the ounces of gold required to buy the Dow Jones Industrial average.

Fed Ex raised its forecast on improving international priority shipment volumes. Consistent with the rest of the transport industry, the company is seeing some stabilization but yields on each shipment are much lower than a year ago.

Saudi Oil Minister Ali al-Naimi said this week that the current level of oil prices are “good for everybody” between $68 and $73 per barrel. I don’t mean to be overly cynical, but it seems to me that whenever OPEC has felt they couldn’t control the price of oil with curbs on supply, they have attempted to stabilize the price through verbal subterfuge.

Presently there is 62 days worth of inventory in storage, and OPEC would like to see that closer to 52 days. Demand will have to pick up to get inventories down to those levels, especially given the cartel’s decision not to impose production cuts this past week.

Finally Pulling Back Some of the Bailout
According to the Associated Press, the U.S. government's guarantee for money-market mutual funds that was set up during the credit crunch will close as scheduled Sept. 18. The program was launched after assets of a big money-market fund, the Primary Fund, fell to less than $1 for every dollar invested by a customer, an event known as "breaking the buck." The collapse of Lehman Brothers triggered the loss.

Real Estate
RealtyTrac released its August 2009 U.S. Foreclosure Market Report, which shows foreclosure filings were reported on 358K U.S. properties during the month, a decrease of less than 1 percent from the previous month but an increase of 18% from August 2008. The report also shows one in every 357 U.S. housing units received a foreclosure filing in August.

“The August report demonstrates that there is still an ample supply of properties filling the foreclosure pipeline even while the outflow of bank-owned REO properties onto the resale market is being more carefully regulated,” said James J. Saccacio, chief executive officer of RealtyTrac. “After hitting a high for the year in July, REOs dropped 13 percent in August, but we also saw a record high number of properties either entering default or being scheduled for a public foreclosure auction for the first time.”

The Washington Post reported that, according to Fitch Ratings, another round of residential foreclosures is on the verge of sweeping through the U.S. housing market. Many homeowners might be unable to cope with higher monthly payments after hundreds of thousands of option adjustable-rate mortgages reset, the credit rating agency said. Between now and 2011, roughly 70% of option ARMs, with a total value of about $189 billion, will reset. "It's a ticking time bomb for some people," said Brian Bethune, an economist at IHS Global Insight.

Fed Beige Book
The Fed Beige Book came out this week, and the report cited and categorized various sectors and their relative strength or weakness in the economy. We have listed some below:

Sectors that were weak but are now improving include tourism, staffing, railroads, automotive, paper products, chemical manufacturing, semiconductors, grocery, and apparel retailing. Sectors that were strong and remain strong include health services, pharmaceuticals, aerospace, discount stores, IT services, and food manufacturing. Sectors that were strong but are showing signs of weakness include tobacco and oil and gas drilling. Sectors that remain weak include financial services, luxury goods retailers, appliance manufacturers, high-end real estate, commercial real estate, coal mining producers, and home and garden centers.

A report by the Congressional Oversight Panel concludes that there is little chance U.S. taxpayers will recover all of the billions spent on rescuing Chrysler and General Motors. "Although taxpayers may recover some portion of their investment in Chrysler and GM, it is unlikely they will recover the entire amount," according to the report. It is "highly unlikely" all of Chrysler's money will be recouped, the report states, and GM's stock price would have to hit record highs to recover all of that company's money.

Grand Theft Home?
From Yahoo Finance: A Wells Fargo & Co. executive who oversees foreclosed properties hosted parties and spent long summer weekends in a $12 million Malibu beach house, moving into the home just after it had been surrendered to Wells Fargo to satisfy debts, neighbors said.

"It's outrageous to take over a property like that, not make it available and then put someone from the bank in it," said a woman who lives a few homes away from the property. Residents said the bank employee, along with her husband and two children, often hosted guests at the home, including a large party the last weekend of August.

Wells Fargo said in a written statement that it would conduct a thorough investigation of the allegations by neighbors, but said it wouldn't "discuss specific team member situations/issues for privacy reasons."

I wonder if the value of using that home will count towards their compensation limits laid out by TARP?

Economic releases this week include PPI, retail sales for August (should be helped by Cash for Clunkers), CPI, capacity utilization, building permits, and jobless data. With the exception of the retailers, earnings reports are basically non-existent. The earnings focus will be on the retailers as Best Buy and Kroger are joined by a myriad of smaller retailers in reporting earnings and comps for the month. Among non-retailers Oracle, Adobe, Discover, Carnival and Palm will also be reporting this week. Expect to hear more from Washington on the health care plan.

Have a great week.


