On the Verge of Recovery?

On the Verge of Recovery?

July 20th, 2009

“Only a few people knew that debt ratios at major financial firms were 33 to 1 – a lethal level of risk. Nobody knew what Freddie Mac was doing. It was like letting your children play with loaded guns. Sooner or later someone will pull a trigger.” -- Felix Royathan

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

INDU: 7.3%
SPX: 7.0%
COMPQ: 7.4%
RUT: 8.0%

Market
The market soared this week, erasing the effects of the four week correction in short order and blowing through the “neckline” of the developing and widely discussed head and shoulders formation. There were a number of catalysts, beginning with Meredith Whitney’s upgrade of Goldman Sachs the day before they reported record earnings. It’s truly amazing how profitable you can be when you borrow capital at virtually zero cost from the government, use your political contacts to put your chief rivals out of business, and then use sophisticated software to manipulate the market. All in a quarter’s work I suppose.

The table below, courtesy Bespoke Investment Group, shows how the S&P 500’s ten sectors have performed over various time periods since the March 9th bottom. Financials have rallied the most, with energy and telecom lagging significantly.



For the past week, basic materials, financials, and industrials led the rally. Healthcare, utilities and consumer goods lagged. The table below, courtesy Finviz.com, shows the weekly sector performance, which favored inflation beneficiaries, exporters, and financials.



The ongoing question is whether the economy has bottomed and if so, what type of recovery will we experience. There are strong arguments suggesting we are close to the end of the recession. Lakshman Achuthan of the ECRI says “the cyclical improvement in the economy is proceeding in a textbook sequence, from long leading indicators to short leading indicators to coincident indicators.” In fact, “there are now pronounced, pervasive and persistent upturns in a succession of leading indexes of economic revival.” The chart below, courtesy of the ECRI, shows the growth rates of the leading and coincident indexes have recently turned upwards.



Our view is that while the economy could technically emerge from the recession sometime in the next two quarters, growth will be extremely slow. Additionally, we feel there is a significant risk of a double dip recession, much like the one in the early 1980’s. What will this mean for the markets? Buy and hold will be a rough way to make any money in this type of environment.

Economy
Actual Consensus Prior
Core PPI 0.5% 0.1% -0.1%
PPI 1.8% 0.9% 0.2%
Retail Sales June 0.6% 0.4% 0.5%
Retail ex-auto 0.3% 0.5% 0.4%
Business Inventories -1.0% -0.8% -1.1%
Redbook Chain Store Sales -5.7%
Core CPI 0.2% 0.1% 0.1%
CPI 0.7% 0.6% 0.1%
Empire Manufacturing -.55 -5.0 -9.41
Capacity Utilization 68.0% 67.9% 68.2%
Industrial Production -0.4% -0.6% -1.2%
Crude Inventories -2.9 mil
Initial Claims 522K 553K 569K
Philadelphia Fed -7.5 -4.8 -2.2
Building Permits 563K 524K 524K
Housing Starts 582K 530K 562K

Retail sales for June were soft ex the heavily subsidized autos and gasoline sales. Backing both of those out of the mix and retail sells fell 0.2%, the fourth straight monthly decline.

The drop in business inventories was led by a decline in autos. The inventory-sales ratio is lower, but still not low enough to drive a massive inventory replacement cycle. The potential for a second half build-up in auto inventories is creating the backdrop for an economic recovery in the 2nd half of the year. Does this set us up for a weak 1st half of 2010 if these cars aren’t sold?

PPI jumped on higher food and energy prices (up 1.1% and 6.6% respectively). Even without those two volatile components, PPI was up much higher than expected. Intermediate goods and crude products were up 1.9% and 4.6%. This was the biggest jump in 14 months for this measure of wholesale prices.

CPI came in a bit higher than expected at 0.7%, fueled by a rise in gasoline of 17.3% which led an increase in the transportation index by 4.2%.

The -0.4% decline in industrial production was better than expected and the slowest decline in eight months. Capacity utilization fell to 68%, which is the lowest level since record keeping began in 1967. Manufacturing accounts for 12% of US GDP.

