Nov 29, 2009

Black Friday Sales-Good or Bad?

Black Friday Sales-Good or Bad?

November 30, 2009

"Regardless of the dollar price involved, one ounce of gold would purchase a good-quality man's suit at the conclusion of the Revolutionary War, the Civil War, the presidency of Franklin Roosevelt, and today." - Peter A. Burshre

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

INDU: -0.08%
SPX: 0.01%
COMPQ: -0.35%
RUT: -1.28%

Markets around the globe declined Thursday and Friday on news that Dubai World (an investment company that manages investments and projects for the government of Dubai, which itself is part of the UAE) is asking for a 6 month reprieve on $60 billion in debt. While emerging markets dropped significantly on the news, the US market may have benefitted (relatively) by the Thanksgiving Holiday, a flight to quality, and the observation that for once US banks may not be the leaders in poor lending as estimates of US bank exposures are extremely small. The biggest risk may not be in the banks, but instead the unwinding of the massive carry trade involving the dollar. Even a short lived flight to quality has the potential to create a short squeeze on the dollar as the carry trade unwinds, and risky assets of all types endure commensurate selling pressure.

Sector performance for the week was defensive as telecom services, health care and utilities led while financials, basic materials, and technology lagged. During the past month conglomerates, healthcare, and basic material stocks have outperformed while financials have lagged badly (see chart below, courtesy

The preliminary Black Friday estimates from all sources are typically inaccurate and should be viewed with quite a bit of skepticism, a lot like preliminary government releases. That being said, I’ll dutifully provide the early estimates for Black Friday sales from the National Retail Federation, which show revenues up 0.5% vs. 2008. The NRF is reporting average revenue per consumer to have declined 8% while traffic jumped 13% both online and at bricks and mortar stores. As we have discussed over the past few weeks, expectations are low enough that any positive comps may be enough to fuel the market.


Actual Consensus Prior
Existing Home Sales 6.1 mil 5.7 mil 5.54 mil
Q3 GDP-second estimate 2.8% 2.8% 3.5%
GDP deflator 0.5% 0.8% 0.8%
Case Shiller Home Index -9.4% -9.1% -11.3%
Consumer Confidence 49.5 47.5 48.7
Personal Income 0.2% 0.1% 0.2%
Personal Spending 0.7% 0.5% -0.6%
PCE Prices 0.2% 0.1% -0.6%
PCE Prices-Core 0.2% 0.1% 0.1%
Initial Claims 466K 500K 501K
Continuing Claims 5423K 5565K 5613K
Durable Orders -0.6% 0.5% 2.0%
Durable Orders ex Transports -1.3% 0.6% 1.8%
Michigan Sentiment 67.4 67.0 66.0
New Home Sales 430K 404K 405k

The economic calendar was heavy for a holiday shortened week. Purchases of new homes in the U.S. rebounded more than anticipated in October as buyers rushed to take advantage of the government tax credit before it expired. Sales rose 6.2% to an annual rate of 430K, the highest level since September 2008. The median sales price fell 0.5% and the number of unsold homes reached a four-decade low. Home values may remain under pressure as builders are forced to compete with mounting foreclosures as unemployment climbs. The median sales price of new houses sold in October 2009 was $212K; the average sales price was $261K. The seasonally adjusted estimate of new houses for sale at the end of October was 239K. This represents a supply of 6.7 months at the current sales rate. The chart below, courtesy of, shows how far new home sales have fallen since the 2005 peak.

As expected, GDP for Q3 was revised downward from 3.5% to 2.8%. Government spending remains strong, being revised up from 7.9% to 8.3%. Personal consumption expenditures were revised downward from 3.4% to 2.9%. Durable goods were revised down from 8.1% to 7.2%, nondurable goods from 22.3% to 20.1%, and services from 1.2% to 1.05. The big reduction came from auto sales, which were revised down to 0.8% in spite of Cash for Clunkers.

Fixed investment was revised down from 2.3% to 0.3% on nonresidential and residential construction weakness. Nonresidential construction fell 15% in the quarter versus a preliminary estimate of -9.0%.

Inventories also dropped, slightly hurting GDP. Export sales were revised upwards, however, imports also increased. The rise in imports was larger than the gain in exports, resulting in a decline in the net export contribution.

The chart below, courtesy, shows real GDP since mid 2006.

Existing home sales also rose in October to 6.1 million, well in excess of consensus. This increase drove supplies to its lowest level since February (7 months).

Trouble in the Middle East

The Dubai World default threatens to be the biggest sovereign default since Argentina. There are some technicalities which could keep this from being classified as a sovereign default; however, given the nature of Dubai World’s relationship with Dubai and the UAE, it should definitely be classified as such. In the market section we mentioned the potential for the unwinding of the dollar carry trade, and for the second week in a row we saw a preview of this trade: the dollar rose, crude fell, gold was down, treasuries rose, and equities fell.

Dubai is the only UAE member not to have its own oil production. The building in the country over the past decade has been gargantuan as they have attempted to turn the small nation into a tourist destination rivaling Monaco. The country features some of the world’s tallest and most exotic buildings, including one that rotates 360 degrees each day, as well as the biggest man made islands in the world. Credit default swaps (CDS) rose dramatically during the week, up roughly 33%. CDS are contracts whose value increases when the market anticipates deterioration in the credit quality of the underlying debt.

Obama and China
This week President Obama visited what is arguably our most important trading partner and certainly our largest creditor, China. While it is always difficult to gauge the effectiveness of these diplomatic missions, the tone from the President relating to China’s treatment of their own currency didn’t appear to be especially well received.

SNL created a spoof on the meetings which seems to sum up the situation very well. The video clip can be viewed below. The best line from the Chinese Premier-“I supposed if I wanted my money, I could call and say I was a Wall Street Banker needing my bonus.”

