Acropolis Investment Management

Daily Insight: Warsh says, "I'm Outta Here"

2011-02-11T07:23:00.003-06:00

U.S. stocks didn’t quite welcome the best jobless claims figure since job destruction began in late 2008, as the major indices spent most of the session in negative territory. The broad market did manage a slight rally in the final minutes of trading that pushed the S&P 500 to positive territory, but the day was essentially a wash.

So why the lack of euphoria? Maybe it’s because the jobless claims news reminds traders that the Fed must eventually unwind its unprecedented level of monetary easing (although fat chance of that happening anytime soon); maybe it’s because traders believed the decline had more to do with the weather (if government employees don’t report to work they can’t file the claims); maybe it was yet another corporate announcement that higher commodity prices are eating into margins – this latest coming from PepsiCo.

Energy, telecom and industrial shares led the broad market to its slight gain. Technology, consumer staples and financials were the day’s losers.

Treasury yields began the day lower (those prices rose as stock-index futures were meaningfully negative in pre-market trading), but reversed to end the session higher and pretty much match very recent highs. There are a lot of people talking about interest rates moving higher in a secular manner. I’m not really buying it as this economy has become conditioned to ultra-low rates and many challenges remain. And first rates have to break their April 2010 levels (the 10-year Treasury yield remains 33 basis points below that mark). Then, even if yields do break out the economy – which means the housing market, household and government debt servicing and the stock market – would have to be able to withstand those higher rates. I think that’s highly unlikely, which means any spike in rates will prove transitory. In addition, we’re seeing that geopolitical risks remain heightened, which makes a durable increase in rates even more doubtful. And speaking of geopolitics, that address by Muburak yesterday was super strange – and he doesn’t do himself any good by looking like Nosferatu.

But back to the topic, at some point rates will normalize but I can’t see how that occurs in the near future.

Yesterday Kevin Warsh announced he’d resign from the Federal Reserve Board of Governors effective March 31. In my opinion, Warsh was one of the more responsible members of the FOMC (the governors have permanent status on the policymaking committee). While he hadn’t actually dissented to QE measures, he’s written a couple of Op/Eds explaining that such “non-traditional” tools carry huge risks and that when the Fed must unwind, they’ll have to do so with “greater force” than in the past. Therefore he was viewed as one of the future dissenters to current policy.

Of course, we can’t know the true reason behind the resignation, but based upon past statements one expects he would rather not be around for the other side of this policy stance. He’ll undoubtedly be followed by the addition of yet another dove (an advocate of keeping policy loose), which will carry meaningful consequences -- history has shown financial turmoil follows long periods of reckless monetary policy. Pimco’s Tony Crescenzi recently commented that we may see a mutiny within the FOMC, meaning we’ll soon have three dissenters to current policy. Well, that mutiny has now become much less likely as the potential opposing force has now been reduced to just two (Fischer and Plosser).

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Brent Vondera, Senior Analyst

St. Louis, MO

http://www.acrinv.com/

Daily Insight: Reality Bites

2010-07-01T07:19:00.000-05:00

Well, I guess the way stocks ended the day yesterday was apropos for the quarter. A decline in the back-half of the session turned into a slide in the final hour, despite a momentary rally from the day’s low. For the quarter, stocks also fell in the back-half, sliding at the end despite a mid-June rally. The difference is for the quarter the final session recorded the period’s nadir.

Stocks actually began yesterday’s session up a bit as traders were feeling a little juice in pre-market trading after hearing European banks borrowed $161.5 billion via the ECB’s three-month lending facility, below the roughly $200 billion expected. This was all part of the refunding we talked about in Tuesday’s letter due to the ECB’s one-year refinancing facility being closed out. Although, an interest-rate strategist at BNP Paribas did mention that many of the banks that borrowed $540 billion via the one-year funding program from the European central bank did so not because they needed it but as an arbitrage opportunity – and much less arbitrage is to be had now that the facility is for a term of three months rather than one year. So it’s possible that the lower-than-expected borrowing from the ECB may not be as positive as it seems -- yet another example of premature excitement I’m afraid.

It is inconceivable that the EU financial system has suddenly begun to heal, as the headlines suggested, when it is likely to get worse. Nothing but solid-to-strong economic activity will heal the loans on their books, the bonds they hold and inter-bank lending rates.

Anyway, the feel-good sensation didn’t last as a much weaker-than-expected ADP employment report later weighed on sentiment -- we’ll touch on that below. Offsetting the bad preliminary jobs report was another strong regional factory survey, but the market appears to be looking forward, concerning itself with what may unfold over the next several months rather than manufacturing activity for a month that has now ended. Reality appears to have overcome easy money.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Aimless

2010-06-29T06:53:00.001-05:00

U.S. stocks wandered aimlessly the entire day…up, down, up, down -- you know the drill, eventually erasing the final rally in the waning 10 minutes of the session. There is zero conviction right now as short-term traders just wait to see which direction we go -- headed to test that 1040 level on the S&P 500 or higher to the top end of the most recent range, about 1118.

The economic data was not a help really. Personal income and spending was offsetting as incomes came in a bit below expectations, while spending a bit higher. Overall, I thought the report was a good one, as the gain in income outpace spending; it would be nice to see this play out for a while, but as we elude to below this is probably not the type of stuff traders would like to see – spend baby, spend.

Energy and basic material stocks were the worst hit groups yesterday, It was a divided session as five of the top 10 industry groups fell with five gaining ground. Consumer staple and telecom shares were the out-performers.