The Philadelphia Fed’s general economic index fell to minus 7.5 from a nine-month high of minus 2.2 in June. Negative numbers signal contraction. “The worst of times in manufacturing is behind us, but we haven’t even started to approach good times,” said Joel Naroff, president of Naroff Economic Advisors.

Filing for unemployment claim benefits fell last week to the lowest level since January, partially depressed by shifts in the timing of auto plant shutdowns.

Housing Starts and Building Permits data for June came in higher than expected. Starts for the June period rose 3.6% from May to an annualized rate of 582,000 (consensus 530,000) while permits increased 3.0% to an annualized rate of 563,000. Starts were down 46% year over year and permits were down 52% Y/Y, figures that seem to be lost in the headline numbers. Does the housing market need an increased level of starts given the excess supply of existing homes for sale? Doubtful.

Don’t Worry, Be Happy
According to the AP, with three months left to go in the budget year, the U.S. government's deficit has hit an all-time high of $1 trillion. The Congressional Budget Office predicted that by the end of the year, the deficit will be 13% of the country's GDP. That compares with a recent high of 6% of GDP in 1983 during the Reagan administration and 30.3% in 1943, when the U.S. spent a huge amount of money to fight World War II.

Remember, we are still waiting for much of the stimulus spending to hit, and are discussing nationalizing healthcare. How will we pay for all of this? By raising taxes, of course. This week’s Barron’s included a table showing that under the current proposals coming from the administration, marginal tax rates for residents making over $1 million in roughly 40 states will exceed 50%. Most of those falling into that category are small businesses, and the proposed increase in taxes for someone at $1 million in income/revenue totals $100,000 per year! Say goodbye to one employee.

Consumer Credit
American Express disclosed their June card metrics; reporting the annualized default rate declined 20 basis pts to 10.2% and the total 30+ days delinquent amount declined by $0.3bil to $1.5bil.

State by state GDP change
The chart below, courtesy the BEA, shows GDP for each state ranked by quintiles. Dark blue and light blue represent the fastest growth, while gold and pale yellow represent the slowest growth. As you can see, three areas (west, southeast, and Great Lakes area) are growing significantly slower than the rest of the country.



Unemployment

From the NY Times: “In California and a handful of other states, one out of every five people who would like to be working full time is not now doing so. It is a startling sign of the pain that the Great Recession is inflicting, and it is largely missed by the official, oft-repeated statistics on unemployment. The national unemployment rate has risen to 9.5 percent, the highest level in more than a quarter-century. Yet it still excludes all those who have given up looking for a job and those part-time workers who want to be working full time.”
The chart below, courtesy the NY Times, shows that when you include those who wish to be employed full time, the rates reach astronomical levels. As an example, the rate in Oregon reached 23%. It was 21.5% in both Michigan and Rhode Island and 20.3% in California.

Government Efficiencies
John Mauldin’s piece from this week included the following two quotes:

“Thus Barro and Perotti are saying that each $1 increase in government spending reduces private spending by about $1, with no net benefit to GDP. All that is left is a higher level of government debt creating slower economic growth.”

“The most extensive research on tax multipliers is found in a paper written at the University of California Berkeley entitled The Macroeconomic Effects of Tax Changes: Estimates Based on a new Measure of Fiscal Shocks, by Christina D. and David H. Romer (March 2007) (Christina Romer now chairs the president’s Council of Economic Advisors). This study found that the tax multiplier is 3, meaning that each dollar rise in taxes will reduce private spending by $3.”

Makes you feel confident about the rapid encroachment of government in our daily lives, doesn’t it?

Government Healthcare Proposal
Here are some details, courtesy of Foster Friess, of the proposed healthcare plan.

“Washington politicians propose to cut health care costs by denying care and squeezing hospitals and doctors. Zeke Emanuel, Rahm Emanuel's brother, and key architect of the Obama health plan, argues for the ‘just allocation of health resources’ (i.e. rationing) in a way that ensures future generations are of the best mental and physical health. To do so, Dr. Emanuel cites that health services should not be guaranteed to “individuals who are irreversibly prevented from being or becoming participating citizens.” He continues, “An obvious example is not guaranteeing health services to patients with dementia.”

