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%
Market
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.
Economy
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.
Economists
“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
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.
Angels
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?
Conclusion
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.
Ned
“Leadership is a potent combination of strategy and character. But if you must be without one, be without the strategy.”—General Norman Schwarzkopf
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