Oct 26, 2009

The Finish Line is in Sight

The Finish Line is in Sight

October 26, 2009

“God writes a lot of comedy…the trouble is, he’s stuck with so many bad actors who don’t know how to play funny.”—Garrison Keillor

Weekly percentage performance for the major indices

Based on last Friday’s official settlement...

INDU: -0.2%
SPX: -0.7%
COMPQ: -0.1%
RUT: -2.5%

Strong showings by a pair of large cap techs helped the market stave off significant losses for the week. The small cap indices, without the benefit of game-breaking stocks, fell 2.5% this week in spite of better than expected earnings reports. The positive news is that both earnings and revenues have been regularly beating expectations. The problem has been that except for a handful of situations, the average stock has actually traded slightly down after beating expectations. This could signify investor complacency and the expectation of ever increasing earnings guidance. The heat map below, courtesy of finviz.com, shows the individual stock performance of the S&P 500. Note the upper left corner where Microsoft resides, one of the few green spots for the week.

Microsoft and Amazon posted stronger than expected revenue and earnings this week, and both stocks were strong performers. Amazon jumped roughly 25% or close to $10 billion in market cap on an incremental $600 million in cash flow, driven by strong sales of electronics. Their electronic book reader, the Kindle, is now Amazon’s top selling product. Mr. Softy added almost 6% on the week on a series of announcements including their earnings release, the debut of their first new operating system in a decade (OK, they did release Vista a few years ago, but it was so bad it doesn’t really count), and opened their first Apple copycat store.

We have used a lot of ink over the past year comparing this market and recession to historical periods, and have recently been maintaining that this decade will mirror the ‘70’s. The chart below, courtesy Bank of America, shows the S&P 500 during the current rally (red line), the Oct ‘74-Oct ‘75 rally (gray line) and the March ’38 to March ‘39 rally (green line). Without trying to suggest one period is more relevant than the other, this rally has been tracing both rallies quite closely.


Actual Consensus Prior
Building Permits 573K 595K 580K
Housing Starts 590K 610K 587K
PPI -0.6% 0.0% 1.7%
Core PPI -0.1% 0.1% 0.2%
Initial Claims 531K 515K 520K
Continuing Claims 5923K 5970K 6021K
Leading Economic Indicators 1.0% 0.8% 0.4%
Existing Home Sales 5.57m 5.35mil 5.09 mil

After a summer in which economic releases routinely exceeded consensus, we have entered a period where it appears consensus on the economy has become somewhat more accurate. The percentage of indicators beating expectations versus those falling short are almost identical. What does this mean for the market? One plausible outcome could be similar to the reaction to stocks beating earnings expectations we mentioned in the Market section: the market could drift lower without a significant economic surprise.

The index of leading economic indicators (see chart below courtesy Briefing.com) exceeded consensus this week and posted its sixth consecutive month of positive growth (although the August reading was revised down 0.2%). Eight of the ten components in the LEI were positive. According to Briefing.com the rise in the LEI is the fastest the index has risen since 1983, although they cite that the rate of increase has no correlation to the rate of economic recovery. It is also interesting to note that whenever this indicator beats consensus, it is typically due to estimated variables such as money supply, orders for consumer goods, and new orders of capital goods.

Sales of existing homes created the most controversy among economic indicators this week as the NAR made a seasonal adjustment that took sales from -5.4% to +9.4%. Typically sales drop off in September, however, sales relative to August were higher than normal, partially due to the home buyer’s credit. There has been quite a bit of discussion about the enormity of the seasonal adjustment.

Distressed sales were 29% of the total and the median sales price was $174,900, down 8.5% y/y and lower by 1.4% m/m. The NAR said “much of the momentum is from people responding to the 1st time buyer tax credit. We are hopeful the tax credit will be extended and possibly expanded to more buyers.” They said 1st time buyers accounted for 45% of home sales during the past year.

GDP in the UK shrank 0.4% in the third quarter, which for some reason was a surprise to the 33 economists surveyed since each of them expected an increase. This follows on the heels of a 1 trillion pound stimulus program. Industrial production shrank 0.7% and construction fell 1.1%. The big whiff by economists reminds me of Will Rogers, who once optimistically said “an economist’s guess is liable to be as good as anybody else’s.”

A reader sent me a link this week to a cool website run by a group called Tip Strategies. The animated map graphically shows the growth of jobs, by geography, since 2004. I was struck by the shrinkage (sorry Costanza) in jobs (note the huge red circles) in the quarter leading up to the 2008 election. As most politicians know, jobs are the key to getting elected or re-elected. Check it out at http://tipstrategies.com/archive/geography-of-jobs/.