Treasury securities continued to rally, making it four of the past five sessions, as the yield on the 10-year fell to 3.02% -- again – and the two-year looks headed below 0.60% -- a record low yield, even below the 2008 and 2009 lows. And the rally continues today as the 10-year yield is down another five bps to 2.97% and the two-year just barely above that 0.60% mark at 0.617%...continued after the jump.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Weaker by the Revision

2010-06-28T07:32:00.001-05:00

U.S. stocks endured another up and down session but the broad market held on to a late-session bump to close higher for the first session of the week – it was the one of the worst weeks of the year with the Dow down 2.94%, the S&P 500 off by 3.65%, the NASDAQ down 3.74%, the S&P 400 (mid cap) sliding 3.75% and the Russell 2000 (small cap) slipping 3.27%.

Financials led the S&P 500 marginally higher as traders viewed banks had dodged a bullet due to watered down limits on derivatives trading and investing in hedge funds – although banks were going to find a way around this anyway, but likely at a higher cost. (Sorry to say, I don’t think banks will dodge the double-dip housing market bullet.) And with the death of Senator Byrd last night and Senator Brown now expressing doubt he’ll vote yes, FinReg may ultimately come up short of the needed 60 votes in the Senate.

Consumer staples led the four major industry groups that closed lower. The other traditional areas of safety – health-care and utilities – did gain ground for the session.

Did the overall market truly rally on the news Friday morning that FinReg was watered down? I’m not sure as this is a strange market environment; you never know if it’s some algorithmic dollar-down computer order buying (that is, programmed to bid prices higher on dollar weakness – waning of the safety trade), as some suggested and is supported by the chart below. And even though FinReg doesn’t appear to be a worst-case scenario for the economy’s credit outlets, House and Senate Chambers rushed agreement via a Thursday all-nighter, which doesn’t exactly give one the sense that a whole lot of consideration was given – the law of unintended consequences will likely be rife with this legislation, if it ultimately passes.

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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: NFIB and What's a Keynesian Central Banker to Do?

2010-06-09T07:29:00.000-05:00

U.S. stocks bounced between gain and loss on several occasions yet again yesterday, but eventually rallied to end a two-day slide that had sent the S&P 500 to a seven-month low.

Comments from Fed Chairman Bernanke reportedly put the brakes on an early-morning rally with his comments on the labor market. The Fed head stated that the unemployment rate is likely to remain “high for a while.” But you can’t keep a good market down, most stocks pulled a reverse of what’s played out over the past couple of sessions and rallied late in the day to close at the session high.

In Monday’s letter, following Friday’s loss that brought the S&P 500 back down to the 1060 handle, we mentioned that it wouldn’t be long before a retest of 1040 occurs – that is the intraday low hit on May 25 and the lowest closing level since last November. We came close to that mark yesterday morning, hitting 1042, and rallied from there; although not in a straight line.

Basic material shares enjoyed a really nice day, jumping 2.49%. These shares, which were among the top-performers when the market was in rally mode, had been hit hard, falling 18% since April 26. Technology shares were the laggards, but all 10 major industry groups did rise for the session.

I did notice commentary suggesting that the market rebounded on speculation the Swiss National Bank (SNB) has intervened to support the euro. Speculation? They have been intervening for a while, as we’ve been discussing. The Swiss Franc has plunged 9.5% over the past six weeks due to the SNB selling the heck out of it to support the euro – yeah, euro would probably be down to that 1.15 USD/EUR level (the all out intervention level) without the SNB’s actions.
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Brent Vondera, Senior Analyst
http://www.acrinv.com/

Daily Insight: It's Different and Consumer Credit

2010-06-08T07:01:00.001-05:00

U.S. stocks slipped again on Monday, beginning the week much like we did last Tuesday (last Monday being a holiday) as the major indices gained ground at the open before sliding late in the session.

Industrial and financial shares led the broad market lower, again. Industrials are feeling the pressure that weaker Chinese growth and European government debt issues will have on the global economy. Financials took it on the chin after Goldman Sachs was subpoenaed by the Financial Crisis Inquiry Commission for failing to comply with information requests in a “timely manner.”

The S&P 500 index that tracks utility shares was the only major industry group to gain ground. Health-care and telecoms performed well on a relative basis, but did decline slightly.

Stocks closed at session lows for the second-straight session as the latest report on consumer credit, which we touch on below, reminded of household balance sheet problems. Overall consumer credit has declined 6.6% since December 2008 and is down 4.6% at an annual rate since GDP turned positive again in the third quarter of 2009. It is unusual for consumer debt to decline, much less during the initial stages of expansion, but then household debt levels are more elevated than at any time in the postwar era.
Click here to read the full Daily Insight.

Brent Vondera, Senior Analyst
http://www.acrinv.com/

Daily Insight: Apps, Durable Goods, New Homes and Shoot to Kill

2010-05-27T07:23:00.001-05:00

After spending most of the day on the plus side U.S. stocks failed to hold positive territory, falling below the cut line in the final 40 minutes of trading. You can’t say it was a mirror image of Tuesday’s session, when stocks erased a 3% plunge to close mildly positive, but it was close. At its intraday peak, the S&P 500 was higher by 1.54%, but momentum began to fade at about 1:00 CDT and completely fell apart as we headed for the close.

There was a report from the Financial Times, out about the time that stocks went negative, stating that China may begin reducing their positions in European government bonds. Obviously, and it shows just how skittish this market is for it to react this way, the Chinese are not going to announce such a strategy to the world; they hold $630 billion in euro-zone bonds, they’re not going to want to see those positions summarily crushed. But from a wider perspective, such action would put immense pressure on the European banking system since they have significant exposure to these bonds. Actually, the exposure is more likely massive, but I don’t have the number in front of me so I’ll call it significant for now.

