May 3, 2010
“As hoped and intended the Fed’s outsized accommodation has successfully quashed any impulse to get healthy after the US economy’s credit-induced cardiac arrest.” “The rally in risk is just a sugar high, destined as all sugar highs, to crash.”—Stephanie Pomboy, MacroMavens
Weekly percentage performance for the major indices
Based on last Friday’s official settlement...
INDU: -1.75%
SPX: -2.51%
COMPQ: -2.73%
RUT: -3.41%
Market
This market has been on an absolute tear for a year, and the upwards march over the past three months has been relentless. Low rates, easy money, rebounding investor confidence, and an economy responding to excessive stimulus have allowed the market to race ahead unfettered. Risk appetites have rebounded faster than Zsa Zsa Gabor (for my younger readers, she’s equally famous for being a lousy actress AND having had nine husbands). According to the Group of 20’s finance ministers and central bankers, the time has come to withdraw the stimulus. “We should all elaborate credible exit strategies from extraordinary macroeconomic and financial support measures” they said last week.
While a pullback on the stimulus is needed, it’s doubtful that the US will be the first to tap the breaks. Chairman Bernanke has adopted his predecessor’s view of bubbles, or should I say lack of a view. The Fed once again pledged this week to keep interest rates near zero for “an extended period” even as we now see improvements in the labor market. The Fed appears to be blind, ignorant, or apathetic to bubbles and in fact apparently favors them over the tougher job of correcting the imbalances they create. So the key for investors is to keep the pedal to the metal in the face of increasing risks and wait for the Fed to blink. When they do, look out below!
Raymond James' strategist Jeffrey Saut, who has been accurately bullish the past 12 months, surprised the market with his latest warning “Don't wait for May to go away!” Saut commented “Our increased caution is driven by a number of metrics. To wit, preliminary data suggests last Friday was the first 90% Downside Day since February, our sentiment gauges are back to as bullish as they were in 1987 (read that bearishly), the CBOE equity put/call ratio is at 0.32, for its heaviest "call volume" relative to "put volume" since August of 2000, stocks are the most overbought since the rally began in March 2009, some of the leading stocks are not responding to good news, Thursday was session 34 in the "buying stampede" that began on February 26th (rarely do such skeins last more than 30 sessions), we've gotten that peak-a-boo "look" into the long envisioned target zone of 1200 - 1250, volatility is back to the complacent 2008 levels, and the list goes on.”
In other words, be cautious, this rally is long in the tooth and exhibiting fatique.
Economy
Actual Consensus Prior
Case Shiller Index 0.6% 1.1% -0.7%
Consumer Confidence 57.9 53.5 52.3
Continuing Claims 4645K 4625K 4663K
Initial Claims 448K 445K 459K
GDP Adv Q1 3.2% 3.3% 5.6%
Chain Deflator 0.9% 1.0% 0.5%
Employment Cost Index 0.6% 0.5% 0.4%
Chicago PMI 63.8 59.9 58.8
Michigan Sentiment 72.2 71.0 69.5
The initial estimate of first quarter GDP came in just under consensus at 3.2%, fueled by household spending. The combined Q4 and Q1 increase in GDP is the biggest two quarter increase since 2003. Consumer spending increased 3.6% versus a weak 2009 and above consensus, adding 2.55% to GDP. Inventories turned positive for the first time in two years, adding 1.57% to GDP. Construction expenditures in both residential and non-residential fell by double digits. Export growth lagged import growth, negatively impacting GDP. Federal spending increased 1.4% while state and local expenditures declined by 3.8%.
Earlier in the week the FOMC statement confirmed that the Fed plans to keep rates low for some time. “Economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
The S&P/Case-Shiller home price index came in under expectations, an increase of 0.6% versus expectations of a 1.1% increase.
Inflation
Inflation (and deflation) concerns abound. I am wondering where the dollar might be if the Euro wasn’t puking all over itself and if that would change our short term outlook on inflation?
I would love to hear from all the economists (and amateur economists) who have views on this topic.
More Hidden Taxes in Healthcare Plan
Of the 19 new taxes embedded in the healthcare reform bill, here are a few that are noteworthy. Individuals without coverage will pay $695 per year or 2.5% of their pay in penalties. Additionally, you will be charged $347 per year up to $2250 for children not covered.
How about 3.8% sales tax on home sales? That’s almost $20K on a $500K home.
The CBO estimates that because of the costs, incentives, penalties, and structure of ObamaCare, 8-9 million people will LOSE their employer sponsored healthcare.
I guess when Nancy Pelosi said “we’ll have to pass the bill for you to see what’s in it” she really meant it.