Wow! Sounds like the movie Logan’s Run, where they killed off anyone over 30 years old. I guess that makes sense-anyone with dementia is probably old, has no chance of becoming a “participating citizen”, and probably would require the government to pay a disproportionate amount of healthcare expenditures for the remainder of their lives versus someone who is younger.

For new readers, please don’t bombard me with notes about being against old people or insensitive, I’m just joking around.

Another Job I Could do in my Spare Time
President Obama announced that over 50 hours was spent negotiating the new healthcare proposal. Is that supposed to impress us? I spend more time than that every week writing a free newsletter (well, not quite 50 hours per week, but you get my point).

If the President and Congress feel that 50 hours spent on something is a lot of time, then I can guarantee that this new plan is full of pork and holes that will create more problems than it solves. The plan is over 1000 pages long, most members of Congress haven’t even read the entire plan, nor could they in the 50 hours spent creating it.

Earnings
I mentioned Meredith Whitney’s upgrade of Goldman as a catalyst for last week’s rally. Earnings were another catalyst. Roughly 10% of companies have reported so far, and the overall results have been better than expected.

Dell reported seeing demand stabilization and expects a sequential revenue increase in the upcoming quarter. Intel also beat estimates and guided slightly higher. The company posted its strongest sequential growth from first to second quarter since 1988.

Goldman Sachs killed their quarter, reporting earnings of $4.93 per share versus a consensus of $3.54. Eliminating the company’s one time dividend of $426 million related to their TARP repayment and earnings were $5.71 per share. Return on equity in the quarter was 23% (annualized). The company generated almost $11 billion in trading and principal investment revenues in the quarter.

Taking advantage of the new ‘mark to imagination’ rules for financial assets, JP Morgan announced a strong quarter as well. While the company doesn’t expect profitability in their consumer loan businesses until 2011, overall profit rose for the first time in two years as investment banking fees were very strong. The company did increase its loss estimates for both prime and subprime mortgages. Losses for credit cards issued by Washington Mutual, which JPM acquired last September, are expected to approach 24% by year end.

Bank of America proved to be less adept than JPM at posting numbers as charge offs on their credit card trust rose to almost 14%, up from 12.5% in May.

General Electric posted a 47% decline in earnings as their finance, health care and NBC divisions were weak. They did report some improvement in their medical imaging and jet engine businesses.

In the transportation space, JB Hunt missed both earning and revenue estimates.

Hand Signals, Iran and the Bird
In an international version of sign language Iranian leaders flipped the US and its allies ‘the bird’ this week, a blow to our new international policy of coddling our enemies. Iran denounced foreign governments as “enemies” for encouraging last month’s protests over the election results. Secretary of State Hillary Clinton maintains that direct talks are still “the best vehicle” for bringing the Iranians out of isolation.

The Obama administration is surprised and frustrated that they haven’t been able to sway the attitude of the Iranians with our “extended hand.” Supreme Leader Khamenei said that they would “show an iron fist” towards countries it deemed to be “enemies”.

States in Trouble
It’s no surprise that state governments are in serious financial trouble. Besides being proliferate, irresponsible spenders, the governments are suffering from a dramatic drop in tax collections. The chart below, courtesy of the NY Times, shows the nearly 12% year over year drop in state tax revenues from the first quarter of 2008.



China
China reported that GDP rose 7.9% in the second quarter as the nation became the first of the major economies to rebound from the global recession. “The pace of the recovery is even quicker and stronger than we initially expected,” said Qu Hongbin, chief China economist at HSBC. “There’s clear evidence that this infrastructure-led recovery is going to be more sustainable than many people expected.”

China’s economy is the only one of the world’s 10 biggest still expanding. The chart below, courtesy of chartoftheday.com, shows the bounce in the FXI since it bottomed late in 2008.



Real Estate
RealtyTrac released their midyear 2009 U.S. Foreclosure Market Report, which shows a total of 1,905,723 foreclosure filings (default notices, auction sale notices and bank repossessions) were reported in the first six months of 2009, a 9% increase in total properties from the previous six months and a nearly 15% increase in total properties from the first six months of 2008. The report also shows that 1.2% of all U.S. housing units (one in 84) received at least one foreclosure filing in the first half of the year!