“A fanatic is one who can’t change his mind and won’t change the subject.”—Winston Churchill

Sep 7, 2009

At the Cusp of a Sluggish Recovery

At the Cusp of a Sluggish Recovery

September 8, 2009

“Prediction is very difficult, especially about the future.”—Niels Bohr, Danish Physicist

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

INDU: -1.1%
SPX: -1.2%
COMPQ: -0.5%
RUT: -1.6%

The market closed lower during the pre-holiday week as weakness in the financial sector led the market down. The group is still the best performing sector for the past three and six months, bouncing more than 100% in the later period. I have heard from many investors lamenting about their inability to pull the trigger on BofA at $3 or Citigroup at $1. I have to remind them that these institutions are (and were at the time) insolvent, with the only thing keeping them afloat being the government view that they were “too big to fail.” Additionally, when exactly would they have made that decision to purchase either of these stocks, especially given that they both peaked around $52? Any purchase would have been catching the proverbial (OK, it’s not really a Proverb, but you know what I mean) falling knife.

Much has been made in the press about September historically being the worst month in the market. While the record supports this viewpoint, the data is not so overwhelming as to make it a bet worth pursuing. Like many market axioms and statistics that have been put to rest during this unusual year, relying on the wrong history can be expensive. While we have been looking for a correction, it is dangerous to base one exclusively on the calendar. While valuations, fundamentals, and macroeconomic conditions would suggest a tepid environment for the market, exceptionally low rates, easy monetary policy, and heavy stimulus counter the fundamentals and have created an environment where stocks have continued to work in spite of the obvious fundamental issues facing them. As Don Hayes says, the market climbs “a wall of worry.”


Actual Consensus Prior
ISM Index 52.9 50.5 48.9
Chicago PMI 50.0 48.0 43.4
Initial Claims 570K 564K 574K
Average Workweek 33.1 33.1 33.1
Nonfarm Payrolls -216K -225K -247K
Hourly Earnings 0.3% 0.1% 0.2%
Unemployment Rate 9.7% 9.5% 9.4%
ISM Services 48.4 48.0 46.4

The ISM came in above consensus and posted its best reading since June 2007. Additionally, the measure was above 50 (indicating growth) for the first time in 19 months. A large portion of the growth has been attributed to inventory building, especially within the auto sector as some experts estimate 30% of the gain came from auto production. This reading suggests that, for the time being, the manufacturing sector has entered a growth phase.

Jobless claims continue to be weak, and last months’ downtick in the unemployment rate appears to be a statistical fluke as the rate jumped to 9.7%. It certainly seems likely that the rate will exceed 10% by the end of the year. According to Barron’s, roughly 14.9 million people are now out of work, however, the U6 data (which most consider to be a more accurate indicator of those seeking employment) shows over 25 million people seeking full time work. The recoveries exiting the past two recessions were coined “jobless recoveries”, and this one seems to be following the same path.

The chart below, courtesy of Barry Ritholtz, shows the number of unemployed exceeding 27 weeks-the limit for the first filing of unemployment claims. While this number tends to peak near the end of recessions, the magnitude of joblessness in this recession is breathtaking.

Rail traffic continues to be soft, indicating continued soft economic activity. The first chart below, courtesy Railfax, shows that lumber and wood product shipments, typically a leading indicator of construction activity, continue to be weak. The second chart, also courtesy Railfax, shows that total traffic continues to be 20% below that of one year ago.

Goodbye Capitalism
According to the New York Times, the Democratic Party of Japan, soon to govern the country after an electoral landslide, is preparing to roll back what it called American-style capitalism "void of morals or moderation." Party leader Yukio Hatoyama, who is expected to become prime minister, lashed out at U.S. economic policies in a commentary published in a Japanese magazine. "The recent economic crisis resulted from a way of thinking based on the idea that American-style free-market economics represents a universal and ideal economic order," he wrote.

Long time readers know that I loath Congress. It’s not the concept of Congress I find repugnant, but the dysfunctional, borderline criminal organization into which it has evolved over the past 230 years. Apparently I am not alone as a recent Pew poll showed that Congress’s approval rating has fallen to its lowest level in 24 years.

Considering that most educated people I know feel Congress is filled with self-dealing, verbally flatulent morons, I’m shocked that their rating could go any lower.

Aren’t we a bit over due for another Revolution?

Retail Sales/Back to School
Family Dollar announced comps up 1%, citing food stamps as the primary driver of their positive comps. Overall, retail comps were better for August, however, they are still running negative. According to, 14 companies beat comparable store estimates while 12 were below estimates. Twenty companies reported negative comparable same store sales and seven reported positive numbers—the most positive figures since April.

Market Watch reported that chain-store sales for the week ended Aug. 29 fell 0.7% from the year-earlier period, according to a survey released Tuesday by the International Council of Shopping Centers and Goldman Sachs. On a week-over-week basis, sales dropped 0.5%. "Although the back-to-school calendar shifts will, on balance, boost year-over-year sales in August a tad, there was little discernible improvement in the trend during the entire month otherwise," said Michael Niemira, ICSC's chief economist. ICSC forecast August comparable sales to decline 3.5% to 4%.