Bank Lending
According to the FDIC, banks in the U.S. cut back the amount of money loaned to customers by $210.4 billion in the third quarter. The 2.8% reduction marks the sharpest drop since at least 1984. The biggest banks, which received billions of dollars in taxpayer bailouts, accounted for a disproportionately large part of the drop. "We need to see banks making more loans to their business customers," said Sheila Bair, the FDIC's chairwoman.

Taxes-from Miller Tabek

Miller Tabek makes the following observations about taxes:

“We bring this up because the list of tax increases that we know about apparently just got a big longer this weekend. We know that the top marginal tax rate is going to increase in 2011 to 39.6% from 35%. We know that the capital gains tax is set to increase 5 full percentage points while dividends are set to be taxed as ordinary income. We know that the upper income brackets will lose the ability to deduct mortgage interest from their state and local tax liabilities. We spoke on Friday of our horror at learning the payroll tax would increase to 1.95% for some individuals and we spoke earlier this fall of the impending tax related to the health care initiative. We know of all these tax increases and we have no doubt that upper income bracket consumption patterns (the top quintile accounts for anywhere from 40-50% of spending) will be affected. We would doubt the argument that it is enough to derail economic growth but it seems at least fair to say that consumption will be affected.”

Are You Kidding Me?
According to the NY Times, Wall Street funds apparently found a way to make big money from the residential-mortgage crisis and leave U.S. taxpayers with most of the risk. The process begins with a hedge fund or a private-equity fund buying a block of mortgages at a deeply discounted price. Then homeowners are offered a principal reduction on their mortgages in return for refinancing the debt into new mortgages backed by government-sponsored entities such as the Federal Housing Administration. The mortgages can then be sold to another government-backed entity, such as Ginnie Mae.

Will the mortgage games ever end?

Dollar and Stocks
According to ISI, the weak dollar benefits stocks about 67% of the time. One reason is the weaker dollar can give large multi nationals an earnings boost. Technology, materials and industrial benefit the most.

Real Estate
The band keeps on drumming in the real estate market. Despite the stock market’s massive run up from the March 2009 low, the fundamentals in real estate keep struggling to find a bottom. Each piece of good news (see Economy section above) is met by a comparable piece of bad news.

“The proportion of U.S. homeowners who owe more on their mortgages than the properties are worth has swelled to about 23%, threatening prospects for a sustained housing recovery. Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American Core-Logic, a real-estate information company based in Santa Ana. These so-called underwater mortgages pose a roadblock to a housing recovery because the properties are more likely to fall into bank foreclosure and get dumped into an already saturated market. Economists from J.P. Morgan said Monday they didn’t expect U.S. home prices to hit bottom until early 2011, citing the prospect of oversupply.”

Of those who took out mortgages at the 2006 peak, more than 40% are under water.

Go Brazil!
Octavio de Barros, Banco Bradesco’s chief economist, said rising exports, increased investment and strong domestic demand will drive Brazil's economy to 6.1% growth in 2010. He also said Brazil's exports will benefit from purchasing by emerging countries, particularly China. Brazil is expected to post 0.5% growth in GDP this year.

More on Gold
People (including us) have been so bulled up on gold that my contrarian nature makes me have second thoughts about holding the metal. The chart below (courtesy shows the relationship of gold and the dollar. As we have mentioned, gold is definitely at risk if the dollar carry trade unwinds.

Thursday the President will be holding a jobs summit, whatever that is. Employment remains a difficult issue, and for the incumbent party jobs are the key to maintaining power in the 2010 elections. The urgency was noted by Representative Barbara Lee, a California Democrat, who said this week “We have to create jobs, and we have to create them right away."

As we move towards year end, I’ll be reviewing my 2009 predictions (they can be found on the website in the January 4th note,, and at some point will be coming up with predictions for 2010. Although the market in 2008 and 2009 was a difficult place to make money, the macro environment certainly seemed simple to predict. I am anticipating that 2010 will be much more difficult to accurately predict, but am looking forward to the process. As always, I appreciate your thoughts and comments, and continue integrating them into the notes.

Have a great week.


“The Fed is a serial bubble blower worse yet, they have refused to hold the most aggressive and damaging speculators accountable for their own losses. Instead, they have participated in a massive socialization of risk, where profits remain private but losses are the taxpayers’ burden.”—Barry Ritholtz

Nov 22, 2009

Is the Data Really That Bad?

Is the Data Really That Bad?

November 23, 2009
“A proposal to give banking regulators authority to block accounting standards is “a terrible idea,” Paul A. Volcker

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

INDU: 0.46%
SPX: -0.19%
COMPQ: -1.01%
RUT: -0.27%

Federal Reserve Chairman Ben Bernanke actually admitted this week that a weak dollar could cause rising commodity prices and inflation, and the dollar responded with a small, but positive move. To my knowledge this is the first time anyone in charge of this country’s currency has admitted what every Econ 101 student already knows-a weak currency is inflationary. While the US dollar caught a slight bid this week, the fed funds futures continue to reduce its belief that he’ll follow words with actions. The odds of a 25 bps rate hike have now been pushed out to Sept 2010.

What is going on with the Treasury market? Yields on the short end are zero (or less), and on the longer end sitting at 3.356% and 4.295% for the 10 and 30 year respectively. The 2-10 spread at 266 basis points (2.66%) is the widest it has been since mid summer, which should help the banks if they ever start lending again.

