Intel, Alcoa and China-An Interesting Trio

Intel, Alcoa and China-An Interesting Trio

January 18, 2010

“The crowd is always wrong at market turning points, but often times right once a trend sets in. The reason many market fighters go broke is they believe the crowd is always wrong. There is nothing further from the truth. Unless volatility is extremely low or very high, one should think twice before betting against the crowd.”—Shawn Andrew

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

INDU: -0.1%
SPX: -0.8%
COMPQ: -1.3%
RUT: -1.0%

Market
After slogging along during the early part of the week, the market corrected hard on Friday. The market closed down for the week, the first loss of the New Year. Defensive sectors definitely outperformed as healthcare, utilities and consumer staples were the only groups showing gains on the week. The laggards included telecom, materials and energy.

Alcoa (see Earnings section below) reported weak earnings during the week as did video game maker Electronic Arts and oil and gas giant Chevron. Policy tightening in China (see China section below) created the backdrop for the weaker market performance last week. It’s ironic that China, not the US, is taking the global lead via policies designed to stem inflation.

The chart below, courtesy of Bespoke Investment Group, shows the cumulative breadth of the S&P 500 over the last six months. What is the significance of the A/D line? This measure is used to determine whether stock prices and breadth are moving together. While volume (another indicator of market conviction) has been light during the first few weeks of January and over the holidays, the A/D line still supports the recent rally.




Economy

Actual Consensus Prior
Trade Balance -$36.4 bil -$34.6 bil -$33.2 bil
Initial Claims 444K 437K 433K
Continuing Claims 4596K 4750K 4807K
Retail Sales -0.3% 0.5% 1.8%
Retail Sales ex-autos -0.2% 0.3% 1.9%
Core CPI 0.1% 0.1% 0.0%
CPI 0.1% 0.2% 0.4%
Capacity Utilization 72.0% 71.8% 71.5%
Industrial Production 0.6% 0.6% 0.6%
UOM Consumer Sent 72.8 74.0 72.5

The November trade deficit widened to $36.4b, above expectations of $34.6b. Exports rose 0.9%, but imports grew faster at 2.6%. Oil imports rose by 2.3% as the nearly 100% increase in energy prices over the past year begins to have an impact. Exports have now risen for a 7th straight month. According to Peter Boockvar, the higher than expected deficit will lead to a reduction in Q4 GDP estimates of 0.1-0.2%.

CPI for December showed inflation remains benign, with headline price growth slowing to 0.1% from 0.4%. Housing prices, by way of owners’ equivalent rent, continue to create downward pressure on this measure of inflation. An interesting fall out from Cash for Clunkers is the rise in used car pricing of nearly 12% since July, primarily attributable to a lack of supply. Year over year CPI increased by 2.7%, primarily driven by energy costs.



December Retail Sales
Expectations of a 0.5% increase proved to be too optimistic as sales declined by 0.3% in December vs. November, the worst drop on record. November and December combined (the holiday season) were up slightly, 1.1% according to the National Retail Federation. For the full year 2009 sales dropped 6.2%.

Trends
As the global population now approaches 7 billion, and is growing by 80 million per year to and estimated 9 billion in 2046, our investing attention should be focused on those areas where shortages of basic products will arise. While its true global penetration of iPhones remains low, we feel that food and water are two areas deserving further focus. Today roughly 70% of available water is being used in food production, and that is rising on a per capita basis as beef consumption rises. At the current pace of consumption there won’t be enough fresh water globally by the end of this decade. Conservation, desalinization, crop enhancement, and more efficient land utilization all represent viable investment opportunities.

An example of a new technology being applied to an existing field was recently announced. Researchers at Adelaide University have been genetically engineering crops to enhance their ability to prevent saline buildup in their leaves. While only being utilized in the lab today, the hope is to soon port this technology over to cereal crops such as wheat and rice. While it is doubtful these crops could grow in salt-water, they have the potential to grow in abandoned lands thought to be fallow, raising overall land utilization.

Opportunities in Health Care
We have discussed extensively the health care bill and its downside, but what about the upside? It appears that the bill, if it passes, will be very watered down from either of the two existing versions. The House and Senate can’t seem to agree on a number of key issues, and with the potential loss of a super-majority in the Senate as the battle for Ted Kennedy’s open seat tightens, healthcare compromise may occur quickly.

The upside is that healthcare stocks, which have lagged the market bounce partially due to the uncertainty surrounding passage of this bill, might actually have some upside if the worst case scenario with health care legislation doesn’t occur.