The EU banking system is in trouble anyway you look at it. The central bank and various euro-zone governments can delay the damage, but they can’t ultimately erase what only good policy and time can cure.

The day’s economic reports were mixed with the April durable goods report beating expectations on the headline number, but missed via the more reliable ex-transportation reading. New home sales for April jumped, destroying the consensus estimate, but as the prior three weeks of mortgage apps have shown, the tax credit simply stole sales from the future…more on these data below.

Nine of the 10 major industry groups closed down for the session, industrials being the only survivor – the S&P 500 index that tracks these shares was up as much as 2.5%, but ended just 0.25% higher . Telecom and tech led to the downside, both were also positive earlier in the session.
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Brent Vondera, Senior Analyst
www.acrinv.com

Market Minute: Putting The Correction Into Perspective

2010-05-26T09:36:00.007-05:00

We officially had a market correction, which is defined as a 10% decline from a market’s peak, but a period of market consolidation was inevitable after the straight-up rally from the March 2009 nadir.

As the market climbed higher, shares moved from being slightly cheap (using a cyclically-adjusted P/E ratio) to expensive. Meanwhile spreads on high-yield bonds (the extra yield investors demand to hold company debt rather than government securities) fell from more than 16 percentage points at the start of 2009 to less than six points.

So we were due for a correction, but that is no reason for investors to fall into the fetal position. Corrections are pretty normal. According to David Rosenberg of Gluskin Sheff, corrections historically have occurred about every 12 months and tend to occur more in the second year of a rebound than in year one.

Market contractions like the last 30 days feel severe, but it must be viewed in the context of an 80% surge from the March lows. It would have been surprising if the markets had not paused to catch its breath. I laid out a plethora of market risks in my April 22 blog post and made it abundantly clear that this recovery will be bumpy and market pullbacks should not come as a surprise.

Before markets turn bullish again, we need to see LIBOR (London Interbank Offered Rate) spreads begin to narrow. LIBOR is the interest rate one bank charges another for a loan and serves as the benchmark for $360 trillion of financial products worldwide, ranging from mortgages to small business loans to credit cards. This key benchmark of interbank lending continues to rise, suggesting that there is rising caution even among banks about lending to each other. Banks’ reluctance to lend to each other stems from concerns about (1) the deteriorating quality of each other’s collateral as a result of the Eurozone’s financial problems, and (2) the U.S. financial reform bill that could adversely affect the credit ratings and profitability of major U.S. banks.

Of course, LIBOR is nowhere near the levels reached at the worst of the financial crisis back in October of 2008 – 3-month LIBOR is currently 0.537% compared to 4.81% in October 2008. Still, I’d expect investors want to see LIBOR come down before they start plowing money back into riskier assets.

Peter Lazaroff, Investment Analyst
http://www.acrinv.com/

Daily Insight: CaseShiller, Consumer Confidence, and What Rout?

2010-05-26T06:50:00.000-05:00

U.S. stocks began the session deeply lower, following another ugly session in overseas trading – European and Asian bourses down 2.0%-3.0% -- as a couple of risks jumped out to drive the safety trade. But as the day progressed U.S. stock traders got the nerve to look the debt and geopolitical risks in the eye to say: You’re not so scary. Now, whether that confidence is due to naiveté or just a willingness to look past what is right in front of our faces right now doesn’t matter, the reversal was extraordinary.

Here’s a quick commentary on some of the news stories that appeared to move the market during the very volatile session – a 3% decline at the open for the S&P 500 that was completely erased by the close.

Stocks bounced from an opening plunge, fueled at least partially by the latest reading on consumer confidence (there are a few different measures but yesterday’s look from the Conference Board is the most-watched), but then dipped back below what technicians are calling the key 1050 level on the S&P 500.

The market then staged another move higher after Federal Reserve Bank of St. Louis President Bullard gave a speech stating that the European debt crisis probably won’t lead the world back into recession, but then fizzled again to remain 2.0% below the opening price.

The third time proved the charm, a rally that made it to the close, helped by news that House Financial Services Committee Chairman Frank believes the Senate’s FinReg language on swaps-trading operations “goes too far.” This boosted the view that one of the most harmful aspects of FinReg, with regard to future credit availability, would be struck from the bill.

Basic material, consumer discretionary, financial and telecom shares closed higher for the session. It was a 5% intraday swing for basic material shares, ending higher by 1.6% after an opening 3.3% slide – even as underlying commodity prices were down yesterday; figure that one out. Consumer staples led the six of the major 10 industry groups that closed down on the session.

Click here to read the full Daily Insight.

Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Existing Home Sales and More European sPain

2010-05-25T07:16:00.001-05:00

U.S. stocks bounced around the cut line for most of Monday’s session in a show of either remarkable or unbelievable resilience -- considering the developments out of Spain over the weekend could be seen as a harbinger of European banking problems soon to come and mounting tensions in Korea. But the major indices did succumb to weakness late in the day, erasing almost all of Friday’s gain in the final 90 minutes of trading.

Financials, energy and basic material shares led the market lower. Health-care and tech were the best performing groups, but even these were down as all 10 major industry groups declined on Monday. Tech actually spent most of the session in positive territory, up as much as 0.85% even as the broad market struggled to peek above the cut line, but sold off by 1.38% in the afternoon.

Four Spanish savings banks are set to merge in a coordinated effort by the Bank of Spain in an attempt to strengthen their solvency. The four banks hold more than $168 billion in assets, which is kind of a big deal for a $1.6 trillion economy. These banks went on a lending binge during the Southern European real-estate boom and as Spanish unemployment has leapt to 20% from 8% in less than two years the banking troubles are clearly widespread.