Merrill put out a piece this week on asset allocation among institutional investors. Based on a survey they conducted with more than 100 institutional investors they found a tremendous strategic desire to move away from US equities, particularly large cap, and toward a more global mandate. Emerging market equities are the most desirable asset class over the next 12 months with 42% looking to add/increase investment. On a percentage basis, nearly as many investors (39%) seek to decrease investment in US large cap equities. This could result in $300-500bn flowing out of US large cap equities over the next 3-5 years from institutional investors.


Actual Consensus Prior
Retail Sales 1.4% 0.9% -2.3%
Retail Sales ex-auto 0.2% 0.4% 0.4%
Business Inventories -0.4% -0.7% -1.6%
Core PPI -0.6% 0.1% -0.1%
PPI 0.3% 0.5% -0.6%
Capacity Utilization 70.7% 70.8% 70.5%
Industrial Production 0.1% 0.4% 0.6%
Housing Starts 529K 600K 592K
Building Permits 552K 580K 575K
CPI 0.3% 0.2% 0.2%
Core CPI 0.2% 0.1% 0.2%
Initial Jobless Claims 505K 504K 505K
Leading Indicators 0.3% 0.4% 1.0%
Philly Fed 16.7 12.2 11.5

The leading economic indictors slowed dramatically in October from 1.0% to 0.3%, slightly less than consensus. Positive contributions from interest rate spreads, stock prices, jobless claims and the average workweek were offset by nondefense capital goods orders, deliveries, consumer expectations and building permits.
Initial unemployment claims rose slightly to 505K. The number of people receiving jobless benefits dropped, as did those getting extended payments.

Housing starts posted their worst decline of the year (-11%), and the lowest absolute number since the spring as the homebuyers credit expired and then was extended. Building permits also dropped by 4%. Mortgage applications just hit a 12 year low, which doesn’t bode well for housing turnover.

October Retail Sales rose 1.4%, .5% more than expected but ex auto’s they were up just 0.2%, 0.2% below forecasts. The Sept headline figure was revised lower by 0.8%, so taken together the Sept/Oct data is a touch light. Motor vehicles/parts sales rose 10.2% in Aug, fell 14.3% in Sept and rose 7.4% in Oct. Sales ex auto’s and gasoline rose 3%, right in line with expectations. Sales rose in the following categories: food/beverages, restaurants, health/personal care, clothing, department stores and online retailers. They fell in furniture, electronics, building materials and sporting goods.

We have been long gold as a hedge against a weak dollar, and the metal has performed as expected, rising to $1163 per ounce. Analysts have been raising their price targets as they tend to do when asset prices go up, and a legitimate question is whether the metal is in a bubble or not. We don’t think so, however, the chart below from The Big Picture shows the metal in relation to US Treasury Bond futures. Today’s ratio is comparable to the prior peak in gold roughly 29 years ago.

Our view is that the commodity won’t turn down until the Fed addresses the ills afflicting the currency. Although Greenspan, whoops, Bernanke (is there a difference other than the beard?) addressed concerns about the dollar’s collapse for the first time this week, with unemployment north of 10% it doesn’t appear the Fed will be acting anytime soon.

Look for a new peak in this chart!

Removing the Stimulus
Bank of Japan Governor Masaaki Shirakawa joined China Banking Regulatory Commission Chairman Liu Mingkang to warn that the loose money policy of the U.S. Federal Reserve could fuel an asset bubble. Shirakawa warned of "new, real and insurmountable risks to the recovery of the global economy" because of the Fed's policy. "The continuous depreciation in the dollar, and the U.S. government's indication that, in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation," Liu said.

European Central Bank President Jean-Claude Trichet said the bank will gradually withdraw the emergency cash it has pumped into the economy in order to ensure it doesn’t fuel inflation. Trichet had previously signaled the ECB is unlikely to renew its offer of 12-month loans to banks after the third tranche in December.

The Chinese Central bank may raise deposit requirements for commercial lenders next year, according to Shanghai Securities News. At a forum in Beijing, former central bank deputy governor Wu Xiaoling said the Peoples Bank of China should be allowed more authority to choose monetary policy tools in 2010 as economic recovery has already become steady. Bank shares eased 1% in the local session overnight on back of the report.

More Accounting Shenanigans by the Banks

An amendment that is strongly supported by the banks is being considered which, in addition to removing mark-to-market accounting, allows a systemic regulator “to order the Securities and Exchange Commission, which now oversees the Financial Accounting Standards Board, to suspend or change any accounting rule that the council thinks is a threat to financial stability.”

“The amendment has been endorsed by the American Bankers Association, which says the SEC’s focus on helping investors is too narrow.”

What!? Reduce transparency even further for a group of zombie banks who almost took this country down as a result of their complete incompetence?


Commercial Real Estate

Goldman Sachs Group Inc. is underwriting $400 million of bonds backed by an Ohio real estate company’s shopping centers, the first sale to tap a U.S. program to unlock lending in the commercial mortgage market. The bond is backed by 28 properties owned by Developers Diversified Realty Corp. The Federal Reserve opened its Term Asset Backed Securities Loan Facility (TALF)in June to newly issued commercial mortgage-backed securities to stimulate lending and avert a wave of foreclosures as borrowers fail to refinance. There have been no new sales of the debt since June 2008, according to data compiled by Bloomberg.

“It would be good for the market psyche to actually see a new deal done,” said Kent Born, senior managing director at PPM America Inc., an investment manager in Chicago. “But as a practical matter it’s not going to get us back to the type of deals that were the bread and butter of the market merely two years ago.” Sales of commercial mortgage-backed debt slumped to $12.2 billion last year from a record $237 billion in 2007, according to JPMorgan.

Deals from JP Morgan and Bank of America are reportedly in the pipeline.