You Have Been Duly Warned
Retrospectively there were plenty of warnings about the financial crisis, some stretching all the way back to the early 1990’s. Recently Brooksley Born, who served as chairperson of the Commodity Futures Trading Commission (CFTC) during the Clinton administration, granted her first TV interview. Ms. Born repeatedly warned both Congress and the President of the need to regulate the OTC derivatives market, but she was rebuffed by many, including then Federal Reserve Chairman Alan Greenspan (aka The Bubblemeister) and Treasury Secretary Robert Rubin. Recall that the crash of OTC derivatives helped trigger the financial crisis last fall. Below is a summary of Ms. Born’s interview:

In The Warning, veteran FRONTLINE producer Michael Kirk unearths the hidden history of the nation’s worst financial crisis since the Great Depression. At the center of it all he finds Brooksley Born, who speaks for the first time on television about her failed campaign to regulate the secretive, multitrillion-dollar derivatives market whose crash helped trigger the financial collapse in the fall of 2008.

“I didn’t know Brooksley Born,” says former SEC Chairman Arthur Levitt, a member of President Clinton’s powerful Working Group on Financial Markets. “I was told that she was irascible, difficult, stubborn, unreasonable.” Levitt explains how the other principals of the Working Group — former Fed Chairman Alan Greenspan and former Treasury Secretary Robert Rubin — convinced him that Born’s attempt to regulate the risky derivatives market could lead to financial turmoil, a conclusion he now believes was “clearly a mistake.”

Born’s battle behind closed doors was epic, Kirk finds. The members of the President’s Working Group vehemently opposed regulation — especially when proposed by a Washington outsider like Born.

“I walk into Brooksley’s office one day; the blood has drained from her face,” says Michael Greenberger, a former top official at the CFTC who worked closely with Born. “She’s hanging up the telephone; she says to me: ‘That was [former Assistant Treasury Secretary] Larry Summers. He says, “You’re going to cause the worst financial crisis since the end of World War II.”… [He says he has] 13 bankers in his office who informed him of this. Stop, right away. No more.’”

Greenspan, Rubin and Summers ultimately prevailed on Congress to stop Born and limit future regulation of derivatives. “Born faced a formidable struggle pushing for regulation at a time when the stock market was booming,” Kirk says. “Alan Greenspan was the maestro, and both parties in Washington were united in a belief that the markets would take care of themselves.”

Now, with many of the same men who shut down Born in key positions in the Obama administration, The Warning reveals the complicated politics that led to this crisis and what it may say about current attempts to prevent the next one.

“It’ll happen again if we don’t take the appropriate steps,” Born warns. “There will be significant financial downturns and disasters attributed to this regulatory gap over and over until we learn from experience.”

Thanks for the Endorsement

Former Federal Reserve Chairman Paul Volcker was an early supporter of Barack Obama's presidential campaign and was named head of the President's Economic Recovery Advisory Board. But that hasn't been enough to get White House support for the tough reforms that Volcker wants enacted to fix what's wrong with the nation's banks. Volcker wants to prevent banks from owning and trading risky securities, and he proposes that the industry be divided into two separate parts: mainstream commercial banking and investment banking, in other words a return of Glass Steagall.

We agree. If taxpayers are going to bear the brunt of the risk for the nation’s largest banks, then they shouldn’t be allowed to act like a sailor on shore leave (no offense to you sailors), gambling away with no recourse for bad bets. Limit their activities to traditional banking services.

“Ask five economists and you’ll get five different answers-six if one went to Harvard.”—Edgar Fiedler

To Stimulate or Not to Stimulate, That is the Question
David Einhorn, the outspoken CIO of Greenlight Capital, said in a letter last week “an alternative lesson from the double dip the economy took in 1938 is that the GDP created by massive fiscal stimulus is artificial. So whenever it is eventually removed, there will be significant economic fall out. Our choice may be either to maintain large annual deficits until our creditors refuse to finance them or tolerate another leg down in our economy by accepting some measure of fiscal discipline.”

Well said.

Commercial Real Estate
The Fed’s Beige Book was released this week and it cited weak or deteriorating commercial real estate markets were reported by all of the Federal Reserve's 12 district banks. The report found that the overall economy is still plagued by weakness in banking and increasing unemployment. Among the few bright spots in the report were observations of "stabilization or modest improvements" in manufacturing and housing.

Oil prices remain over $80 per barrel, a level that has in the past led to a reduction in consumer demand. OPEC says speculators are to blame for the recent rise in the price of oil. OPEC Secretary-General Abdullah al-Badri said there is no economic justification for the price increase, and so it seems to be the result of financial trading. "There is no shortage of oil supply. We have floating storage of 125 million barrels," al-Badri said.

Mr. al Badri should consider looking to the United States Federal Reserve and Congress, the inept keepers of the dollar, for the answer to his questions.

Investor Complacency
The VIX, which measures volatility and typically investor fear, has settled near a 12 month low in the mid 20’s. The index peaked at an all time high above 80 just after the Lehman collapse last year. Given the economic uncertainty, I’d say that the VIX is too low, suggesting investor complacency.

The call to buy stocks is becoming manic as every investment advice column seems to be screaming BUY!

National Debt
Shadowstats.com has calculated that the 2008 deficit, reported at $1.4 trillion, was actually $5 trillion and total obligations are over $60 trillion. Why the discrepancy? Shadowstats calculates the obligations in a similar manner that companies are required to handle their own accounting. When liabilities are incurred (think pension obligations or in the case of government Social Security), then the company must account for those in the period they are earned, not when they are actually paid out.