“In spite of the industry-wide moratorium earlier this year, along with local, state and national legislative action and increased levels of loan modification activity, foreclosure activity continues to increase to record levels,” noted James J. Saccacio, chief executive officer of RealtyTrac. “Unemployment-related foreclosures account for much of this increased activity, and the high number of borrowers who find themselves owing more on their mortgages than their homes’ are now worth represent a potentially significant future risk. Stemming the tide of foreclosures is a critical component to stabilizing the housing market, so it is imperative that the lending industry and the government work in tandem to find new approaches to address this issue.”

The chart below shows the foreclosure rates by county.



Novel Cure for Real Estate Woes
Nassim Taleb, who is (no correction this week) the author of the Black Swan, was interviewed by the Financial Times and made the following suggestion as a way to help solve the residential housing crisis:

“The only solution is to transform debt into equity across all sectors, in an organized and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming “binary” – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from “hopers”, hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers.

It is sad to see that those who failed to spot the problem (or helped to cause it) are now in charge of the remedy. Just as the impending crisis was obvious to those of us who specialize in complexity and extreme deviations, the solution is plain to see. We need an aggressive, systematic debt-for-equity conversion. We cannot afford to wait a day.”

When Pop Culture Meets Politics
New Jersey Governor Jon Corzine (another Goldman alum, these people are everywhere) has reportedly selected a reality show winner as his running mate for the upcoming November election. Randal Pinkett, a winner of Donald Trump’s “The Apprentice”, has become the front-runner to take the Lieutenant Governor role. Currently Mr. Pinkett is busy in his job duties as an “entrepreneur, speaker, author, scholar and community servant.”

Corzine’s competitor, Republican Chris Christie, has not yet announced a #2 selection, but is rumored to be considering Sponge Bob.

Conclusion
This should be a very busy week for earnings. The economic calendar is light this week, with the leading economic indicators coming Monday, existing home sales Thursday, and the Michigan Consumer Sentiment on Friday.

I am leaving for vacation on the 24th and I’m not sure how much of a note I will be putting out next week. The following week’s (Aug 2nd) note will also be short and/or limited. I will be back to full publishing on August 9th.

Have a great week.

Ned

“We believe that stimulus packages, in all their forms, make the same mistakes that got us here. They will lead to extreme overshooting or extreme undershooting. They lead to more borrowing, by socializing private debt. But running a government deficit is dangerous, as it is vulnerable to errors in projections of economic growth. These errors will be larger in the future, so central bank money creation will lead not to inflation but to hyper-inflation…” – Nassim Taleb and Mark Spitznagel

Calm Before the Earnings Storm

Calm Before the Earnings Storm

July 13, 2009

“If you want to know what God thinks of money, just look at the people he gave it to.” Dorothy Parker.

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

INDU: -1.6%
SPX: -1.9%
COMPQ: -2.3%
RUT: -3.3%

Market
After four straight weeks of declines, the market is testing technical support levels, settling in around the declining 200 day moving average. The S&P 500 has now pulled back 8% from the early June high. Based on a $50 EPS for 2009, the S&P is trading around 17.5 times. That EPS estimate has bounced around quite a bit over the past year, so making a market valuation determination is more art than science. UBS reported that US investors were net sellers of stocks for the fifth week in a row.

The International Monetary Fund said the global economic rebound next year will be stronger than it forecast in April as the financial system stabilizes and the pace of contractions from the U.S. to Japan moderates. They said in a revised forecast that the world economy will expand 2.5% in 2010, compared with its April projection of 1.9% growth. For 2009 they estimate a contraction of 1.4%, worse than the April forecast for a 1.3% drop.

Defensive stocks and securities (i.e. treasuries) once again led the markets this week. Healthcare and consumer staples once again were the best performing groups while basic materials and industrials were the worst performing groups. Healthcare’s relative strength has been moving up dramatically as concern settles in about economic growth.

Nouriel Roubini, an economist at New York University who accurately warned of the credit-market meltdown, said the U.S. economy will remain in recession for an additional six months and then experience a shallow recovery. As bad as the recession has been, it could have been worse, he said. "This is a great recession that could have ended up in a near depression."