On the Korean peninsula, the South has begun to respond, although tepidly, to the March 26 sinking of their warship. The North has reportedly ordered their military to ready for combat. One can hardly take anything news that comes out of the North at face value, but conditions are ripe for trouble.

We’ve mentioned a couple of times now that risk lurks around many corners, just waiting to jump out and scare the complacency out of everyone. A couple of these risks have begun to do so.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Jobless Claims, Philly Fed and For All the Wrong Reasons

2010-05-21T06:43:00.000-05:00

As everyone knows, U.S. stocks got hit hard yesterday, extending the latest losing streak to three sessions but the weakness has really been in play for three weeks, hitting a crescendo since the so-called “flash crash” two weeks back. Yesterday’s open to close decline was actually larger than the May 6 (flash-crash day) move.

Stocks looked ready to stage a comeback on a couple of occasions yesterday, a rally late in the morning session and then again about mid-way into afternoon trading. But a late-session slide, which coincided with news that the Senate came up with the 60 votes necessary to end cloture and clear the way for passage of financial regulation legislation -- which they ultimately passed last night, slammed the market back down to close at the intraday low. The Senate version will have to be reconciled with a House plan passed in December. After that it gets signed.

To no surprise, financials led the market slide. Industrials, energy and basic materials (all the most cyclical industries that are having trouble now that the state of the global economy are in doubt again) weren’t far behind. Telecom, consumer staples and utility shares were the relative winners, but even these were off by roughly 3%.

The broad market – as measured by the S&P 500 -- is now off its recent high by 12%, a decline of more than 10% is considered a correction, as markets follow the Shanghai Composite lower. The Shanghai exchange is down 18% since April 15 and 25% off its near-term peak. The trend of Shanghai leading has been in place since late 2008. I’m not saying this trend is in place for the long term, but it’s tough to ignore for now. As China continues to rein in its stimulus, which has provided a kick to the entire Asian region, commodity-rich economies and technology & certain industrial firms, the market may continue to pull back from the risk trade. Of course, concerns over Europe and the drag those economies will have on global growth are also part of the problem. But Shanghai has been quite the indicator.

Click here to read the full Daily Insight.

Brent Vondera, Senior Analyst
www.acrinv.com

Market Minute: Tips For Market Volatility

2010-05-19T08:33:00.000-05:00

The fact that market volatility has been elevated recently is no secret. Volatility can have a harmful effect on investor behavior. One of the most common mistakes is attempting to time the market, as investors generally react too late to be able to capitalize on gains or avoid major losses (not to mention the significant costs that come with market timing).

It’s no surprise that this behavior is more prevalent in volatile markets since it is our human nature to seek safety in times of trouble. The problem with selling in fear is that you also have to determine the appropriate time to re-enter the market. Unfortunately, most people that wait until “the coast is clear” miss out on the gains and end up buying at high prices. I don’t have to tell you that selling low and buying high is harmful.

Today I would like to present you with a few tips that you may find useful in volatile times. Follow these tips and you will never fall victim to market timing.

Stay the course. Maintaining your target asset mix of stocks, bonds, and cash is the most important part of a long-term investment plan. In fact, 90% of variation in portfolio performance can be attributed to your asset allocation. There is no one-size-fits-all allocation since everyone’s asset mix depends on individual objectives, time horizon, risk tolerance, and current financial situation. Once you (with the help of your financial advisor) determine the appropriate asset allocation for your circumstances, stick to it.

Continue automatic investment contributions. Making regular contributions to your 401(k), IRA, or taxable investment accounts is one of the best and most disciplined ways to grow your wealth. For most people, this means having a predetermined sum transferred directly from their paycheck into an investment account. Others will have automatic transfers from a checking or savings account. Regular contributions result in better average purchase prices – you buy more shares when prices are low and fewer shares when prices are high – and take emotions out of investment decisions.

Tune out the noise. These days there is an amazing amount of news outlets vying for your attention. Newspapers, magazines, and news reporters all try to identify the causes of every market gyration and predict the next move, but it’s impossible to explain market activities until long after the dust has settled. Try to ignore all this noise and keep focused on your long-term goals. As a close friend of mine so perfectly said to me, “I’m going to let you worry about all the nonsense.” Good idea.

Volatility is the norm, with market fluctuations cancelling each other out over the long term. There is never any guarantee in the financial markets, but staying on course over the long run increases the chances of meeting your financial goals.

Peter Lazaroff, Investment Analyst

www.acrinv.com

Daily Insight: Regulatory Regime, Housing Starts and Give Me Yield Baby!

2010-05-19T06:56:00.002-05:00

U.S. stocks began the session higher on Tuesday, but prices deteriorated as we headed into the afternoon session. Chances of recovery within the eurozone are falling, which caused traders to run for a little more cover. German Chancellor Merkel sated that she would support a tax on the financial sector to help fund the costs of the sovereign-debt rescue plan.

Combining with this ongoing worry was a surprise ban on naked short-selling and credit-default swaps by German regulators. I’m certainly not going to defend naked positions, but this sudden unilateral decision had on affect on U.S. trading as people believed it would shake up European markets when they opened last night – and indeed they were shaken, down 2.5%-3.0% across the board. Politicians can maintain their attempt to control the markets from responding to terrible policy decisions, but if they take away just one in a number of ways to short policy then traders will just shift their assault to the currency – and the euro surely doesn’t need additional attack.

Further complicating things was an amendment out of the U.S. Senate that would allow states to enforce their own credit-card rate limits regardless of where the issuer is located. Banks currently get around various state usury laws by domiciling in states with the least regulations – imagine that. Differing state laws is about as messy as legislation can get, leading to confusion within the industry. This is on top of the debit-card “swipe” fees – the fees charged to merchants on each transaction, which continues to whack shares of Visa and MasterCard. Financial regulation is really starting roll.