Real Estate Subsidy
According to Barron’s, a recent Brookings Institute analysis demonstrates persuasively that the $8,000 subsidy actually costs $43,000 per extra house sold; and that the new $15k tax credit will ultimately cost $292,000 per home.

How does that math work? :

“[The] refundable tax credit, which was part of the February stimulus bill, gives $8,000 to first-time homebuyers (but is phased out at higher incomes). It is scheduled to expire on December 1, 2009, although the sponsor of the initial proposal, Senator Johnny Isakson, now wants to extend the credit for another year, and expand it to $15,000. This extension would be a mistake. Approximately 1.9 million buyers are expected to receive the credit, but more than 85% of these would have bought a home without the credit. This suggests a price tax of about $15 billion – which is twice what Congress intended – for approximately 350,000 additional home sales. At $43,000 per new home sale, this is a very expensive subsidy.”

I can’t wait for these jokers to run our healthcare system. Anyone want to bet we become the first country in the history of the world to experience a decrease in life-expectancies?

Tax Fairness
Much has been made about who pays and who doesn’t pay their fair share of taxes. A recent report showed that the top 5% of wage earners in California pay 55% of the state’s taxes while the bottom 50% of earners pay 3.5% of the state’s taxes. Most economists would agree that a more broad-based tax base is healthier and more sustainable than such a narrow one.

It’s difficult for voters to enforce fiscal responsibility on elected officials when 50% of taxpayers are net receivers of benefits and repeatedly vote for more while only 5% (I know, this is probably higher) are net payers and vote for less. Multiple studies have shown that the majority of voters tend to vote with their pocketbooks.

I’ve also heard arguments saying that the top taxpayers are actually net receivers of benefits from the state due to the opportunities provided to them by the state. Can anyone explain that logic in light of 5% paying 55% of the taxes, because I don’t quite get it?

Support for Obama Slipping
A recent Gallup Poll showed that President Obama’s approval rating has fallen to one of the lowest levels ever for a new President. This follows up on the much ballyhooed 78% approval rating on the day he took office. As I discussed back in February, ratings this low make it very difficult for the Administration to be aggressive on the policy front.

The charts below show the Rasmussen surveys, which show a declining approval rating and a rising percentage of voting adults strongly disapproving of the President.

I’m not sure if I’m a better sports prognosticator than market prognosticator, but so far two of my three beginning of the year sports predictions have come true. First, the Lakers won the World Championship, now the Angels have been defeated in the ALCS. When I wrote those predictions in January I think I assumed the Angels would get beat by the Red Sox once again, however, it was the Yankees benefitting from too many Angel miscues and an extraordinarily friendly schedule.

Oh How Far the Proud Have Fallen
While I’m on sports, it was interesting to listen to the gloating coming from my Fighting Irish loving next door neighbor after they lost to SC by “only a point.”

Does anyone else remember the days when Notre Dame fans expected their team to win, not just come close?

Earnings reports continue this week, and the economic calendar is pretty full with the first look at Q3 GDP coming out Thursday (estimated at 3.2%). Personal spending and income come out Friday. The CaseShiller Home price index for August comes out Tuesday, and is expected to decline 11.9%.

Have a great week and a Happy Halloween. Don’t forget to set your clocks back on Sunday.


“Leadership is a potent combination of strategy and character. But if you must be without one, be without the strategy.”—General Norman Schwarzkopf

Oct 18, 2009

Dow 10K, Again

Dow 10K, Again

October 19, 2009

“A government big enough to give you everything you want, is strong enough to take everything you have"--Thomas Jefferson”

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

INDU: 1.3%
SPX: 1.5%
COMPQ: 0.8%
RUT: 0.2%

First the hype. The Dow crossed the 10K mark for the 26th time in the past decade. As I have mentioned in a number of prior notes, one of the best investments ever was made by CNBC when they bought those Dow 10K hats for their anchors. I can’t remember ever buying a commemorative piece of clothing and having the opportunity to wear it more than once or twice, much less 26 times! Smart guys.

Once again the market finished the week in positive territory, but we saw a significant surge in large caps vis-a-vis small caps. Could this be the beginning of a rotation into the larger caps, which have lagged the small caps in this seven-month rally? At the beginning of the rally small caps were markedly less expensive than large caps, a situation that is now reversed. Small caps have typically led rallies off major bottoms, eventually replaced by their larger peers. It’s a trend worth watching closely.

Whether this is the beginning of such a rotation or not, it is definitely a point in the cycle when stock picking will win out over beta picking. Beta picking occurs when markets broadly rally, and typically the smallest stocks with the highest beta outperform, regardless of their fundamentals. Eventually these markets will mature, and investors will begin rotating into companies with stronger fundamentals and picking winners versus losers becomes the primary driver of out-performance.

Companies have cut back expenses significantly, setting the stage for explosive earnings growth when/if revenue growth returns. Reporting companies have been beating EPS expectations at a record pace this quarter, primarily as a result of stabilizing revenues and massive cost cuts. If the economy continues to stabilize, EPS growth should continue to far exceed estimates.