Economy

Actual Consensus Prior
ISM Services 47.0 46.0 44.0
Oil Inventories -2.9 mil -2.8 mil -3.7 mil
Gasoline Inventories +1.92 mil +0.9 mil
Distillate Inventories +3.7 mil +1.8 mil
Consumer Credit -3.2 bil -$8.8 bil -$15.7 bil
Wholesale Inventories -0.8% -1.0%
Initial Jobless Claims 565K 603K 617K
Export Prices 0.8% 0.3%
Import Prices 0.2% 0.2%
Trade Balance -$26.0 bil -$30.0 bil -$29.2 bil
Michigan Sentiment 64.6 70.3 70.8

Initial jobless claims for the week were better than consensus at 565K. Unemployment, now at 9.5%, continues to rise and should exceed 10% sometime late in the fall. We expect that the unemployment condition won’t improve until late 2010, which should keep consumer spending in check despite the massive stimulus programs.

Wholesale inventories declined for a 9th straight month. The chart below, courtesy of Briefing.com, shows the inventory to sales ratio for the past 10 years. The decline from 2001-2008 has been attributed to more efficient inventory management systems. The jump from mid 2008 until recent is due to the rapid decline in sales in spite of massive cuts in inventories.



The June ISM services index was slightly ahead of consensus at 47 versus 46, and up from the May measurement of 44. This was the highest reading since Sept ‘08 when it was at 50, which serves as the cut off point between contraction and expansion. New orders rose to 48.6 from 44.4, export orders rose 7.5 points to 54.5, the highest since March ‘08. Prices paid also rose above 50 to 53. Inventories fell to 45.0% from 47.0%.

From Peter Boockvar: May Consumer Credit fell $3.2b to $2.5 trillion. Consumer credit outstanding is now at the lowest level since Dec ‘07 and May is the 8th month in the past 9 that has seen a decline. Most of the decline was in revolving credit which fell $2.9b while non revolving credit outstanding fell by $400mm. With respect to current economic activity, less credit use equates with less spending whether its due to rising unemployment, cut credit lines, or consumers wanting to pay down debt. Deleveraging is desperately needed in order to put this country back on a firmer foundation and no government policy is going to stop the deleveraging freight train at this point.

The following two charts come from Jim Furey of Furey Research Partners. The first shows that the year over year change in total hours worked has troughed near the end of recessions, and the current level is approaching an all-time low of -4%.



Jim’s second chart shows the changes in the rate of unemployment, and how this recession’s rate has superseded that of the previous seven recessions. Jim argues that the rate of change has peaked, and that the end of the recession is near.



Pension Problems
Al Lockwood, a successful midcap manager at Roxbury Capital and amateur equity strategist, recently sent me a note reiterating the concerns I have expressed regarding the funding status of corporate pension plans.

“S&P recently put out a report about the effect on the global equity declines pension funding status. In 2007, pensions in aggregate were overfunded by $63 billion, but by year end 2008, they were underfunded by $308 billion, a 22% shortfall to their obligations. Other Post Employment Benefits, which are typically not funded, add another $257 billion to the total.

If the stock markets do not miraculously rebound, future cash flows and earnings will be severely impacted. Assuming EPS of $60 normalized (who knows what normal is anymore?) I estimate the aggregate earnings for the S&P 500 are about $550 billion. That means that the current unfunded obligation would wipe out all earnings if companies were to fund in one year, which they won't. ”

The Wall Street Journal also had an article this week on public pension plans entitled “Public Pensions Cook the Books”.

“Some plans want to hide the truth from taxpayers. Public employee pension plans are plagued by overgenerous benefits, chronic underfunding, and now trillion dollar stock-market losses. Based on their preferred accounting methods these plans are underfunded nationally by around $310 billion.

The numbers are worse using market valuation methods (the methods private-sector plans must use), which discount benefit liabilities at lower interest rates to reflect the chance that the expected returns won’t be realized. Using that method, University of Chicago economists Robert Novy-Marx and Joshua Rauh calculate that, even prior to the market collapse, public pensions were actually short by nearly $2 trillion. That’s nearly $87,000 per plan participant. With employee benefits guaranteed by law and sometimes even by state constitutions, it’s likely these gargantuan shortfalls will have to be borne by the unsuspecting taxpayer.”