To no surprise, financial shares led the market lower. Consumer discretionary shares also got hit hard, along with tech. Consumer staples and telecoms were the relative winners for a third session. All 10 major groups did decline during the session.

In other regulatory news, U.S. stock exchanges and regulators proposed a six-month pilot program to help guard against events like the “flash crash” that occurred on May 6. Circuit breakers will be put in place on individual stocks (trading paused if a stock price moves 10% or more in a five-minute period). Broader circuit breakers will be rolled out at a later date that will force a pause in market-wide trading. These new circuit breakers are aimed at electronic exchanges. The New York Stock Exchange has had circuit breakers in place for many years, as laid out below the jump.

Click here to read the full Daily Insight.

Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: First Look at Manufacturing and Eurozone Still Pressures

2010-05-18T07:07:00.001-05:00

U.S. stocks remained under pressure as the 5% slide in Shanghai overnight (Sunday night) and continued concerns that the European crisis will derail the global economic recovery weighed on investor sentiment. However, the market shook off its morning-session weakness, rallying in the afternoon to erase a 1.8% decline, closing just above the cut line.

Six of the 10 major industry groups gained ground during the session. Telecom and consumer staple stocks led the led the way – so there remains a safe-haven play here (telecoms are not traditional safe-havens, but since the sector is dominated by Verizon and AT&T it is the dividend yields that has investors seeking succor in this area). Energy shares led the four declining groups. Industrials, basic material and financials rounded out the losing sectors.

We’ve talked about this European debt crisis since first bringing it up in the December 9, 2009 letter and really got into it with the February 10 issue when we stated: It was always a fantasy that the EU would escape bailing out Greece, and unless things go very well they’ll be bailing other countries too as the Greek situation is the canary in the coal mine. But we’ve also said that EU trouble has implications beyond that continent as the eurozone is the world’s second-largest importer (a plunging euro will make life more difficult on the globe’s main exporting economies – specifically Asia) and the entire situation puts the hurt on European banks. It appears the market is beginning to think about these implications and unfortunately is likely to keep pressure on riskier assets.
Click here to read the full Daily Insight.

Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Jobless Claims, Import Prices, On the Dole

2010-05-14T07:14:00.002-05:00

U.S. stocks spent most of the session bobbing around the cut line (the opening price for new readers), but slid in the final 90 minutes to make it two up and two down for the week thus far.

The fact that regulators have moved beyond Goldman Sachs and are now scrutinizing eight banks with regard to their mortgage-bond deals certainly didn’t help investor sentiment.

Also, a couple of retailers forecast weak same-store sales results for the second quarter, which led to some worries about today’s retail sale report for April.

Finally, more people seem to be talking about what we mentioned yesterday: a European economy that has become heavily dependent on government spending isn’t going to respond well to the necessary austerity plans coming from EU members.

Consumer discretionary shares led the declines (been a while since that happened as performance-chasing behavior in the sector has been running wild), with financials not far behind. Of the 10 major industry groups, only telecoms gained ground for the session.
Click here to read the full Daily Insight.

Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Mortgage Apps, Trade and The Fabulous Keynesian Experiment

2010-05-13T07:18:00.001-05:00

U.S. stocks rallied on Wednesday to have now fully recouped the big losses from late last week – the ubiquitously called flash crash. Another 1.2% pick-up and all of last week’s decline is gained back. More government back-stopping (this time from the EU), a few click of the heels, and voila the worries from just seven days back go poof. Man that was easy.

Stocks picked up momentum after a Portuguese bond sale went well, Spain announced a measure to cut their deficit and the UK election results offered optimism that the new coalition government will make progress on their debt situation. More on this below.

Tech, industrials and basic material shares were the top-performing groups yesterday. Tech has really benefited from the equipment-spending snap back after businesses froze spending for most of 2009; Chinese stimulus measures have also played a major role as Asia is the growth engine, for now. Health-care and consumer staples -- the traditional areas of safety -- were the laggards, but all 10 major groups did gain ground.

Click here to read the full Daily Insight.

Brent Vondera, Senior Analyst
www.acrinv.com

Reflecting On The Market Sell-Off

2010-05-12T14:42:00.000-05:00

I was out of the office on the two trading days that followed last week’s “flash crash,” which allowed me some time to reflect on the events of that day.

In case you haven’t heard, market indexes dropped precipitously in a matter of minutes last Thursday on basically no fresh news (unless you count the reports that a new Pampers diaper made by Procter & Gamble is causing rashes).

The first conclusion I’ve come to is that last Thursday’s market action clearly demonstrates the inherent risks of our increasingly automated stock market.

High-frequency traders account for 50% to 70% of daily trading volume and, thus, these computerized trading systems provide gobs of liquidity in a normal market. But when the high-frequency crowd jumped ship last Thursday, they took their liquidity with them. I don’t think this right or wrong, fair or unfair. However, I will remember this event the next time I hear someone argue that the “constant” liquidity these computerized trading systems provide justifies their grab-every-fractional-cent-in-sight nature.

Another conclusion I have reached in the aftermath of the “flash crash” is that while human error and computer glitches are accused of being the primary culprits for the epic freefall, I think in some sense the market had been craving a sell-off.

In my April 22 post I suggested that the market would take a breather once earnings season slowed down. There is nothing wrong with sentiment growing bullish, but it’s a problem when markets are willing to shrug off just about any bad news. The bright side of a sharp market reversal like last week’s is that the jubilation dissipates and investors more soberly assess the potential risks at hand.