Tax Receipts Remain Weak

The chart below, courtesy the Rockefeller Institute, shows the cumulative changes year over year in income, sales, and property taxes for the US over the past five years. Typically tax rates have little to do with the actual amount of taxes collected, GDP is the primary catalyst to tax receipts. As you can see in the chart below, as of the end of the second quarter the rate of decline in tax receipts hadn’t yet bottomed. This decline is putting severe pressure on state and local governments at a time when the Federal government is attempting to stimulate the economy with massive deficit spending. Since state and local governments need to run balanced budgets, their resulting pullback is having a contra effect on the efforts of the Feds.

The headline in this weekend’s Orange County Register-State Officials Pay to Drop 18%!

An official of the International Energy Agency said the world is much closer to running out of oil than the agency's statistics had shown. Under pressure from the U.S., the IEA distorted statistics to show that more oil would be available, the official said. "The IEA in 2005 was predicting oil supplies could rise as high as 120 million barrels a day by 2030, although it was forced to reduce this gradually to 116 million and then 105 million last year," the official said. "The 120 million figure always was nonsense, but even today's number is much higher than can be justified, and the IEA knows this."

Healthcare and Taxes
According to ISI the proposed health care bill is dangerous for the health of small businesses. Provisions include a payroll tax of 8% of payrolls if small businesses do not offer health care. In addition, high income earners will get hit with a host of new payroll taxes taking marginal federal rates to 44% for the individuals earning more than $500,000.

Add on 11% state income tax in CA, 8.5% sales tax, and miscellaneous other taxes (including capital gains), and for the residents of some states the government is taking well over 60% of the incremental income above $500K.

This certainly seems like a back door way to cap pay without having the authority to explicitly do so.

ISI’s Ed Hyman notes 4 items that are pointing to higher inflation: gold, GSCI, the trade weighted dollar, and import prices ex fuel have begun to move up. The fed's favorite measure the 5-year forward TIP market is also stirring.

Multi-Family Housing
According to the Wall Street Journal, after losing billions on single-family residential loans, Fannie Mae and Freddie Mac are bracing for another round of losses, this time on apartment lending. Previous losses already forced the U.S. Treasury to pump more than $110 billion into the companies. Fannie, which has the highest delinquency for multifamily properties, saw apartment loans that were 60 days or more late on payment increase to 0.62% in September, up from 0.16% the same month last year.

Tax Burden
A couple of weeks ago I discussed the tax burden in California on the highest wage earners, which generated a number of responses and questions about Federal Taxes. (being acquired by Intuit) put out the following statistics regarding income taxes (this is federal income taxes only, and excludes capital gains, etc):

Top 1% (making over $500K) pay 41% of federal income taxes
The top 5% (making over $200k) pay 61% of federal income taxes
The top 10% (making over $100K) pay 71% of federal income taxes
The top 25% (making over $75K) pay 87% of federal income taxes
The bottom 50% (making less than $40K) pay 2.9% of federal income taxes
A full 47% of “tax units” will pay zero. Of 307 million Americans there are 152 million “tax units.”

The median income in the US is just over $50K per year.

Real Estate
I somewhat understand why the homeowner’s tax credit is in place, to somehow reward those willing to take on more risk or trying to get the housing market moving. But why are we providing tax breaks to homebuilders? This just increases supply in the same market where we are providing incentives to people to absorb that supply.

Government continues to amaze me with their basic misunderstanding of supply and demand. If they want home prices to stabilize or go up, and are willing to provide tax credits to accomplish this goal, then why are they also providing tax breaks to those who would increase the supply, thereby putting further pressure on prices?

More Real Estate
The outlook for the home market dimmed this week as residential construction and mortgage applications fell and loan delinquencies reached a record. “I don’t think the housing crisis is over,” Mark Zandi, chief economist with Moody’s, said. “I think we’re going to see another leg down.”

New home sales may begin to pick up by the start of the so-called spring selling season, said Toll Brothers Inc., the largest U.S. luxury homebuilder. Existing house sales may take longer. Residential construction and property sales led the way out of the previous seven recessions going back to 1960, said David Berson, chief economist of PMI Group, the mortgage insurer in Walnut Creek, California.
“You don’t pay a mortgage with economic output, you pay a mortgage with a paycheck,” Jay Brinkmann, MBA’s chief economist, said.

The share of all types of home loans with one or more payments overdue climbed to a record seasonally adjusted 9.6% in the third quarter, the Washington-based trade group said in a report yesterday.

There are signs that parts of the U.S. are rebounding. California, among the states where the housing bust started, is one of the few areas that’s beginning to recover. October home prices in Orange County, San Diego and the San Francisco Bay Area increased from a year earlier, MDA DataQuick, a San Diego property information service, said this week. The number of sales also increased in the Bay Area and Southern California.

Mortgage Rates
If the Federal Reserve is content letting the long end of the yield curve rise, it seems as though their goal of lowering mortgage rates may be at risk. The spread between the FHLM 30-year mortgage and 10-year yields is 84 basis points. Currently (data through May 6) the Federal Reserve has bought $366 billion of MBS and has the authority to buy up to $1.25 trillion.

Because of this massive buying, anything is possible with this spread, even inversion. Unless the Federal Reserve plans on driving mortgage rates lower than Treasuries, this spread cannot tighten much more than it already has. Once this spread cannot tighten any further, mortgage rates will be at the mercy of the Treasury market.

Velocity of Money

From Jim Furey of Furey Research Partners:

“Falling money velocity, as has been the case since 1Q08 is accompanied by declining inflation, lower interest rates and small-cap relative outperformance. Current money velocity is at its lowest level since ’81. Examining four key periods of declining money velocity since 1981, we make the following observations: i) core and headline inflation rates have fallen in each period by an average annualized rate of -17% and -14%, respectively; (i) the Fed Funds target rate has been reduced during each period by a -38% average annualized rate; and (iii) small-caps have outperformed large-caps on average by +5% annualized rate.

