March 22, 2009
In honor of St. Patrick’s Day: “May the saddest day of your future be no worse than the happiest day of your past.”
Weekly percentage performance for the major indices
Based on last Friday's official settlement...
INDU: .8%
SPX: 1.6%
NDX: 1.6%
COMPQ: 1.8%
RUT: 1.8%
Markets
This was another volatile week in the markets, with the rally continuing in the first half of the week, peaking on Wednesday with the Fed announcing a bazillion (just kidding) dollar subsidy program for treasuries and agency debt (see Fed below). The S&P 500 nestled right up to that 800 number I discussed last week, peaking at 794 on Wednesday before pulling back slightly to close at 772. The consensus is very confused right now-those who want to be bullish are concerned that stocks were actually down for two days at the end of the week, while those who want to be bearish are a bit skittish after watching the S&P race up 19% in just eight days. I’m sticking to my strategy outlined in the past few notes, moving more towards net neutral from slightly net long around the 800 level and tipping net short if the market moves into the 830 range.
I thought the internal action of the markets was more interesting than the moves of the indices this week. The financial and material stocks, typically not bed partners, led the market higher. The financials were strong on more confidence in the Treasury plan to stress test the banks, the Fed’s plan to flood the markets with more liquidity, and the possibility that, net of the massive write-downs, the underlying lending business might be profitable this quarter given the enormously steep yield curve (which the Fed engineered to help the banks).
The run-up in material stocks was a bit more confusing. The more bullish feel the move is a sign of an anticipated rebound in the global economy. The more bearish feel the move in materials is a reaction to the coming decimation of the dollar after the Fed completes its plan to inflate another US bubble to save us from the pain of a protracted recession. I have been discussing this for the past six months (the Feds actions are inflationary) and now it appears the market may be recognizing this as well (I guess that tells you which camp I fall into).
Many have questioned how we can have inflation when demand is slack and capacity utilization is at a very low 71%. The answer lies in the dollar. We could face a scenario where demand doesn’t return in the US, yet inflation occurs anyway due to the monetary phenomena called quantitative easing-where in effect the Fed prints trillions of dollars to inflate us out of our quagmire. This has never been done successfully (think Germany in the early part of the last century), however, the Fed is intent on continuing this Keynesian experiment. It is interesting to note there will be a G-20 meeting this week in which one of the topics will be moving the world from utilizing the dollar as the global reserve currency to some type of basket of securities. The rest of the world is beginning to recognize that we have not been good stewards of our currency, and they may no longer be willing to support our behavior, even though they are encouraging us to stimulate in the short run.
Oil
Oil rose this week even though OPEC announced that they would be leaving production unchanged. Although demand is still waning and inventories are building, the commodity moved up with the weakening of the dollar. It will be interesting to see if OPEC members will stick with their quotas if the rise in oil continues (see chart below). Many of the member countries are hurting from the $100 drop in the price of oil, and are more interested in pumping at $50 plus versus the mid $30 level touched in February.
Economy
PPI came in at 0.1% vs. estimates of 0.4%, but 0.2% vs. 0.1% ex food and energy (which is good for those who don’t eat or drive). The annualized measure was -1.3% vs. -1.4% and 4.0% vs. 3.8% ex food and energy.
Housing starts and building permits surprised to the upside on new condo starts (do we need more housing right now?). The measure jumped 22% vs. January with an increase of 83% in multi-family units. Mortgage applications were up 21.2% on strong refi activity. Purchase activity remains weak or non-existent.
Industrial production declined 1.4% vs. an expected decline of 1.3%. Capacity utilization was in line at 70.9%. CPI measured 0.2% vs. an expectation of 0% and 1.8% vs. 1.7% ex food and energy.
The Leading Economic Indicators for February came in at -0.4% vs. a -0.6% estimate. The increase in December was revised down to a decline, and January’s initial number was also revised down due to revisions in manufacturers’ new orders and real money supply. Six of ten indicators were up in February-interest rate spread, supplier deliveries, building permits, real money supply, and new orders. Negative contributors were average weekly jobless claims, unemployment insurance, stock prices, index of consumer expectations, and average weekly manufacturing hours.
Go Jim!
Jim Rogers of Soros and The Investment Biker fame says the US bailouts are adding to the risk of depression. “The US is taking assets from competent people and giving them to incompetent people. That’s bad economics.” He advised letting AIG go bankrupt, and insists we are repeating the mistakes of Japan in the 1990’s. “People should be prepared for inflation as governments worldwide are printing money to prop up economies at a time when commodities supply is under pressure.”
Shoot the Messenger
Based on new legislation introduced in the Senate yesterday, the SEC would be required to reinstate the uptick rule. “Abusive short-selling is tantamount to fraud and market manipulation and must be stopped now” said Senator Ted Kaufman.
Seriously? Does anyone actually believe that the market collapse was caused by short-selling and not failed economic, regulatory, and operational strategies? It makes more sense to blame your horoscope for the market decline.
Fed
As touched on earlier, the Fed announced they would be buying $750 billion in agency and other debt plus $350 billion in long term Treasuries, causing yields to plummet (see chart below) on the 10 year to 2.55%. The latest policy statement from the Federal Open Market Committee (FOMC) enticed buyers to enter the bidding process and initially pushed stocks markedly higher. Buyers rallied around financial stocks, which helped provide leadership to the broader market. The Fed will bolster its balance sheet by buying up to $300 billion of Treasuries during the next six months. The Fed will also purchase an additional $750 billion of agency mortgage-backed securities this year, bringing the total to $1.25 trillion.