China
China unexpectedly raised the proportion of deposits that banks must set aside as reserves to cool their economic growth. Officials fear a developing credit boom threatens to stoke inflation and create asset bubbles.
Beginning today (January 18th) reserve requirements will increase by 50 basis points. The existing level for big banks is 15.5%, 13.5% for smaller, rural banks.

China's government also issued orders to its departments and local governments to slow down rapidly increasing real estate prices. "With the recovery of the real estate market, such problems as excessively rising house prices have recently emerged in some cities, which call for great attention," according to the General Office of the State Council, the Chinese Cabinet. The country will keep a close watch on capital flow to "stop overseas speculative funds from jeopardizing China's property market," the Cabinet said.

Note that the last time China raised its reserve ratio was June 2008 as commodity prices skyrocketed.

TBTF Tax
U.S. President Barack Obama announced a plan to levy a fee on about 50 financial institutions to raise between $90 and $120 billion. The money would be used to cover the cost of TARP and reduce the federal deficit. The President said the levy is not a punishment but rather a way to prevent excesses. Investment banks would be hit harder than commercial banks because the fee would not be levied on insured deposits as it would on other liabilities.

“Clearly this is designed as a political measure,” said Roberton Williams, an economist for the Tax Policy Center, a Washington-based research group run jointly by the Urban Institute and Brookings Institution.

Earnings
A weak earnings report from Alcoa started the week and caused weakness in the economically sensitive sectors. Intel posted strong revenue and earnings on better than anticipated PC growth, but inventories and lead times were up, which could signal peaking margins. The stock traded down the day after the call.

Fiscal Imprudence
President Obama will put cutting the budget deficit on the back burner to help Americans get back to work, said Christina Romer, chairwoman of the White House Council of Economic Advisers. "We are talking about actions right now to jump-start job creation," she said. "You don't get your budget deficit under control at a 10% unemployment rate."

My guess is that there will never be the “right time” to get your budget deficit in order while this Administration is in power. Of course, the last two administrations are guilty of the same sin.

Finding a Way to Make a Buck
Hedge funds are loaning record amounts of money to unprofitable and bankrupt companies, according to HedgeFund.net. Banks have been avoiding financing companies in distress, creating an opening for hedge funds.

Some hedge funds and other nonbank lenders charge interest rates as high as 19% in this mostly unregulated corner of the debt market, according to a survey by Pepperdine University’s Graziadio School of Business and Management. Firms also layer on fees, including costs as high as 12% of the loan for monitoring the value of a borrower’s collateral assets, according to the survey. Some lenders demand closing charges of up to 4%.

Funds exclusively devoted to lending reaped returns that outpaced the hedge fund industry index for six of the eight years from 2001 to 2008, according to HedgeFund.net. .

Do as I say, not as I do
The SEC filed another lawsuit against Bank of America, saying shareholders were kept in the dark about huge losses at Merrill Lynch when the bank took over the firm. The SEC sued again after a judge refused to let it add charges to an existing lawsuit against the bank.

Remember, this is the same SEC which allowed AIG to skirt securities laws regarding disclosure and avoid reporting how $100 billion or so in government aid was used.

I’ve said it before, but people in glass houses just shouldn’t.

The Not-So-Golden State
S&P lowered its rating on California's $64 billion in general-obligation debt from A to A-minus and assigned it a "negative" outlook. The firm said it is worried that the state will run out of cash if California's "revenue and spending trajectories continue."

According to the CME Group, California is now ranked in the Top 10 of sovereign debtors likely to default. Greece is #9.

Real Estate
According to RealtyTrac, A total of 2,824,674 U.S. properties received a foreclosure filing in 2009, a 21% increase in total properties from 2008 and a 120% increase in total properties from 2007.

Wow!
According to The Big Picture, from September 5, 2008 forward (the day the GSEs were put into conservatorship) the U.S. Government is likely to spend more money bailing out Fannie Mae (FNM) and Freddie Mac (FRE) than they have on the Iraq and Afghanistan Wars combined!

Conclusion
Earnings season is here, and will be a key to maintaining the torrid rise of the market. The market is anticipating strong EPS growth throughout 2010, without which we could experience a serious correction. In spite of the much anticipated “correction”, it is certainly beginning to feel as though the “pain” in the market is now to the downside.

Have a great week.

Ned

“Mann traoch, Gott Lauch” which means “Man plans, God laughs.”-- Old Yiddish expression