Implications of rising money velocity. Money velocity at 3Q09 posted a slight uptick from 2Q09, but it is too early to tell if it has begun a cyclical upswing, such as in ’87, ’94 and ’04. We do know that when it does start moving upwards, we can expect rising inflation, higher rates and small-caps to underperform large-caps, if past is prologue.”

Thanks Jim

Are the data points really that bad? The real estate market is still on life-support without government intervention. Will the stimulus be enough to turn that market, or will the cost associated with re-inflating that bubble be enough to sink us?

The other data is mixed, and that is to be expected at this point in the “recovery”. Anticipate continued mixed results on the economic front, with some deterioration as much of the low hanging fruit has been picked. The preliminary 3rd quarter GDP came in at 3.5%, but it looks like it will get revised down to 2.5%, which many are suggesting is purely due to government intervention. Certainly we have a long way to go.

With the leaders of the market rally (techs, small caps, financials, and inflation trades) pulling back while higher quality and more defensive names move to the forefront, it would appear that at minimum the market may pause into the end of the year. I am net neutral, with a long bias towards higher quality names and a short bias towards lower quality names.

Have a terrific Thanksgiving. Remember that Friday is a shortened trading day and the US markets will be closed on Thursday.


"The baby will talk when he talks, relax. It ain't like he knows the cure for cancer and he just ain't spitting it out."—Justin’s Dad

Nov 8, 2009

Don't Fight the Fed

Don’t Fight the Fed!

November 9, 2009

“How are you going to regulate systematic risk when you are the systematic risk?”—Senator Jim Bunning questioning Ben Bernanke

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

INDU: 3.2%
SPX: 3.2%
COMPQ: 3.3%
RUT: 3.1%

The success of the Fed’s plan to encourage investors to increase their risk and buy securities was made very clear to me this week during a conversation with a reader, who commented that he “needed to buy some stocks since his 5% CD’s were rolling over, and 1% just wasn’t that enticing.” I’m still baffled how leverage, risk, excessive liquidity and easy credit are the cure for a problem caused by leverage, risk, excessive liquidity and easy credit. As the title suggests, don’t fight the Fed, at least in the short term!

The market closed the week with strong gains, although volume was stronger on the down days than the up days during the week. Almost right on cue following our comments over the past two weeks that the transports could be signaling further downside in the markets, Wonderful Warren (aka the Oracle of Omaha), announced his intention to acquire Burlington Northern in his biggest acquisition ever, $44 billion, helping to spark a 6%+ increase in the transports for the week. Rolfe Winkler posted a chart this week (below) which shows Buffet’s recent investments have received quite a bit of support from the Fed, almost $134 billion worth. Is it possible that Buffet’s endorsement of recent government bailouts and his “buy America” pronouncement were procured in exchange for continued government support of his investment positions? The Burlington announcement makes this an interesting quid pro quo.

Earnings estimates have been rising steadily since the early summer months. Jeremy Grantham asserts that “earnings estimates in particular merely follow the market up, not the other way around as one would hope. So it is a law of nature that strong estimates will abound after a major market rally.” Expect to see earnings estimates continue rising into year end and early 2010, but eventually revenue growth will need to return to support the earnings. A reader wrote in last week asking what percentage of companies were beating earnings and revenue estimates. The answer, courtesy of Bank of America Merrill Lynch, shows that 80% of companies beat earnings estimates this quarter while 53% also beat revenue estimates.

Speaking of the Fed, for some reason they bothered to hold a meeting this week at which they unsurprisingly decided to leave rates unchanged. While the Fed rarely specifically spells out their plans for rates, translating the comments after this meeting leads us to believe that the Fed doesn’t plan to raise rates until the next bubble (i.e. financial asset values) is so big that when it pops the collective ear drums of the world will pop.

Don’t fight the Fed.


Actual Consensus Prior
Construction Spending 0.8% -0.2% -0.1%
ISM Index 55.7 53.0 52.6
Factory Orders 0.9% 0.8% -0.8%
ISM Services 50.6 51.5 50.9
Productivity-preliminary 9.5% 6.5% 6.6%
Initial Claims 512K 522K 532K
Continuing Claims 5749K 5750K 5817K
Nonfarm Payrolls -190K -175K -219K
Unemployment Rate 10.2% 9.9% 9.8%
Average Workweek 33.0 33.1 33.0
Hourly Earnings 0.3% 0.1% 0.1%
Consumer Credit -$14.8 bil -$10.0 bil -$9.9 bil

First time unemployment topped 10% for the first time since 1983 (see chart below courtesy, well above the Administration’s peak estimate of 8.5% they projected in February. Temporary employment, typically a leading indicator of hiring, rose for the third straight month, increasing 33.7K in October. Without that increase the employment picture would have been significantly weaker. Unofficial estimates of the “underemployed”, i.e. those wishing to be employed full time but unable to obtain employment, rose 1% to 17.5%. The second chart below, courtesy of Barry Ritholtz, shows the number of unemployed longer than 27 weeks, dating back to 1948. Even if the economy stabilizes and hiring moves back into a 150K-200K per month range, it could take 3-5 years to achieve prior levels of employment.

This is a Test
According to Bloomberg, some of the largest central banks, including the European Central Bank and the Bank of Japan, are starting to exit from stimulus measures implemented to tackle the financial crisis. ECB President Jean-Claude Trichet said the central bank will start to withdraw liquidity initiatives. "There are all kinds of risks," said Jim O'Neill, London-based chief global economist at Goldman Sachs. "We don't know how much of the improvement in markets is due to central banks' largesse, and neither do they. They're pretty nervous, but they've got to get out of it at some stage."