Scary stuff!

Credit
Consumer-loan delinquencies rose to 3.23% in the first quarter, the ABA says, as payrolls contracted. Unpaid balances on delinquent credit-card accounts rose to a record 6.60%.

Inflation
Longer term readers know that I am bearish on the dollar and inflation long term, although I don’t anticipate inflation to be an issue until 2011 or2012. Niels Jensen takes the opposing view, and I thought I’d share his comments.

“We are effectively caught in a liquidity trap. The Bank of England, the European Central Bank and the Federal Reserve have all flooded their banking system with enormous amounts of liquidity in recent months but what has happened? Instead of providing liquidity to private and corporate borrowers as the central banks would like to see, banks have taken the opportunity to repair their balance sheets. For quantitative easing to be inflationary it requires that the liquidity provided to the market by the central bank is put to work, i.e. lenders must lend and borrowers must borrow. If one or the other is not playing along, then inflation will not happen.

This is illustrated in chart 3 (below) which measures the growth in the US monetary base less the growth in M2. As you can see, the broader measure of money supply (M2) cannot keep up with the growth in the liquidity provided by the Fed.”

Kalifornia
As we all know, California is now issuing IOU’s since they have passed the July 1st deadline for setting a new fiscal budget. In an effort to cut state spending, the governor has ordered state offices to close three days a month. Honestly, will anyone notice the missing services?

The irony is that the one true “green shoot” (again, I hate that term) in the economy has been government spending and hiring. What will happen now that the fiscal crisis of the states begins impacting employment?

I’m awaiting a new federal bailout plan for the states. Maybe they could call it IOU2?

The Long Term Market Cycles
From Art Cashin on CNBC via The Big Picture.

“David Rosenberg, formerly chief economist at Merrill Lynch and now at Gluskin Sheff was a guest host on CNBC’s Squawkbox this morning. During the discussion he alluded to an 18 year cycle in the market. Not to quibble but many traders have thought of it as the 17.6 year cycle. Here’s how I outlined it back in May 2002: Yesterday, as the elders were being asked about the hiding place of the great Bull Market one of the fogeys mentioned the “near 18 year cycle.” Like the fat and lean years, it refers to so-called “easy” times to make money in the market versus times requiring much harder work. The fogeys suggested it was near 18 years because it was approximately 17 years, 7 months. For ease of explanation to the juniors, one of the fogeys decimalized the number as 17.6 years so they could use their calculators. He then postulated this example - Let’s say the markets topped out in about February 2000. Let’s call that 2000.2. Subtract 17.6 and your back in about July 1982 (1982.60). The Dow was around 900. So you could see why those were a fat (easy) 17 years. Take away 17.6 again and you are back around January of 1965 and the Dow is around 900. (Yup - just like 1982.) Many twists and turns in those 17 years. Lots of chances to make money. But you had to work for every penny. Take away 17.6 again and you are back around May of 1947. The war is over. The Dow is around 170. Lots of prosperity ahead. Take away 17.6 and you are back around Sept of 1929 and the Dow is around 350. He began to go on. The juniors had had enough. Folks don’t like to hear that you can do well only if you do your homework everyday. Having lived through two of those cycles, we can attest to the work cycle.”

Retail Sales
Same store sales (year over year growth at stores open more than one year) for the month of June were reported this week. Looking at 27 retailers, 15 missed their same store comp estimate, 11 beat, and one was in line. On an absolute basis, 22 of the 27 posted negative comps. The average decline was -7.6%. Retail Metrics reports that June comps fell 4.3% overall.

The consumer continues to struggle.

Oil
Oil has been weak the past three weeks, including a $10 drop this week, after a doubling off its bottom (see the June 15th note http://weeklymarketnotes.blogspot.com/2009/06/japan-to-rescue.html). As we have discussed, the commodity moved well ahead of the fundamentals, partially in anticipation of a global recovery (which we feel is premature), partially over concerns about the dollar (again, which may be premature despite the abuse being place on the dollar), partially due to the ill-conceived cap and trade proposal, and partially due to speculators.