The chart below, courtesy finviz.com, shows that material stocks outperformed significantly this week as a weak dollar and surging demand (primarily from China) for industrial commodities drove the stocks. China is a voracious consumer of basic materials, and they are rapidly converting their excess dollar holdings into the same.


Actual Consensus Prior
Export Prices 0.0% 0.7%
Import Prices 0.6% 0.3%
Retail Sales -1.5% -2.1% 2.2%
Retail Sales ex-auto 0.5% 0.2% 1.0%
Business inventories -1.5% -1.0% -1.1%
Initial Claims 514K 520K 524K
Continuing Claims 5992K 6000K 6067K
Core CPI 0.2% 0.1% 0.1%
CPI 0.2% 0.2% 0.4%
Empire Manufacturing 34.57 17.25 18.88
Philadelphia Fed 11.5 12.0 14.1
Capacity Utilization 70.5% 69.8% 69.9%
Industrial Production 0.7% 0.2% 1.2%
U of Michigan Consumer Sentiment 69.4 73.3 73.5

The economic release calendar was full this past week, with most of the important measures showing slight improvements and, for the most part exceeding consensus. The exceptions to this trend include the University of Michigan Consumer Sentiment index as consumer concerns about inflation resurfaced. The indicator is highly correlated to gasoline prices (which have been rising), unemployment (which has marginally improved), the stock market, and media coverage (which has been spewing about the economic recovery).

Retail sales ex-autos (which were weak after Cash for Clunkers ended) for September were better than expected, posting a 0.5% gain. "It's mildly encouraging," said Paul Dales, U.S. economist at Capital Economics. Furniture stores posted the biggest sales gain, at 1.4%, followed by gasoline stations, with 1.1%, and general-merchandise stores, including discount chains, at 0.9%.

Capacity utilization and industrial production both came in above expectations. The chart below shows both measures over the past 16 years. Industrial production is at its lowest point in this series, as is capacity utilization. Capacity utilization is a key measure to watch as the Fed will also be watching this measure as they consider when to remove their stimulative policy.

I have railed against the To Big To Fail policy of the Fed and Treasury, wondering why we are taking an anti-capitalistic stance by throwing capital to the weaker operators. Recently Paul Merski of the Independent Community Bankers of America (a DC based trade group) testified to congress that community banks make 20% of all small business loans, even though they only represent about 12% of all bank assets. He also stated that roughly ½ of all small business loans under $100K are made by community banks.
Consistent with the recent results of the large banks, Merski notes that “since Glass-Steagall was repealed in 1999, the giant banks have made much of their money in trading assets, securities, derivatives and other speculative bets, the banks’ own paper and securities, and in other money-making activities which have nothing to do with traditional depository functions.”
I’m sure we are all now feeling better knowing that we didn’t just spend nearly a trillion dollars bailing out key lenders, but instead just saved giant hedge funds disguised as banks.

More Dow 10K
From Peter Boockvar:

“With the DJIA approaching 10,000 again, let’s reminisce about 1999, the year it first passed that magic level on March 29th. Millennium by the Backstreet Boys was the best selling album, American Beauty won the Academy Award, the Euro was established, SpongeBob SquarePants aired for the first time, Hugo Chavez was elected President of Venezuela, Karl Malone, Pudge, Chipper Jones, Jagr and Kurt Warner won MVP awards and the average price of a gallon of gasoline at the pump was about $1.20. US nominal GDP ended at $9.6b vs $14.1 as of Q2 ‘09. Also, on March 29th 1999, the DXY was at 100.36 (now 75.60), the CRB was at 192.40 (now 269.15), gold was at $280 (now $1,060), oil was $16.44 (now $74.80), corn was $2.32 (now $3.85), copper was $.62 (now $2.83), the 10 yr yield was 5.19% (now 3.38%), and the fed funds rate was at 4.75% (now 0-.25%). Oh, how time flies.”

According to Bloomberg, U.S. stocks and the dollar are moving in the opposite direction more than ever before as a weaker currency boosts the value of sales outside America. The correlation coefficient using 120 days of data between the Dollar Index and the Standard & Poor’s 500 Index is minus 0.43, near the level of minus 0.45 reached on July 7. The reading three months ago was the lowest in the currency gauge’s 42-year history.

“When the dollar drops, that’s good for companies that are making products in the U.S. and selling them abroad,” said Frederic Dickson, who manages $20 billion as chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. “Investors are expecting U.S. multinational companies to have positive earnings surprises as a result of the dropping dollar.”

Companies in the S&P 500 generated 48%of their revenue outside the U.S. in 2008, an increase from 44% in 2006, according to data compiled by S&P. While the S&P has been rising since March, the dollar has fallen 14%, the largest drop over a two quarter period ever.