This is Another Fine Mess you’ve Gotten me into
The problem is, as Don Kohn said last month, they do not understand the monster they have unleashed:

“Our limited knowledge of the determinants of asset prices and their effects on credit has made it more challenging to respond to the crisis and explain our actions to the public. More generally, while most of the literature on the effects of monetary policy assumes that the federal funds rate is the single relevant tool for monetary policy, the financial crisis has shown that a wide array of policy measures, acting on the prices of different assets, may be needed in extreme circumstances. The research literature that could help gauge the potential impact of these measures and the exit from them is disappointingly sparse.”

As we have repeatedly questioned-who is going to buy all the paper on the Fed’s books when it decides to reverse its quantitative easing?

The coming week will mark the first offering of treasuries by the Treasury Department since the Fed completed its commitment to buy $300 billion of the paper. The $81 billion coming this week should reveal whether the markets are ready to support treasuries on its own or a continuation of the program will be required to quell a rise in rates.

Stay tuned.

While I typically don’t discuss specific positions in this note, I have commented often about our long position in gold. This week India helped us out by aggressively buying gold from the IMF- 200 tons. Now, I doubt they are planning to make jewelry with this much of the yellow metal, so it would appear that this is the first significant move by a central bank to diversify away from the Dollar and Euro.

Although I have been very critical of him, I am starting to miss the strong dollar days of Robert Rubin.

Jobs were foremost in voter’s minds this past week as Republicans won gubernatorial races over Democratic incumbents in Virginia and New Jersey. As we mentioned two weeks ago, voters typically vote based upon their wallets, and in New Jersey it was high tax rates undoing Mr. Corzine, the incumbent, while in Virginia it was the mere threat of higher taxes.

Stock Focus
I have mentioned my personal Starbucks indicator (again, full disclosure I have a position in the stock) in prior notes (the length of the line at my local SBUX) has been improving since roughly April, and the stock price has followed, rising from high single digits to just over $21. SBUX was also used as an example of a company negotiating better lease rates with an estimated annual savings of $500 million fueled by lower real estate costs. This past week the company announced solid earnings driven by cost cuts and improving, but still negative same store sales.

Cisco Systems (CSCO) announced order improvements in their quarterly conference call this past week. CEO John Chambers, who has been the canary in the coal mine for recessions and recoveries, was almost giddy during the Q&A session of the call. I sat with John (pre Reg FD) as he pre-announced downside to the quarter and a marked slowdown in capital spending in late 2000, and then listened to his call two years ago as he again lamented about a marked slowdown in orders.

Ford (F), the only U.S. automaker that did not seek bankruptcy protection, surprised analysts with a third-quarter profit of $997 million. Ford benefited from the government's "Cash for Clunkers", rebates, cost-cutting measures and market share gained after General Motors and Chrysler went bankrupt. At the same time, it gained market share faster than Japanese competitors Honda Motor and Toyota Motor even though consumers are favoring foreign makers again (see chart below courtesy BEA).

Alternative Energy
Speaking of autos, the alternative energy push will hurt the continually short sighted domestic auto industry. Barron’s showed that Toyota, Nissan, Hyundai, Honda and Panasonic are the top 5 holders of auto related alternate-power patents.

Where are the domestic auto makers? Most likely spending your tax money on healthcare benefits and political contributions.

I mentioned last week that I would be attending the 39th annual AEA Tech Classic in San Diego. While it isn’t surprising to see conference attendance down in this economic environment, both the number of financial services attendees and presenting companies was down significantly over prior years. I think this was my 14th time attending, so I have a decent perspective on the attendance. There were roughly 80 presenting companies compared to a few hundred in some prior years.

The conference organizers were giving away passes in the last week, which are typically priced near $2000.

Health Care-Politics as Usual
Health care reform squeaked through the House Saturday by a 220-215 vote as the threat of working during the Christmas holiday got the House version moving. The plan passed with virtually no discussion as speaker Pelosi squashed any attempts at questioning the bill or virtually any portion of the bill. Democrats must now be especially motivated to get this passed after viewing the results in Virginia and New Jersey, which could be a precursor to the 2010 elections. A loss of even a handful of seats next year could mean this type of bill won’t get passed in the next session.

It was interesting to note that one Republican voted for the bill while 29 Democrats voted against it.

Goodbye Sarbanes Oxley

“That the Democratic Party is the vehicle for overturning the most pro-investor legislation in the past 25 years is deeply disturbing,” said Arthur Levitt, a Democrat who was chairman of the Securities and Exchange Commission under President Bill Clinton. “Anyone who votes for this will bear the investors’ mark of Cain.”

Is anyone in Washington ever held accountable for their votes?

More on Mark to Imagination

From Floyd Norris “This year, a subcommittee of the House Financial Services Committee held a hearing at which legislators sought no facts but instead threatened dire action if the chairman of the financial accounting board did not promptly make it easier for banks to ignore market values of the toxic securities they owned. The board caved in, which may be one reason why banks are reporting fewer losses these days. But the board’s retreat was not enough to satisfy the banks. The American Bankers Association is now pushing Congress to give a new systemic risk regulator — either the Federal Reserve or some panel of regulators — the power to override accounting standards. The view of the bankers is that the financial crisis did not stem from the fact that the banks made lots of bad loans and invested in dubious securities; it was caused by accounting rules that required disclosure when the losses began to mount.”

The superciliousness continues.

Real Estate and Business Health

According to The Wall Street Journal, bankruptcy filings by U.S. businesses increased 7% in October, according to researcher Automated Access to Court Electronic Records. Last month, 7,771 businesses filed for bankruptcy, compared with 7,271 in September. The real estate and retail sectors suffered the most, said Jack Williams, a bankruptcy law professor at Georgia State University. “Almost any financial challenge could cause a business to file for bankruptcy in these difficult times,” Williams said.