Greece and the Euro
After a tumultuous few weeks, the IMF and European Union announced a $146 billion bailout package for Greece. As is typical for IMF programs, Greece agreed to an austerity program requiring them to make cuts equal to 13% of GDP. Remember that only a week ago there was discussion of this bailout being as low as $59 billion. As we’ve seen in US bailouts (think Bear Stearns, AIG, Lehman, etc), it’s better to be first in line while there’s still capital available. I’d hate to be Spain or Portugal right now.
Last week two year Greek notes were yielding 23% after S&P lowered its rating and warned that investors may only received 30% of their principal if the country restructures. The spread between Greek and German bonds closed the week at 825bps (8.25%). Germany was the last holdout on the aid package, finally approving the bailout plan after recognizing that a Greek default would lead to a collapse of the Euro and potentially both the German and French banking systems. According to The Economist banks from those two countries hold 71% of Greece’s sovereign debt, or just over $100 billion.
Banks in the Eurozone also hold $42 billion in debt issued by Portugal, whose debt was also downgraded by S&P last week. Sovereign-debt risk has become a "major and real threat" to the world's financial system, said Zhou Xiaochuan, China's central bank chief. He said developed countries are the biggest sources of such risk.
The crisis is certainly demonstrating the weakness in the structure of the Euro. Without a single authority over the issuance of debt and fiscal policies there is no way to restrain a member state from behaving irresponsibly. Once again, socialize the losses!
Could this bring down Europe if it continues escalating? Possibly. If so, it will also bring down the US, which is Europe’s largest trading partner (and vice versa).
Pension Problems
I’ve discussed the underfunded pension problem in both corporate America and state/local governments for the past 18 months. Now, according to ISI, it appears that pension funding relief proposals have surfaced recently in the Senate. One example, HR 4213, includes options to fund pension shortfalls over a 15 year period or a "2+7" period (interest only for 2 years then 7 years thereafter).
Will we ever learn that creative accounting only delays and magnifies the problems?
Goldman Hearing
I watched the Goldman Sachs Senate hearing on Tuesday, and three things were quite apparent. First, the Senators had absolutely no idea what they were talking about. They were just looking to make empty political points by launching comments such as “you’re nothing more than a casino pit boss.” Second, Goldman executives obviously have no remorse for hosing their clients, feel like they’re the smartest guys in the house, and are convinced their business model based upon making money in any way possible is justified. Third, the Senate was obviously grandstanding in an effort to gain public support for their financial reform bill.
The hearing makes me wonder if the SEC case isn’t just a stab in the dark effort to generate PR for this same bill, which doesn’t address the biggest problems inherent in our financial system today such as TBTF. "The timing is serendipitous, but it should increase the pressure on Republicans," said Sen. Byron Dorgan, D-N.D.
In spite of the questionable timing of the investigation, the charges are definitely real. Goldman has certainly violated client trust and their fiduciary responsibility, and could be guilty of fraud. A finding of fraud or a systematic breakdown in fiduciary responsibility to their clients would cause a devastating blow to the firm.
Does this Sound Familiar?
“The investigation revealed that National City sold off bad loans to Latin American countries by packing them into securities and selling them to unsuspecting investors, that Wiggin had shorted Chase shares during the crash, profiting from falling prices, and that Mitchell and top officers at National city had helped themselves to $2.4 million in interest-free loans from the bank’s coffers.”
No, this isn’t a quote from a recent Wall Street Journal article, but instead from on written in 1932.
Thanks to Bob Bronson.
More Goldman
Bloomberg reported that the US attorney in Manhattan is investigating Goldman for criminal charges as well. According to Douglas Jensen, a NY based attorney and former deputy chief of the US attorney’s office in NY, “In order to proceed criminally in a case, you need to have very clear evidence of lying, cheating and stealing,”
To me that seems like an awfully low hurdle to clear.
Final Comment on Goldman
Bailing out the UK, Again
Ever since WWII the English have been heavily reliant upon the US, without whose support they would be speaking German right now. Since the new Administration has reordered all of our old relationships, the UK has been feeling a bit insecure and concerned about their status with us. Given their recent fiscal woes, and the high probability the US won’t bail them out, the English have figured out a new way to take money from us.
The UK created a “bonus” tax on banker bonuses above $40K, at the usurious rate of 50%. How did the big US banks respond? By zapping their employees globally, including those in the US, by a whopping 7% to offset the cost of the tax.
Talk about taxation without representation.
Earnings
Earnings season continued this past week with close to 80% of the S&P 500 beating estimates. The chart below, courtesy of Jim Bianco, shows the historical percentage of companies in the S&P 500 beating estimates since 1992. One thing to note is that 50% of companies beating estimates appear to be the floor. The green, vertical line around the end of 2001 shows when Reg FD was enacted. Note the significant and sustained jump in the number of companies beating estimates from that point forward. This is probably due to the way companies began guiding the street more directly and consistently after Reg FD.