According to Barclays Capital, central banks are increasingly putting reserves into the euro and the yen, a move that is putting more pressure on the U.S. dollar. Central banks put 63% of new reserves into Euros and yen during the second quarter. "Global central banks are getting more serious about diversification, whereas in the past they used to just talk about it, and it looks like they are really backing away from the dollar” said Steven Englander, chief U.S. currency strategist at Barclays.

The Administration’s proposed healthcare legislation is offset by $404 billion in cost savings over a decade in both the Medicare and Medicaid programs. That includes $117 billion in cuts to Medicare Advantage, a program in which private insurers offer 10 million senior-citizen enrollees benefits such as dental or vision coverage not offered by the government program.

If there are $400 billion in Medicare and Medicaid savings, let’s have the government show us that they can achieve these savings, and then maybe we will give them the opportunity to take on another entitlement program. Until then, stand down!

First Stanford, now Harvard?
According to Bloomberg, Harvard, considered the world’s richest school, paid almost $500 million to investment banks to escape interest-rate swaps that backfired. The data was obtained from the school’s annual report.

Harvard paid $497.6 million during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects, the report said. The university also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps.

The Oil Conundrum
The price of oil rose to a one-year high Friday, closing at nearly $78 per barrel. The jump came after the U.S. Energy Information Administration released data showing that gasoline inventory unexpectedly decreased by 5.2 million barrels last week. Analysts warned that the rally might not last. "A correction is on the cards. I would expect profit-taking to set in next week and for oil to retreat to the mid- to low-$70s," said Ben Westmore, an analyst at National Australia Bank.

I haven’t discussed oil much the past couple of months as I haven’t been involved on either side of the trade since mid-late August. After being very short through early February, and then slightly short through June, we have no exposure today. A smart PM/reader asked a number of months ago how I could be bearish on the US dollar AND oil. My comment at the time was that short term I was bearish on both because I felt the supply/demand equilibrium favored a short position in oil. Around mid-August it became apparent that global concerns about the dollar were increasing and it was time to abandon the net short position in energy. We are now looking for a pullback and, unless or until evidence of a double dip recession arises, will use the pullback to establish a net long position.

ISI’s Ed Hyman sees the orderly decline of the dollar as a positive for the stock market. "Investors outside the U.S. are purchasing companies in the Standard & Poor's 500 Index at the cheapest valuations on record, their buying power boosted by a seven-month decline in the dollar.” ISI’s Eric Boucher writes that the “S&P 500 is priced at 19.9 times earnings, the biggest discount to the MSCI World Index of 23 developed countries since May 2003. For euro-based money managers, currency translations push the cost of U.S. stocks down to 13.6 times profits, the lowest level ever relative to global equities and a discount that dollar-based investors have never enjoyed. Overseas investors that hold almost $2.5 trillion in U.S. equities are getting a bigger slice of corporate America with each euro, yen and pound they spend just as S&P 500 companies from PepsiCo Inc. to General Electric post higher overseas sales. While more losses in the dollar would cut returns, the last time U.S. stocks were this inexpensive, in 2003, the S&P 500 began a four-year, 62 percent advance.”

I have been receiving a lot of emails about where opportunities in technology might be occurring. Presently I feel we are in a scenario where internet bandwidth is temporarily greater than PC CPU power. Historically when this imbalance has occurred, it has paid to be involved in PC related stocks (think Dell, Intel, etc).

I do, however, think that this imbalance will be short lived as consumer devices generating gigabytes of data become ubiquitous. Cisco recently purchased Flip, makers of a flash based, pocket sized video camera, for $350 million. I own a Flip camera, and this weekend alone created 4GB of new video! Cisco plans improvements in picture stabilization as well as a slew of accessories for the device. Their ultimate goal is to make video creation so simple and ubiquitous that bandwidth consumption accelerates, driving sales of their higher margin network equipment. The increase in video content also has the potential to drive a consumer PC upgrade cycle as CPU cycles won’t be able to keep up with the demands of HD video.

More Public Pension Problems
An analysis by PricewaterhouseCoopers concludes that within an average of 15 years, public pension funds will have less than half of the money needed to pay promised benefits. After losses of $1 trillion on investments by U.S. state and local pension funds covering police officers, teachers and other government employees are forcing managers of the retirement plans into a difficult choice. They must either try to boost returns by taking on even riskier investments or start cutting benefits.

I smell tax increases coming.

Real Estate
RealtyTrac spokesman (and reader) Rick Sharga said “during the third quarter, home foreclosures in the U.S. reached a record high. They were the worst three months of all time.” The firm said 938K homeowners received some form of foreclosure notice. The number is 23% higher than that of last year's third quarter and 5% higher than the second quarter.

Amazingly, just 6 states account for 62% of US total foreclosures: California, Florida, Arizona, Nevada, Illinois and Michigan.

Hard to Believe, but more from the Not So Golden State
About half of California’s personal income tax revenue, which finances 50% of the California government’s general fund, comes from 144K taxpayers, or about 1% of the total legal population of the State.

The governor supports a budget overhaul, proposed last month by a bipartisan commission that would reduce personal income taxes as well as eliminate corporate and sales levies. Instead, revenue would be raised through a new business receipts tax that would collect more revenue from companies providing services.