I’ve said this before and I’ll say it again: stocks rarely go up in a straight line. The S&P 500 has seen five pullbacks of at least 5% since March 2009, none of which ultimately prevented the market from continuing upward. This latest 8.7% drop from the April 23 peak may prove no different than the others.

The final topic I’ve reflected upon is Greece. Before the big plunge, the S&P 500 was already down on concerns about Greek debt problems and the stability of the Euro zone.

I’ve avoided talking about Greece in past weeks simply because I was never that concerned about the situation to begin with. Greece’s economy is just 2.3% the size of the U.S. economy. A default on Greece’s debt would not be big enough to derail the global economy or topple any major financial institutions in the U.S. That said, if a Greek default causes a major bank in, say, Germany to fail then all bets are off.

Still, even if Euro zone economies stagnate for years, the global economy is not highly reliant on them. Only 13.6% of U.S. exports go to Euro zone countries and only 12.7% of our imports come from the Euro zone. Europe’s economy is also of little threat to Asian economies, which are leading the world’s economic recovery. This is not to say that there wouldn’t be any global economic consequences of a Greek default, but I don’t think pain and terror would spread across the globe the way it did following the Lehman Brothers bankruptcy in 2008.

That’s all for this week. Thanks for reading and keep those comments and questions coming!

Peter Lazaroff, Investment Analyst
www.acrinv.com

Daily Insight: Small Business Optimism, Consumer Confidence and The Killer Crossover

2010-05-12T07:07:00.001-05:00

U.S. stocks were unable to build upon Monday’s powerful snap-back as concerns that the Chinese will further tighten lending requirements weighed on the basic materials and energy sectors and doubts began to surface over the effectiveness of Europe’s bailout plan.

Commodity-related (basic materials and energy) have been a play on both massive monetary easing and Chinese stimulus, and now that one seems to be going by the wayside these sectors were yesterday’s worst-performers. Of the 10 major sectors, utility and consumer discretionary shares were the only groups up on the day.

The $38 billion 3-yr auction went very well as buyers stormed in. The bid-to-cover (measure of demand) came in at a near-record of 3.27, and all for 1.41%.

The Chinese stock market is worth watching as it has been a leading indicator for the direction of the S&P 500 over the past two years (only exception being a six-week period last summer). That market is now officially in bear market territory again as the Shanghai Exchange is down 20% from its most recent peak.

So the Shanghai has had two cyclical bull markets (in a secular bear) over the past 18 months – the rallies incited by the government’s very aggressive stimulus package, and the reversals on the talk of and now actual reining in of that policy. The Shanghai had plunged 72% from October 2007 peak to the November 2008 trough. Currently, the index remains 56% below its record high. We’re watching the folly of the most aggressive Keynesian experiment in history and insaniac monetary policy.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Europe's Poker Face, The Unlimited ATM and Today's Data

2010-05-11T07:07:00.000-05:00

U.S. stocks recouped about 40% of the prior week’s losses as the market surged following European policymakers’ announcement they’ll go “all in” with regard to bailing out Greece and attempting to contain what sure appears to be a debt contagion.

Industrial, financial and consumer discretionary stocks definitely liked the news – all were up more than 5% for the session. Tech and basic material stocks rallied more than 4%. Energy shares were up more than 3%. Even the worst-performing group during the session, telecoms, managed a 2.4% gain.

“All in.” I heard, or read, someone refer to it this way; that’s a great analogy. We are after all talking about a game of poker here; if the market gets a sense that the EU is bluffing, they’ll go right at the throats of the weakest sovereigns. The stronger governments of German and France are definitely “all in,” the IMF is “all in,” and the ECB may or may not be “all in” – they haven’t yet expressed just how aggressive they’ll be buying up government and private debt as they try to avert what could have turned into a run on southern European banks.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Oil Slick, Mortgage Apps, Jobs Picture and Service-Sector

2010-05-06T07:19:00.000-05:00

The headwinds of European debt concerns and the evaporation of Chinese stimulus continues to assault the markets, although the major indices held in there pretty well considering the drag the Eurozone is going to put on global growth. The run, well maybe a jog for now, for safety persists as Treasury securities recorded a second-straight session of meaningful gain.

The dollar rallied as the euro got slammed again -- pretty much shaping up as our commentary suggested would be the case via the March 24 letter entitled Can the Dollar Rally Continue? (archived on the website) – as even ECB council member Axel Weber acknowledged that Greece’s fiscal crisis is threatening “grave contagion effects.” He’s got it partially right at least, it’s just not the Greek budget but the entire entitlement-centric system is crumbling, and another EU banking crisis is not out of the question. To repeat, so-called rescue packages can ease the concern on a day-to-day, even week-to-week basis, but eventually the Eurozone will have to ultimately face reality; their system is not sustainable.

Eight of the 10 major S&P 500 industry groups decline for the session, led by energy, industrials and consumer discretionary shares. The traditional areas of safety out-performed the market for a second day – health-care and consumer staples were the only groups in the black. Naturally, with this weakness, volume has begun to pick up, hitting levels that we haven’t seen with this consistency since early in 2009.
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Brent Vondera, Senior Analyst
Acropolis Investment Management
www.acrinv.com

Daily Insight: Driven to the Shadows, Lost in Translation and Pending Home Sales

2010-05-05T06:54:00.002-05:00

U.S. stocks took a little bit of a beating yesterday, as the market has run into the headwinds of EU debt troubles and China’s early-stage unwind of their stimulus measures via the tightening of lending standards. The broad market has dropped 3.5% over the past seven sessions, but then again it had rallied 80% from the March 9, 2009 13-year low.