Its no wonder vacancy rates for retail and office space are rising.

From Peter Boockvar: “China’s economic bounce has continued so far into Q4 as evidenced by both the October state enterprise and private sector weighted manufacturing indices which rose to the highest level since April ‘08. There will also likely be no change in economic policies for the foreseeable future according to the Minister of Commerce as he believes the global recovery is still fragile. While China cannot single-handedly lift global economic growth, it clearly remains the most important country in the world in terms of driving economic activity which so far has spilled over into many other countries via trade.”

The Cost of Moral Hazard

Asian Strategist Andy Xie wrote this past week
“Today, governments and central banks are celebrating their victorious stabilizing of the global financial system. To achieve the same, they could have saved Lehman with $50 billion. Instead, they have spent trillions of dollars, probably more than $10 trillion, to reach the same objective. Meanwhile, a broader goal to reform the financial system has seen absolutely no progress.”

“Because policy makers mistakenly think stimulus spending can bring back growth, they are pushing too hard. The eventual consequences are inflation and bubbles along the way. These bubbles will be short-lived. The current boom market is a good example.”

Andy has been the king of identifying emerging bubbles over the past 15+ years, his comments deserve respect.

The market will attempt to hold onto last week’s gains during a light week for economic and earnings releases. The upcoming holiday shopping season should be one of the key fundamental drivers of the market through year end. Expectations are low, which could set up for upside surprises and further market returns. Countering the low expectations for the holidays is the fact that earnings growth has been stretched across negligible revenue growth, an unsustainable situation. Either sales will need to improve or earnings growth will falter. Valuations seem extended, but are rarely the singular cause for either a rally or correction. Jeremy Grantham notes that the S&P 500 fair value is now 850, down about 200 points from here. Jeremy is a great investor and wonderful writer, and while quite prescient over the past 24 months, he has also under-valued the S&P 500 since 1998.

Have a great week.


“Practical men who believe themselves to be quite exempt from any intelligent influence are usually the slaves of some defunct economists.”—John Maynard Keynes

Nov 1, 2009

How Bad Would The Economy Wobble Without Its Training Wheels?

How Bad Would The Economy Wobble Without Its Training Wheels?

November 2, 2009

"Years of practice enable the trader to act on the instant when the unexpected happens as well as when the expected comes to pass." - Jesse Livermore

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

INDU: -2.6%
SPX: -4.0%
COMPQ: -5.1%
RUT: -6.3%

The market fell again this week, much more convincingly than the prior week as volume surged. The press typically looks for singular reasons to explain daily stock action, and the list of contributors to this week’s downturn is long, formidable, and somewhat contradictory: valuation, economic data, the dollar, inflation, health care, ineffective government policy, weak lending, a flailing consumer, a long held view that stocks have come too far too fast, inflation, deflation, above consensus GDP, loose monetary policy, spiking crude, rising savings rates, unemployment, the end of mutual fund fiscal years, and weak capital spending. Our concern arose when the Dow Transports made double top and rolled over (see chart below, courtesy Dow Theory asserts that the transports and the industrials must confirm each other when making new highs; that when manufacturers’ are producing more they must also be shipping more. The Transports have acted as a canary in the coal mine for many market corrections.

John Roque, strategist at WJB Capital, notes that only 38% of stocks now reside above their 50 DMA versus 88% three weeks ago. Why is this significant? It confirms what we inherently know-the market has been losing steam. In Dow Theory parlance, the market is in phase 3-the distribution phase.

Last week we lamented investor complacency surrounding the market and the lack of skepticism after a 60% run. We noted that the VIX had dropped from highs over 80 a year ago to the low 20’s. Right on cue the VIX spiked to over 30 this week, including a 24% gain on Friday alone. And what of the lack of volatility we discussed? Over the past seven trading days the Dow has experienced six triple digit moves. It looks like this idyllic ride is about to experience a bumpy road. Hang on tight!


Actual Consensus Prior
CaseShiller Home Price Index -11.3% -11.9% -13.3%
Consumer Confidence 47.7 53.5 53.4
Durable Goods Orders 1.0% 1.0% -2.6%
Durable orders ex-transports 0.9% 0.7% -0.4%
Chain Deflator 0.8% 1.4% 0.0%
GDP-advanced 3.5% 3.2% -0.7%
Initial Claims 530K 525K 531K
Continuing Claims 5797K 5905K 5945K

The big news on the economic calendar was the advanced GDP report for Q3, which came in ahead of consensus at 3.5%. This positive GDP report has been hailed as the end of the Great Recession. We’ll reserve our judgment on that conclusion for another note, but will comment that the report was anything but clean. The Nominal GDP measure was actually below forecast as it rose 4.3% versus consensus of 4.6%. The difference was a 0.8% gain in the deflator versus an expected 1.4%, which gave the real GDP measure a 0.6% boost.

As they (whoever “they” are) say, the devil is in the details. Government stimulus was significant in pushing the GDP measure into positive territory. I have seen estimates that the Cash for Clunkers package added 1.0% to GDP (personal consumption added 2.4% overall). On the back of the home buyer’s tax credit, residential construction added 0.5% to GDP, which is the first positive contribution to GDP from that segment since late 2005.

In a slap in the face to the weak dollar proponents running our government, it is interesting to note that imports grew faster than exports (see net export chart below). State and local spending declined due to their current budget crises and inability to deficit spend (at least legally) while Federal Government spending, not hampered by balanced budget constraints or other such common sense requirements, grew by 8%.

David Rosenberg observed “The OECD estimates that the amount of stimulus injected into the U.S. economy is equivalent now to 5.6% of GDP. So if we were not seeing at least a statistical recovery in the economy, well that would mean real trouble.”