When will this government learn that at some point they need to just say NO to spending programs and get back to providing basic services?

More Bait and Switch
According to USA Today, if the President’s plan for health care overhaul makes its way through Congress and then onto his desk for signature this year, Americans will have to wait several years to enjoy full benefits of the measure. Some cuts in Medicare and tax increases to pay for the plan would take effect immediately. But families with low and medium incomes would not get tax credits to help with insurance premiums until 2013.

Benefits are conveniently “scheduled” to occur just after the next Presidential election. We’ll see.

Telling It like It Isn’t
According to the Financial Times, one of five hedge fund managers is not straightforward with investors about the fund or its performance, according to research by New York University's Stern School of Business. According to researchers' data, a large percentage of managers did not give the right amount of money under management. Managers also exaggerated performance data and did not include some key points in regulatory and legal history. Funds with compliance problems often failed to mention those issues.

Is it any wonder Main Street doesn’t trust Wall Street?

Late to the Party, Again
Former Federal Reserve Chairman Alan Greenspan, once the defender of large financial institutions, and creator of the biggest asset bubbles in US history, said this week that U.S. regulators should consider breaking up large financial institutions considered “too big to fail.” The Bubble Master had plenty of opportunities to address this issue during his 16 or so years running the Fed, but instead chose to ignore ever-concentrating risk to the determinant of this country.

Why won’t he just go away?

Earnings will continue this week with Gannett, BB&T, Hasbro, Apple, Texas Instruments, Blackrock, Caterpillar, Coca-Cola, Microsoft and Wells Fargo among the hundreds of reporting companies.

Have a great week.


“Insured deposits are being used in ways that I don’t like to see.”--Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation

Oct 11, 2009

Market Finds Support

Market Finds Support

October 12, 2009

“There are no secrets to success. Don’t waste your time looking for them. Success is the result of perfection, hard work, learning from failure, loyalty to those for whom you work, and persistence.”—Colin Powell

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

INDU: 4.0%
SPX: 4.5%
COMPQ: 4.4%
RUT: 6.0%

The markets ripped upwards this week, bouncing off their 50 day moving averages (see chart below courtesy Bespoke), reaching new one year highs. Much has been made about these new highs in the market; however we must point out that one year ago the market was in the midst of a plummet from higher levels. In fact, the S&P 500’s all time peak of 1565 was reached October 9, 2007. Since then the index is down over 30%. According to Bespoke Investment Group, analysts are now the most bullish they have been since their extreme bullishness two years ago. Our contrarian nature keeps us focused on moving away from this crowd, which collectively tends to be the most bullish near peaks and the most bearish near market troughs.

Earnings season will kick off in full force this week as companies discuss third quarter results and their outlook for the fourth quarter and the all important Christmas selling season. Earnings expectations remain somewhat modest and easy to exceed, although at some point companies will have to begin delivering on revenue estimates to sustain their most recent rise. Last quarter was characterized by companies beating earnings estimates on lower cost structures yet missing revenue estimates. As investors have discovered through both expansions and contractions, companies posting strong EPS without commensurate increases in revenue eventually falter. Coca Cola was the perfect example of this in the 90’s, posting high teens EPS growth on mid single digit revenue growth for years, until they finally faltered as they couldn’t cut expenses enough to offset their lack of revenue growth.


GDP Q2-Final -0.7% -1.2% -1.0%
Consumer Conf 53.1 57.0 54.5
Case-Shiller Housing Price Index -13.3% -14.2% -15.4%
ISM Services 50.9 50.0 48.4
Consumer Credit -$12.0 bil -$9.5 bil -$21.6 bil
Initial Jobless Claims 521K 540K 554K
Continuing Claims 6040K 6105K 6112K
Wholesale Inventories -1.3% -1.0% -1.6%

The biggest economic story this week was the massive $12 billion decline in outstanding consumer debt in August (see chart below courtesy Gluskin Sheff). The consensus was looking for an $8 billion contraction. This was the seventh month in a row of debt retrenchment. In other words, the tidal wave of the credit collapse continues unabated. Keep in mind that the $12 billion (5.8% annualized decline) reduction took hold during the peak for cash-for-clunker auto sales in August. This held the contraction in non-revolving credit to $2.1 billion. According to David Rosenberg, the total decline outside of the auto subsidy would have exceeded $20 billion during the month.

The Sept ISM services index hit 50.9, up from 48.4 and above 50 for the first time in a year. Remember that a measure above 50 signifies expansion in the non manufacturing sector. Business Activity rose 55.1, the highest level in two years, but the other components were mixed as just 5 of 18 industries reported growth. New Orders rose to 54.2 from 49.9 and backlog rose 11 pts to 51.5. Employment remained sluggish, rising to 44.3. Export orders fell back below 50 to 48.5 from 55.0. Prices paid fell to 48.8 from 63.1. The ISM said “even with the overall month over month growth reflected in the report, respondents’ comments vary by industry and remain mixed about business conditions and the overall economy.”