As we’ve been touching on, the Chinese are in the process of reining in their stimulus efforts for fear of further inflating the housing market. Traders on the Shanghai Exchange got their first chance to react this week (they were closed on Monday) and pushed the index down another 1.2% to a seven-month low. Also in the region, the Aussie central bank hiked their benchmark interest rate for the fifth time in six months – man, it would be nice to have short-term rates at 4.25%. But maybe a little too much too fast Aussie’s, looks like you’ve been tricked into thinking the Pacific growth story is sustainable; we’ll see as the Chinese lay off the nitrous.

The EU sovereign debt crisis also played a role in spooking traders after Germany’s economic minister added uncertainty to the situation when he stated the $140 billion EU/IMF rescue was not intended to cover Greece’s borrowing needs for the next three years, but possibly just 18 months – more on this below.

Market sentiment will continue to ebb and flow because the EU government debt problem isn’t going away. Talks, plans and even implementations of bailouts may ease investor concerns in the short term but the reality of dealing with these structural issues will be harsh and felt by the global economy.

Basic material shares led the major industry groups lower, with industrials and tech also down big. The relative winners were traditional areas of safety – health-care and consumer staples – but they also closed lower as all 10 major groups declined.
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Brent Vondera, Senior Analyst
Acropolis Investment Management
www.acrinv.com

Daily Insight: Spend It Like You Got It and Factories Humming

2010-05-04T06:54:00.001-05:00

U.S. stocks were able to shake off some market weakness overseas and China’s continued pull-back of stimulus measures, as they tighten lending standards, to end two-sessions of decline on Monday. The three major indices gained back most of Friday’s losses.

Certainly a bang-up manufacturing report helped to ease some concerns but the Commerce Department showed the income/spending ratio deteriorated again, which means spending is being stolen from the future. These reports pretty much offset each other, if one is thinking beyond the here and now. More on this data below the jump.

A reader expressed surprise that I didn’t touch on the attempted car bombing in Times Square in Monday’s letter, particularly since I’ve spent several years talking about the importance of geopolitical risks/domestic security with regard to economic growth. The markets found it unnecessary to put in any additional terrorist premium as futures trading was not affected in the least, so I decided not to use space on the topic. However, while we’re on it now, even though it didn’t seem like a serious explosive device, one would think it to be a large enough act to raise concern of the larger issue of terrorism, but no worries for this market…yet. When risks lurk around many corners, it’s only a matter of time before some form jumps out and scares the complacency out of everyone.

Industrials, consumer discretionary (spend it like you got it), and financials led the market higher. The S&P 500 index that tracks basic material shares was the only group down for the session.
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Brent Vondera, Senior Analyst
www.acrinv.com

April 2010 Recap

2010-05-03T16:17:00.002-05:00

Market volatility picked up in April as investors grew concerned about the indebtedness of several European countries, a major oil spill in the Gulf of Mexico, and Goldman Sachs’ legal mess. Despite the concerns, the S&P 500 managed to post a 1.58 percent gain for the month.

Corporate earnings reports helped offset some of the negative sentiment, with 77.9 percent of companies in the S&P 500 that have reported beating expectations. According to Bloomberg, earnings estimates for companies in the S&P 500 increased 10 percent on average in April, the largest monthly increase since at least 2006. Earnings have certainly benefited from low expectations and year-ago comparisons, but this era is rapidly coming to a close. On the bright side, positive earnings results and outlooks with little price movement allow the fundamentals underlying the market to catch up to the price action.

A bigger reason for domestic equities’ April performance was the Fed’s decision to keep its benchmark interest rate at a record low to help keep the economy from dipping back into a recession. The Fed continues to paint a “Goldilocks” scenario for the economy in which growth is not too hot and not too cold. Although there are signs of prices picking up in the production pipeline, consumer prices have been showing deflationary signs in recent months. In addition, it’s very unusual for the Fed to tighten until the unemployment rate goes down.

Small caps continued to outperform large caps during April. Smaller firms tend to thrive in low interest rate environments, which allow them to borrow cheaply to fuel their growth. Additionally, new net inflows into small cap funds may also be providing support to small cap stocks, with the four-week moving average inflows topping $701 million in April according to Lipper FMI data. Small caps began the year with outflows exceeding $144 million.

The best performing S&P 500 sector was Consumer Discretionary, which benefited from improving sales data and consumer confidence. Consumer Discretionary and Industrials, which has benefited from global economic improvement, are the top performing sectors year-to-date. Healthcare stocks were the worst performers in April as the sector’s earnings reports exposed the bottom-line effects of the new U.S. healthcare legislation.

Volatility, as measured by the VIX Index, perked up 25 percent. For a market that seemed overly complacent in recent months, the return of volatility can be interpreted as a healthy development. The uptick in volatility coincided with several negative events including fraud charges by the SEC against Goldman Sachs, continued Eurozone debt problems, financial regulation concerns, and tightening by numerous foreign central banks.

Problems in Greece, Spain, and Portugal sent investors fleeing to the safety of U.S. assets. As a result, Treasuries rallied and the dollar strengthened. Mortgages followed Treasury yields lower, with spreads more or less unchanged, as the market yawned in response to the Fed’s MBS-buying program coming to an end. Meanwhile, Commercial MBS gained despite widespread worries about rising commercial defaults and high-yield bonds add to a record run that began in late 2008.

Overall, investors continue to show desire to put cash that yields nothing to work, but they are hesitant to stick with riskier bets in the face of volatility. Investors have plenty of headwinds ahead including the removal of monetary and fiscal stimulus, interest rate uncertainty, weak housing market, national debt burdens, Chinese economic and policy questions, expiration of the Bush tax cuts, and the growth-restraining effects of the rapid rise in commodity prices.