Now the head of the CFTC, Gary Gensler, is holding hearings to explore whether traders, index funds and ETFs should be limited in their holdings of energy futures. “Our first hearing will focus on whether federal speculative limits should be set by the CFTC to all commodities of finite supply, in particular energy commodities, such as crude oil, heating oil, natural gas, gasoline and other energy products,” Gensler said in the statement. “This will include a careful review of the appropriateness of exemptions from these limits for various types of market participants.”

Gensler said the CFTC is reviewing exemptions from position limits for “bona fide hedging,” after seeking public comment on whether the exemption should continue to apply to traders who are in the market for financial reasons, rather than those that actually use the commodity.

One of the factors Gensler cited is the recent volatility of oil. The chart below, courtesy of the IMF and Bloomberg, show the increase in volatility which now approaches that of the Gulf War and the OPEC price wars.



As one Senator said this week “We don’t mind people making money, but when the price goes from $35 to $70 it’s too much.”

I wonder if a move to $60 would meet his approval?

Al Franken to Senate-Get Ready for Another Al Franken Decade
The Democrats in the Senate now have a filibuster proof majority with the Senate race in Minnesota finally being settled. After nine months of legal shenanigans, comedian Al Franken has won the seat, giving the Dems 60 seats in the Senate.

As someone who feels that gridlock is the best we can hope for from our elected officials, the House and Senate majorities concern me.

Real Estate
A high end real estate banker told us that home refinancing deals are very difficult right now, and are often requiring cash down to get the LTV in line given the weakness in sales comps. This is the reverse of the past few years, when homeowners were treating their homes like a piggy bank, refinancing and pulling out excess equity. The sales comps have been challenged since the bulk of the transactions have been REO and short sales.

Late payments on home-equity loans (HELOC) rose to a record in the first quarter as 18 straight months of job losses left more borrowers unable to pay their debts, the American Bankers Association reported. Delinquencies on home-equity loans climbed to 3.5% of all accounts from 3.0% in the fourth quarter, and late payments on home-equity lines of credit climbed to a record 1.9%.

The chart below, courtesy of Housing Bubble Bust.com, shows that housing valuations have historically moved in lockstep with GDP. Beginning around the end of last decade, housing values soared ahead of GDP, and are now crashing back towards GDP.



Goldman Sachs and Market Manipulation
The prosecutor who filed charges against a former Goldman Sachs employee, who purportedly stole a proprietary trading program, said “The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways.”

Presumably the traders at Goldman would know how to use the software, does that mean they could be manipulating markets? I guess that’s why they are called the “Bandits of Broad Street.”

A Fickle Public
The most recent Rasmussen poll shows President Obama’s support among independents has fallen, and his approval rating is at the lowest levels since he took office. A mere 28% strongly approve of the job he is doing versus an early year high of 45%. Those who strongly disapprove of him is at 46%, near the 2009 high of 48%. It appears he has been losing support amongst independents, who were key supporters during last year’s election.

More Conflicts of Interest
From The Big Picture: This exchange occurred during an interview former Assistant Secretary of Treasury Paul Craig Roberts by of Max Keiser:

Max Keiser: “Does the US Secretary of the Treasury work for the people or does he work for the banking system on Wall Street?”

Dr. Paul Craig Reports: “He works for Goldman Sachs.”

He also called the attempts to bail out the banking system to-date “a fraud.”

Conclusion
Earnings kick in full force this week. As I have been stating over the prior few weeks, this set of earnings will have to exceed consensus and carry a positive tone about business conditions to support further gains by the market. I have pulled my position all the way back to net neutral, and will probably look for opportunities to move net short as earnings season unfolds.

Have a great week.

Ned

“Well done is better than well said." - Benjamin Franklin

Bye Bye Bernie

Bye Bye Bernie

July 6th, 2009

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


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

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

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

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



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

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

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



Economy

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

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



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

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

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

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

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

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

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

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

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




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

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

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

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

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

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

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

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

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

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

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



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

Have a great week.

Ned

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