Housing prices rose once again versus the prior month, but declined on a year over year basis by 11%. Consumer confidence missed consensus and fell significantly from the prior month as the unemployment picture continues to weigh on the consumer psyche.

A Note from Ron Paul
“Anytime the central bank intervenes to pump trillions of dollars into the financial system, a bubble is created that must eventually deflate. We have seen the results of Alan Greenspan's excessively low interest rates: the housing bubble, the explosion of subprime loans and the subsequent collapse of the bubble, which took down numerous financial institutions. Rather than allow the market to correct itself and clear away the worst excesses of the boom period, the Federal Reserve and the U.S. Treasury colluded to put taxpayers on the hook for trillions of dollars. Those banks and financial institutions that took on the largest risks and performed worst were rewarded with billions in taxpayer dollars, allowing them to survive and compete with their better-managed peers. This is nothing less than the creation of another bubble. By attempting to cushion the economy from the worst shocks of the housing bubble's collapse, the Federal Reserve has ensured that the ultimate correction of its flawed economic policies will be more severe than it otherwise would have been.”

Sorry Mr. Taxpayer
CIT Group filed for bankruptcy to cut $10 billion in debt after the credit crunch dried up its funding and a U.S. bailout and debt exchange offer failed. CIT listed $64.9 billion in debt in its Chapter 11 filing. The U.S. Treasury Department said the government probably won’t recover much, if any, of the $2.3 billion in taxpayer money that went to CIT December 21, 2008.

CIT said it plans to exit quickly due to support from bondholders, who voted in favor of a prepackaged plan. CIT has $1 billion from investor Carl Icahn to fund operations while it reorganizes. The company had asked bondholders to exchange $30 billion in debt for new securities and equity. Debt holders rejected the exchange offer.

CIT’s largest unsecured claim holders were Bank of America at $7.5 billion and Bank of New York Mellon with a claim of $3.2 billion. Citigroup also has a $2.1 billion claim.

Cash for Clunkers is estimating that the Cash for Clunkers program cost taxpayers $24,000 per vehicle sold. They estimate that 82% of sales would have happened anyway and thus the handout of up to $4,500 really only enticed 18% of the buyers of 690k vehicles sold under the program.

And this is the crown jewel of the Administration’s stimulus plans? I’d hate to see the ones that didn’t work.

2009 vs. 1982
From David Rosenberg: “this is not the onset of a sustainable secular bull market as we had coming off the fundamental lows of prior bear phases, such as August 1982, when:

• Dividend yields were 6%, not sub-2%.
• Price-to-earnings multiples were 8x, not 26x.
• The market traded at book value, not over two times book.
• Inflation and bond yields were in double digits and headed down in the future, not near-zero and only headed higher.
• The stock market competed with 18% cash rates, not zero, and as such had a much higher hurdle to clear.
• Sentiment was universally bearish; hardly the case today.
• Global trade flows were in the process of accelerating as barriers were taken down; today, we are seeing trade flows recede as frictions, disputes and tariffs become the order of the day.
• A Reagan-led movement was afoot to reduce the role of government with attendant productivity gains in the future; as opposed to the infiltration by the public sector into the capital markets, union sector, economy and of course, the realm of CEO compensation.

Commercial Real Estate
Billionaire investor Wilbur Ross-“All of the components of real estate value are going in the wrong direction simultaneously. Occupancy rates are going down. Rent rates are going down and the capitalization rates (the return that investors are demanding to buy a property) are going up.”

U.S. office vacancies hit a five-year high of almost 17 percent in the third quarter, while shopping center vacancies climbed to their highest since 1992, according to the property research firm Reis Inc.

Global Trade
U.S. negotiators obtained promises from China to eliminate obstacles blocking the sale of wind-power equipment and pork to China. Responding to a U.S. demand for greater intellectual-property protection, China said it will launch a four-month campaign to stop theft of copyrighted material through the Internet. The U.S. agreed to stop accepting trade-protection cases against China. Both countries pledged to refrain from "abusing" trade-dispute procedures, including submitting complaints to the World Trade Organization.

Real Estate
Last week I was critical of the seasonal adjustment for New Home sales. The King Report noted that without the seasonal adjustment, new home sales for September were 31K versus foreclosures of approximately 40K in California alone for the same month. The decline from August was 16% versus a typical 10% decline.

Good Money after Bad
The U.S. government doesn't have an alternative to going along with a third multibillion-dollar rescue for troubled auto lender GMAC, experts said. "We are in too deep for us to sensibly back out now. We will probably lose less money by putting in more now," said Douglas Elliott, a fellow at the Brookings Institution and a former investment banker. Bailout talks with the Obama administration continue, but the third rescue may have essentially begun, according to the New York Times, which notes that GMAC sold $2.9 billion of bonds backed by the FDIC.

The Feds obviously haven’t learned one of the basic tenets of investing “don’t throw good money after bad.”

We remain net neutral, with a long bias towards higher quality names and a short bias towards lower quality and higher beta names. Oil has backed down from its recent high of over $80 to $77, and we will look for a spot to enter a long position in the commodity at a lower price, certainly below $70, on anticipated continued weakness in the dollar.

I am traveling to the 39th Annual AEA Classic in San Diego this week as a guest of B. Riley and Company. In my view this has always been the best small cap tech conference of the year. Attendance appears to be down once again this year as Wall Street continues to cut back. I have found that the future success of groups of stocks are inversely proportional to the attendance at their conferences, and I hope to find some interesting pieces of information which I can share with you next week.

Have a great week.


Because this rally has been a "race to rubbish," the quality names have largely been ignored and still represent decent value.–Al Lockwood, value manager, reader and friend.