Commercial Real Estate

According to CB Richard Ellis, the US industrial vacancy rate jumped to 12.4% in 2Q from 11.5% in Q1 and 9.5% in 2008. The nationwide office vacancy rate rose to 16.5% from 15.5% in Q1 and 13.7% last year.

Chrysler Defaults, Again

The US Treasury is learning everyday about the risks of lending OUR TAX DOLLARS to corporations in trouble. The bankrupt remains of Chrysler received a default notice on a $3.34 billion loan from the US Treasury. The company reported a $10.2 billion loss last quarter, highlighted by an $11.8 billion loss on the sale of assets to Fiat. Ironically, the US Government (again, you and I) funded the sale of Chrysler’s operating assets to Fiat, so there is very little left to repay the loans.

There are winners in this deal. Chrysler has spent $55 million on legal fees since their April 30th bankruptcy filing. What is it they say about cockroaches, attorneys and nuclear holocaust?

Cash for Clunkers part Deux
I picked up another anecdotal nightmare story in the auto industry from one of my industry contacts, this one negatively impacting the dealers. Evidently the recent Cash for Clunkers program was so hastily enacted that the rules determining which cars actually qualified for clunker status weren’t clearly defined. My contact told me that they accepted 120 “clunkers” for trade in during the program, but have only been reimbursed for 10 of those. They recently received a request asking for additional paperwork on the remaining 110, with no guarantee that the $4500 credit they issued to new buyers would be reimbursed by the government program.

ISI’s auto survey plunged as the Cash-for-Clunkers program ended in the survey period. They expect sales to be about 10 million this month, which would mean a decline in retail sales of about 2.5% in September after rising 2.5% in August.

BP announced that they had made a “giant” discovery of oil in the US Gulf of Mexico which may contain more than 3 billion barrels. The find is expected to generate 600K barrels of oil per day. Full production won’t occur until 2020.

Merger Activity

Disney agreed to buy Marvel (think Snow White meets Spider Man) in a $4 billion transaction. While it appears the deal has some interesting synergies, it is more important to note that a pick up in M&A activity is viewed as bullish by the market. In the oil services sector, Baker Hughes agreed to buy BJ Services.

Market Valuation
We periodically have included the thoughts of Al Lockwood, midcap manager, budding market strategist, friend of the firm, and all around smart guy. This week Al wrote “It is noteworthy that from a bottom-up perspective, it's becoming increasing difficult to find cheap stocks on an individual company basis.”

Accounting Chicanery
Courtesy of the Big Picture: “It appears that NZ Farming (NZX) ran into a little trouble with the regulators when they accidentally included the suggestion of “fudging depreciation” in their account statement:”


The Hang Seng fell in August for four straight weeks, ending the month down 22% and nearly 30% from its recent highs. China’s market has been a leader during the past nine months, beginning its recovery before most developed countries. We have cited questions about the pace and legitimacy of recovery in China, and it appears that these questions are beginning to concern investors.

The Dollar
Just so there is no confusion, we are bearish on the dollar for the intermediate and long term (think 2-7+ years). The chart below from shows the recovery in the Euro versus the dollar over the past six months. The long term debasement of our currency is borderline criminal, and will eventually be bullish for dollar based commodities (think oil) and negative for US savers and investors.

Municipal Heat
CNN reports that the light at the end of the recession tunnel is distant and dim for the nation's cities, according to a survey by the National League of Cities. While optimistic federal officials hint at an economic turnaround, city finance officers say the picture remains bleak for city governments. This is chiefly because a top source of municipal income, property tax revenue, tends to lag behind changes in the market. Because cities typically phase in property tax assessments, the full weight of declining real estate values in the past two years will not be felt by cities until 2010, 2011 and 2012, city officials say.

The takeaway: Residents can expect cities to continue to cut municipal work forces, services and construction projects, while bumping up taxes and fees, experts say.

Bearish View
Recently David Rosenberg is sounding much more bearish than your author, quite an accomplishment. As he said in Barron’s this weekend “I’m not being purposely bearish. I view it as almost a public service.” He also said that “the scuttlebutt is that the cash-for-clunkers triggered an even greater rush of activity in August and that we will see 14.3 million (annualized) units of auto sales on the month, which would be the highest tally since April 2008 and a 27% MoM increase over July. But the folks at are noting that sales towards the end of the month were tapering off towards an 8 million rate.”

The summer of the “staycation” has ended, and while we face a shortened post holiday week, the race to year end is in our sights. October and December typically include a fair amount of window dressing-October because it’s the year end of many mutual funds and December because it’s the year end for everyone else. September and October represent the last full trading months of the year as both November and December are shortened due to the holidays.

Hoping not to sound like a three-handed economist, we expect the economic news to begin moderating somewhat during the 4th quarter, which may not be enough to sustain the market at these levels. On the more positive side, low rates, easy monetary policy, and moderate expectations create a positive investing backdrop.

Have a great week.


“On the commercial side, I think we are fairly early in the down cycle.”
-Matthew Anderson, Foresight Analytics

Ned W. Brines
O (562) 430-3232