Mortgage Rates
Since the Fed began buying mortgage backed securities in January, the spreads on mortgages over treasuries have dropped significantly (see chart below). This week the 30 year fixed rate hit its lowest absolute rate (4.96%) since 1971. Refi activity has been very strong; however, new purchase activity remains moribund.
The Dollar
The dollar starting to roll over as the Fed keeps printing new dollars. The newest commitments by the Fed will increase its balance sheet by $1.15 trillion. On the day of the Fed’s announcement the dollar fell 2.7%, the biggest drop in almost 40 years and is down 8% this month.
What happens if foreigners were to stop buying our debt, leaving the Fed as the only buyer? In short, the dollar collapses, rates sky-rocket, and the economy drags on in a slump. Unfortunately, this negative loop may have already started-looking at the chart below you can see that foreign purchases of US assets have declined dramatically. This very well could be a short term phenomena, but it is one which needs to be monitored very closely.
The Bottom
FDX announced earnings this week and saw profits fall 75% on the first decline in sales in at least 10 years. The decline in domestic air shipments was the 13th in a row. The firm says their outlook assumes continued weak global macroeconomic conditions and stable fuel prices. The company said operating results decreased significantly in the quarter, as the continued deterioration in global economic conditions led to lower shipment volumes at FedEx Express and FedEx Freight and a more competitive pricing environment.
The co thinks that this is about the bottom, saying that by Q4 they do not think there is going to be continued quarterly sequential declines. When asked about volumes bottoming, especially in international, and why they feel that way the company said that when “they were referring to the bottom they were referring QoQ sequentially in terms of big deep red numbers.”
Talk About Tax and Spend
According to insiders, the new administration inserted a provision in the $787 billion stimulus package that made it OK for companies such as AIG to pay bonuses to executives. Evidently having some remorse over passing the bill, House Democrats are voting on a proposed 90% tax on executive bonus payments by companies receiving more than $5 billion in federal aid. My favorite quote came from Ways and Means Chairman Charles Rangel “This is not going to happen again, the light is flashing and letting them know that America won’t take it.” The hypocrisy coming from Congress is nauseating.
NY rep Steve Israel, obviously confused about the bill he signed, said “We passed a recovery act; we did not pass a license to steal. The middle class will no longer subsidize pay for failure.”
Interestingly foreign employees of these companies aren’t subject to the tax.
Red Ink
President Obama’s new budget plan is estimated to result in deficits averaging $1 trillion a year for the next decade. The CBO projects a total of $9.3 trillion in deficit from 2010-2019, which is $2.3 trillion worse than the President’s predictions four weeks ago.
AIG
From Josh Rosner (via The Big Picture)
“The AIG bonus hearings on executive compensation the current “bonus bill” is a sideshow that avoids addressing the lack of enforcement of existing law.
To the layman it appears, had the law (below) been enforced, we would get to the root of the problem. Of course Congress has no interest in reducing the lobbying dollars they can collect from firms that rely on those TARP dollars. They would rather pretend to be ineffective populists than effective legislators and responsible public servants.
Doesn’t anyone feel that we could get more accomplished if we enforced the following law?”
§ 1352. Limitation on use of appropriated funds to influence certain Federal contracting and financial transactions
Problems South of the Border
Things in Mexico aren’t that rosy. Besides the spate of murders and kidnappings throughout the country, one of the leading employers (CEMEX) is now facing possible government assistance. According to Bloomberg, it seems the company is operating at very low levels of cash. Although I am not clear on the absolute level of debt, reports suggest that CEMEX’s debt levels could represent as much as 30% of the total private sector debt outstanding in Mexico.
What did you say?
From Barry Ritholtz:
“Washington Mutual’s holding company is suing federal regulators for billions of dollars, saying the fire sale of the bank’s assets to JPMorgan Chase violated its rights. The lawsuit was filed Friday in federal court against the Federal Deposit Insurance Corp., which seized the Seattle-based savings and loan in September. It was the largest bank failure in U.S. history.
Lawyers for the holding company, Washington Mutual Inc., argue that the bank was worth more than the $1.9 billion JPMorgan paid for it in a deal arranged by the FDIC. The lawsuit argues that if WaMu’s assets had been liquidated prudently, they would have been worth more than that.
An FDIC spokesman did not immediately return a call seeking comment Saturday.”
While Barry used much more colorful language than I to describe these cretins, the grandstanding and chest pounding by bankers, regulators and politicians are downright disgusting.
Semiconductors
Eric Savitz, the long time and insightful tech writer at Barron’s, commented this weekend that the recent rally in the SOX (see chart) is lacking a key ingredient to help it sustain: end market demand. In my view, these stocks tend to trade based upon the current months’ production activity. Inventory plummeted so low coming out of the year end it overshot to the downside, and recently there has been some inventory replenishment. The stocks have rallied 16% from their recent bottom, about in line with the market.
Conclusion
Earnings and economic releases will be light this week. I expect the market could continue its most recent run upward and personally will continue to lighten my exposure. I feel I am well positioned if the market roles over, favoring healthcare, consumer and non-bank financials at the expense of technology, materials and energy. As I mentioned last week, I significantly reduced my net short position in energy. While I feel the fundamentals for energy are challenged at best, the dollar policy concerns me and creates a potential upside to oil.
Have a great week.
Ned
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