Jim Furey, the proprietor of small cap, independent research firm Furey Partners, just completed some interesting analysis on the most recent earnings season. Jim notes that the 20%+ median earnings increase from Consumer Discretionary stocks lead all major sectors by at least 8%, and the sector’s 1.6% median revenue surprise ranked third behind technology and industrials. He also noted the average consumer stock increased 4.2% in the two days after reporting. Additionally, he notes that Discretionary stocks’ median 35% year over year earnings growth primarily was derived from margin expansion as sales only grew 2%.
Thanks Jim.
Oil
According to Bloomberg, oil volatility has stabilized recently as global inventories continue to build. OPEC, which produces 40% of global oil, presently has 6 million barrels a day of excess capacity. Slack demand has resulted in record stockpiles, including US’s 356 million barrels. Additionally, inventories still being held on ships continue to rise. Oil has risen 3% this year in anticipation of increased demand from the global recovery.
Goldman analysts are looking for price spikes in the near future as demand accelerates without corresponding increases in production, wiping out the spare production. OPEC has announced plans to add 12 million barrels per day of capacity over the next five years.
Valuation
Jeremy Grantham has long been one of my favorite investors and writers. In his most recent missive, he wrote the following regarding low rates:
“Collectively, we forego hundreds of billions of potential interest, but at least we can feel noble because we are helping to restore the financial health of the banks and bankers, who under these conditions could not fail to make a fortune even if brain dead. We are also lucky to have a tiny fraction of our foregone interest returned by the banks as loan repayments with “profit.” Some profit! Oh, for the good old days when we could just settle for a normal market-clearing rate of interest. But that, I suppose, would be wicked capitalism, and we had better get used to bank and speculator-benefiting socialism.”
People in Glass Houses Really Shouldn’t
Former Vice President Al Gore has made millions selling books, videos, and tearing up the speaking circuit on behalf of global warming. A recent article from the Heartland Institute (I’ll admit I don’t know them, but am guessing they’re a rather conservative lot), is taking a shot at Mr. Gore’s apparent hypocrisy.
It seems the former VP recently spent $8 million on an oceanfront property in Montecito, CA. Heartland queries that if he truly believes that global warming will cause ocean levels to rise, why would he park himself right in front of the action?
Additionally, in an apparent about face on his recommendation that “we all need to reduce our ecological footprint”, Mr. Gore’s property is a sprawling 1.5 acres, contains fountains, spas and a pool (BTW-Southern California is suffering from a major water shortage), and has six wood burning fireplaces, which Mr. Gore has previously gored as “carbon-intensive luxuries”.
If the former VP truly believes his own hubris, then this seems like a questionable move.
Status Check
Financial blogger Barry Ritholtz recently posted a 13 point status check on the economy and market. I have reprinted excerpts below:
Macro-Economy:
1. The Economy is recovering; The recession is over: The free fall of 2008-09 is over, and a gradual improvement is seen across the board. Industrial manufacturing, exports, autos, retail sales, durable goods, travel all confirm the economy is “healing.”
2. But, the recovery is “Lumpy”: — Part of the reason some people doubt the recovery story is how unevenly distributed the improvements are. Geographically, much of the country is still soft. In retail, it is pent up demand plus luxury goods. In technology, its mobile devices and consumer products. Financial firms are taking advantage of the steep yield curve and ZIRP to arbitrage profits, as opposed to actually lending. Profits are not evenly distributed either.
3. Government spending is only part of the story: In the midst of the crisis credit froze, the consumer panicked, and business spending looked to be going extinct. Uncle Sam temporarily bridged the gap. But the argument that government spending is the only game in town is overstates the case. Private sector CapEx spending and hiring is improving (albeit slowly). Consumers have come out of their bunkers and are dining out, going to the movies, hitting the malls, traveling.
4. Weak Improvement in Employment: The massive labor under-utilization is one of the two biggest drags on the economy (Real Estate being the other). Near record low hours worked suggest that employers can simply increase hours rather than make new hires. Thus, I do not look for a V-shaped employment recovery — forget about 400-500k NFP data — anytime soon.
There are 15 million unemployed, and 8 million underemployed — it will take a long time for them to be re-absorbed into the economy. The 2001 recession took 47 months to return employment to pre-recession levels. This recession will likely take 65-75 months to achieve that goal — if not longer.
5. Real Estate (Commercial and Residential): We do not believe that residential real estate has found its natural price level yet. It remains over-valued. This is due to artificially low mortgage rates, foreclosure abatements and mortgage mod programs. We are probably 10-15% over valued, when measured by Median Sales price to median Income, Rent vs Ownership Costs, and Home Value as a Percentage of GDP.