The National Retail Federation is expecting a drop of 1% in retail sales during holiday season. This report is typically overly optimistic, so plan accordingly.

Jobless claims came in at 521K, less than consensus and down from the prior period. The chart below, courtesy of Briefing.com, shows the 4-week average initial claims since September 2005.

Continuing claims came in slightly less than anticipated, but still exceeded 6 million. The chart below, dating back to 1991, shows the dramatic increase in continuing unemployment claims.

Credit Conditions
Every Friday the Fed releases the assets and liabilities of US commercial banks, a report which shows how much the banks are actually lending. For the week ended Sept 23rd, commercial and industrial loans outstanding fell for a 12th straight week to the lowest level since Nov ’07. What have the banks been doing with their capital? Primarily buying US Treasuries, agency paper and MBS (guaranteed by FNM/FRE) as almost free money from the Fed has created a nice spread.

From the NY Times this week: “The continued disarray in debt-securitization markets, which in recent years were the source of roughly 60% all credit in the United States, is making loans scarce and threatening to slow the economic recovery. Many of these markets are operating only because the government is propping them up.”

The debt-securitization markets finance corporate loans, home mortgages, student loans and more. In good times, they enabled banks to package their loans into securities and resell them to investors. That process, known as securitization, freed banks to lend even more money.

Many investors have lost trust in securitization after losing huge sums on packages of subprime mortgages that had high default rates. The government has since spent more than $1 trillion trying to restore the markets, with mixed success.”

As we have discussed in the past, now that credit risk between banks has been normalized, the next step is repairing investor confidence and freeing the banks to lend. Without this secondary market the velocity of money has ground to a halt.

Ben Bernanke commented Friday that the Federal Reserve would tighten monetary policy once the economy improves. He finally admitted that they must address inflation at “some point.” The dollar strengthened on the comments, showing a rare flash of strength in response to an even rarer comment by a US official on their concern for either the dollar or inflation.

Due Warning
We posted this quote in our March 1, 2009 note from Robert Prechter of Elliot Wave International, who correctly advised massive shorting against the market in July 2007, “is now recommending covering those shorts. The market is compressed. When it finds a bottom and rallies, it will be sharp and scary for anyone who is short. I would rather be early than late.” Mr. Prechter first achieved notoriety by recommending shorting the market two weeks before Black Monday, 1987.

Robert now feels the market is over bought, the dollar over sold, and the economy will sink into deflation. He feels the dollar could rise for the next year or more. He also expects the stock market to break the March 2009 lows before the end of 2010 and bank failures to accelerate.

More from the Not-So-Golden State

This past week California raised the yields on part of a $4.5 billion bond offering after getting a weaker response than at a sale of short-term notes two weeks ago. The deal from California, the largest borrower and the lowest rated among U.S. states, will push new municipal issues this week to a five-month high, according to data compiled by Bloomberg. The state raised preliminary yields by two to four basis points on maturities ranging from 2015 through 2029. Tax-exempt bonds due in 20 years may yield 4.66%, and those due in 2025 might pay 4.42%, according to Dan Solender of Lord Abbott & Co.

Commercial Real Estate
According to Bloomberg there was a stunning omission from the government’s June 30 list of “problem” banks, a list of 416 lenders. One outfit not on the list was Georgian Bank, the second-largest Atlanta-based bank, which supposedly had plenty of capital. It failed last week.

It is estimated that Georgian’s clean-up will be unusually costly. The book value of Georgian’s assets was $2 billion as of July 24, about the same as the bank’s deposit liabilities, according to an FDIC estimate. The FDIC calculates the collapse will cost its insurance fund $892 million, or 45%of the bank’s assets.

The key question that we have been raising for over a year is how many other “healthy” community banks are out there waiting to implode? That’s impossible to know, which is what’s so unsettling about Georgian’s sudden downfall. Just when the conventional wisdom suggests the banking crisis might be under control, along comes a reality check that tells us we have no idea what’s in bank portfolios.

We have often discussed the nature of construction loans and how quickly they go from performing to non-performing. In the case of Georgian, they reported a 12x jump in nonperforming loans to $306.4 million from $24.7 million three months earlier, mostly construction loans. On its March 31 report, the bank said just $79.1 million of its loans were 30 days or more past due. That included the loans it had classified as nonperforming.

Is it any wonder the FDIC keeps increasing its estimates for the losses it’s anticipating from future bank failures? In May, the agency said it was expecting $70 billion of losses through 2013. This week, it bumped that to $100 billion. The agency also said its insurance fund would finish the third quarter with a deficit, meaning liabilities exceed assets.

Monkey off their Back

The Angels won the ALDS this morning (Sunday), coming back from a 5-1 deficit to beat the Red Sox 7-6 at Fenway. As most of you know, I am a long time (40 years) and long suffering Angel fan, and after losing to the Sox in every imaginable way possible in previous playoffs, this was especially sweet. Now it looks as though the Yankees will be the only thing standing in the way of the long awaited Freeway Series versus the Dodgers.

