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%
Market
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 Finviz.com).
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.
Economy
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 calcluatedriskblog.com, 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 briefing.com, 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 chartoftheday.com) shows the relationship of gold and the dollar. As we have mentioned, gold is definitely at risk if the dollar carry trade unwinds.
Conclusion
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, http://weeklymarketnotes.blogspot.com), 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.
Ned
“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
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