Commercial real estate tends to lag residential by 18-24 months. It is still adapting to the downsizing of America, particularly retail. The over-investment in commercial real estate of the past decade will take at least another 5 years to resolve, if not longer.
6. Deflation? Inflation?: Well, as my pal Jeff Saut notes, we definitely have “flation.” Just not the type that everyone fears.
As of today, Deflation is a fact, inflation is an opinion. We are still living in a period of falling prices, heavy discounts, wage deflation, asset depreciation and lack of pricing power. The S&P500 is below levels seen in the 1990s; Wages are flat for a decade.
The risk going forward is that the Fed fails to remove the accommodations in time. But they have Japan as an example of Zirp with no inflation. So long as labor under-utilization is near record levels, they can take their time in tightening.
7. The rest of the world: Europe is a disaster, and is likely to remain that way for a while. Asian economies are doing very well, helping to pull the rest of the world along — but China’s market is at 6 months lows, something few people are discussing. The risk in China’s real estate and stock markets has been mostly ignored,. Commodity regions and emerging markets still have strength.
Market Overview:
1. Cyclical Bull, Secular Bear: The secular bear market collapse of 55% was right in line with other such debacles. The collapse was faster and more furious than typical, but the depth was normal. The snapback is also well within the range of bear market rallies — cyclical bull runs that last 6 to 24 months and range from 25% to 135%.
While it is possible that we are witnessing the start of a new 1982-like Secular bull market, the valuations argue against it. Stocks most likely simply did not get cheap enough — or despised enough — to initiate a multi-decade bull run. My best guess about that bottom is its likely 3-7 years away.
2. Snapback: The 75% bounce over a year seems like a lot — until you put it into the context of a six month 5,000 point collapse. We call that the Armageddon trade — Dow 5000! 3000! We’re going to zero! – was a spasm of panic. It has been mostly unwound the past year.
3. Correction coming (eventually): The cyclical bull tends to end with ~25% correction that lasts about a year. So we are always looking for signs that this run is over. Despite the recent turmoil, we have not found confirmation that the bull run is over — yet.
4. Liquidity: Institutional fund managers seem to be all in (only 3% cash), while Investors are at only median levels of equity exposure. Liquidity is still abundant, free money abides. Money flows for the past few months have gone into US equities — that is a new element — at about $2B per week.
5. Internals: The market technical/internals remain constructive: Breadth and momentum are positive. New 52 week highs are also strong. Earnings are supporting some of the move, as year over year compares are absurdly easy. The uptrend remains in place, and until it is broken we maintain an upside bias.
6. Sentiment: The biggest risk is the unusually high level of bulls. We are not at the sorts of extremes yet that make the contrarian in us scream SELL.
Thanks Barry
Taxing LPs
In case you missed it, the President’s new tax plan for 2010 calls for taxation of carried interest as ordinary income more than doubling what many will pay on taxes from such gains. Here is an excerpt from a related article:
“Executives at buyout, venture-capital and hedge-fund firms will pay an estimated $24 billion more in taxes over nine years if President Barack Obama gets his way. Obama‘s 2010 budget proposal, released today, proposes raising taxes on the managers by treating carried interest, the portion of profits they take from successful investments, as ordinary income instead of capital gains. That change would boost the tax rate, starting in 2011, to 39.6% for most executives from the 15% they now pay. The proposal applies to partnerships that receive a portion of the profits they make for their clients. It will likely reignite a debate begun in 2007 amid the biggest buyout boom in history, when firms including Blackstone Group LP and Och-Ziff Capital Management Group raised their profiles through public stock listings. While the House of Representatives approved the tax change that year, the measure wasn‘t taken up by the Senate.”
I have long joked that Twitter is useful if you want to let people know that you have broccoli stuck between your teeth. Well, I guess I have broccoli stuck between my teeth and want to let you know about it because I started using it this week. I have been a subscriber to a couple of friends’ workout Tweets, but decided to start doing it myself. I am sending out the morning economic data via Twitter. I’m not saying I won’t forget some mornings, but if you are interested in receiving them, just click on the “Follow Me on Twitter” button on the upper right of the website. It’s easy to join (just requires an email and password), and more importantly it’s easy to unsubscribe.
Conclusion
This week features the tail-end of earnings season. Additionally, there is key economic data, including the unemployment rate and non-farm payrolls on Friday. As I finish writing the Asian markets are weak.
I am not sure if I will be publishing next Sunday as its Mother’s Day, and I will be spending the day pampering my wife and mother.
Have a great week.
Ned
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