I will be rooting hard for the Angels, however, remember in my January 4 note one of my predictions for 2009 was that the Angels would lose in the ALCS. Let’s hope I’m wrong there.

The price of gold closed at record highs this week, nearly hitting $1050 per ounce. While gold is at record highs in dollar terms, the commodity is still down 10% from its highs when priced in Euros and Yen. As shown in the charts below (courtesy Bespoke and Bianco Research), the price of gold is up considerably over the last five years, but the recent run has only been strong in dollar terms. This suggests that the strength is solely a function of a weaker dollar rather than any real pickup demand.

Attention Mr. Bernanke

The Reserve Bank of Australia’s decision to boost the overnight cash rate target to 3.25% from a 49-year low of 3% followed the first expansion this year in U.S. service industries (ISM). Manufacturing in emerging markets increased the most in the past three months since the second quarter of 2008, according to the HSBC Emerging Markets Index of data from purchasing managers.

Gold and material stocks jumped on the news.

Private Equity & VC
Bloomberg is reporting that Stanford University is reportedly offering stakes in funds run by Silicon Valley neighbors Sequoia Capital and Kleiner Perkins in an asset sale that may raise $1 billion. The university’s endowment is seeking bids on portions of $6 billion in holdings of venture capital, buyout, real estate and energy funds, said people close to the deal, who declined to be named because the plan is private. Those stakes also carry $5 billion in future investment commitments to the fund managers.

Stanford began shopping the fund stakes about a month ago, according to a fourth person with knowledge of the matter. Its goals are to determine pricing and shift the mix of endowment assets, not raise cash. Stanford won’t sell more than 20 percent of its holdings in a single fund, and may decide against any dispositions, the person said.

Downward Pressure on CPI
According to Eric Boucher at ISI, bond bulls are enjoying an unprecedented inflation backdrop. "Apartment Glut Deepens" is the title of a WSJ story about falling rents (housing has about 40% of the weight in US CPI.). Near term it is likely the low CPI run will continue and with it the bond bull market.

Real Estate
Home values in 20 U.S. cities climbed in July by the most in almost four years, helping stem the record plunge in household wealth that’s depressed spending.

The S&P/Case-Shiller home-price index rose 1.2% in July from the prior month, the biggest gain since October 2005. Home values are firming as low borrowing costs and government tax credits lift home sales.

How the Public Option Really Works
The Federal Housing Administration (FHA) provides home loan insurance for mortgages with low down payments. Their volumes have quadrupled since 2006 as the private lenders and insurers pulled back from the market. During a House committee meeting this week, a former Fannie Mae executive testified that the FHA may require a US bailout because of $54 billion MORE in losses than it can withstand.

House legislation has been introduced that would require an increase in the FHA’s minimum down payment from 3.5% to 5%. Presently 17.5% of FHA loans are delinquent or in foreclosure, well above the national average of 13%.

This serves as another example of the private sector understanding the market better than the government. Let me repeat this one more time: Government isn’t the solution, it’s the problem.

Retail Sales
Same store sales grew 0.6% in September, feeble but welcome growth for an industry which hadn’t seen a positive comp in over a year. Analysts had expected a 1% drop. "Let the retail recovery begin!" the International Council of Shopping Centers said.

That seems a bit too optimistic for us, but we are certainly happy to see some improvement for the retail sector.

That’s a lot of Tamales
The Congressional Budget Office released its final estimate for the US budget deficit before the official figure is announced for the year that ended Sept. 30, estimating a record $1.4 trillion. The deficit for the 2008 fiscal year was $459 billion.

The Son of Hawley-Smoot Tariff Act

The U.S. Commerce Department is investigating China's dumping of steel in the U.S. market. The move was instigated by a petition from U.S. Steel last month regarding carbon and alloy steel pipes. The government already slapped tariffs on tubular and steel pipes from China used in oil drilling and on certain low-priced tires.

We may not see a full tariff act, which occurred in the 1930’s and helped to lengthen the Depression; however, a series of tariffs over time could have a negative impact on this fledgling recovery.

President Obama has been looking for some bipartisan support outside of D.C., seeking public endorsement of his health care overhaul because he has been unable to get support from Republicans on Capitol Hill. The White House distributed a statement from California Gov. Arnold Schwarzenegger saying he supports many of Obama's goals. Other public statements came from New York City Mayor Michael Bloomberg and former Wisconsin Gov. Tommy Thompson.

For the President’s sake let’s hope he can find better Republican support than the Governator, who technically isn’t even a Republican.

Earnings begin in earnest this week, with releases from industry bellwethers such as Johnson & Johnson, Intel, Abbott Labs, JP Morgan, Landstar, Citigroup, Goldman Sachs, Harley-Davidson, Safeway, Google, IBM, General Electric, Halliburton, Mattel, and Bank of America featured this week. Mixed in will be the periodic preannouncement (both positive and negative) to keep the markets hopping. The economic calendar is light this week.

Have a great week.


“Most people can stay excited for two or three months. A few people can stay excited for two or three years. But a winner will stay excited for 20 to 30 years-or as long as it takes to win.” – A.L. Williams