Peter Lazaroff, Investment Analyst
Acropolis Investment Management
www.acrinv.com

Daily Insight: Q1 GDP and Chicago PMI

2010-05-03T07:25:00.000-05:00

U.S. stocks gave back nearly all of the prior two-session rebound on Friday as the broad market declined 2.51% for the week – the first meaningful pullback in 10 weeks. The Dow held just about the 11K mark, but slipped 1.75% for the week. The NASDAQ got thumped by 2.73% last week, but is still up 14% over the past three weeks. The broad market made a key reversal as it hit a new 19-month high, failed to hold that level, and dipped below the prior week’s close.

Financials led the declines, the group generally leads no matter the direction, falling more than double that of overall market. Tech, industrials and consumer discretionary shares rounded out the worst-performers. The S&P 500 index that tracks utilities shares was the sole gainer, up about 0.5%.

Greece struck a EU/IMF deal but it effectively ensures the country will remain a zombie as a huge percentage of its revenue will be necessary to pay these loans back – revenues that will already be depressed as its economy has become ultra-dependent on government spending. The Greek government also pushed out its schedule for getting the deficit within the 3%-of-GDP EU guideline – although “guideline” isn’t the correct word as budgetary rules are not enforced and can’t be based on the zone’s massive entitlement programs. They now say that the threshold will be met by 2014, previously stated to be achieved by 2012, but that’s highly unrealistic as well. The deal will involve direct loans to Greece, for now planned at $145 billion over three years with EU members on the hook for $80 billion of it.
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Brent Vondera
www.acrinv.com

Daily Insight: Jobless Claims and FOMC is FIDO

2010-04-30T07:22:00.000-05:00

U.S. stocks rose again on Thursday, helping the S&P 500 erase more of Tuesday’s slide. – a 1% pick up today will compete the circle. Of the major indices, the NASDAQ gained the most, followed by the S&P500 and then the Dow.

The German Parliament came to consensus on supporting their $11 billion share of the Greek rescue package, which will prove to be the first in a series of installments over the intermediate term. Optimism over the corporate-profit story also goosed stocks, along with Federal Reserve Board nominees that are unlikely to put pressure on Bernanke to tighten anytime before the unemployment rate hits 8% -- more on that below.

Financials, which led the market lower on Monday and Tuesday, was the top-performing sector for a second-straight session. Industrials and consumer discretionary rounded out the top spots. Energy and utility shares were the worst-performing groups, but all 10 majors gained ground on Thursday.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Richmond Booms, Housing Hesitation, Euro Trash, and The New Vigilante

2010-04-28T07:45:00.000-05:00

U.S. stocks took a little hit on Tuesday after Portugal and Greece had their credit ratings cut by S&P -- Greece thrown to junk category and Portugal down two notches to A-as S&P stated the Portuguese government could struggle to stabilize it relatively high debt ratio through 2012.

I’m not sure whether it was the credit downgrades of Portugal and Greece, or the assault on Goldman Sachs by members of the Permanent Subcommittee on Investigations -- a circus event that showed these senators have no clue how market-making or hedging works. Goldman is not a fiduciary no matter how many times a politician wants to paint them as such; they are a market maker, which means they’re on both sides of the trade. Not that the ignorance of the political class should come as a surprise, but maybe market participants are finally acknowledging that these are the same rubes creating upcoming regulations on the financial industry, regulations that will have ramifications well beyond Wall Street. Thus far the go-for-the-gusto market sentiment has blocked clear thinking but it is only a matter of time, the potential peril via this growing wave of populism-by-convenience will be recognized.

Are investors also awakening to the fact that the European debt problems are looking increasingly like contagion? European economies, heavily dependent on government expenditures, will run into additional growth problem no matter how they react to their debt issues, has to get everyone’s attention. If the EU countries in the target circle make the tough choices to get their public finances in some sort of order, then intense near-term and intermediate economic damage will result; if they don’t then higher interest rates and debt burdens will crush them both in the short and longer-terms – either way you look at it, Europe is going to work as a large drag on global growth.

It was a broad-based decline with all 10 major industry groups down. Financials and basic materials were the worst performers, with health-care and telecoms the relative winners.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Achtung Baby, Today's Data, CAT's Not All That

2010-04-27T07:34:00.000-05:00

U.S. stocks held onto early-session gains for most of the session but eventually succumbed to a bit of weakness as Europe’s sovereign debt issues remained in focus and China appears willing to continue their pull-back of stimulus measures.

Stocks got off to a good start after Caterpillar’s results were released during pre-market trading but the results didn’t justify the reaction, unless you’re talking about the go-for-the-gusto behavior of this stock market that has people ignoring the signs of weakness. (If you want more specifics on these results, I’ll post some comments at the end of the letter.) But the recent weakness in Chinese stocks, off 8% in 10 sessions as traders fear removal of the stimulus measures, and a spreading contagion in Europe was just enough to sap momentum late in the session.

Consumer discretionary, industrial and basic materials were the only three of the major industry groups to close higher yesterday. Consumer discretionary shares remain on fire, up 125% from the March 2009 low and up 25% since February as the momentum trade comes in. Are you kidding me? These shares are now just 10% below their all-time high hit in 2007, but this time the unemployment rate is 10% vs. 5%, incomes ex-transfer payments are down instead of rising and the cash-out refi is dead. Performance chasers don’t care about these realities; their actions are blind to anything but quick money. Some things never change, and never will.

Financials led the decliners, with health care and utility shares the next worst performers.
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Brent Vondera, Senior Analyst
www.acrinv.com

Preference for Value

2010-04-26T15:04:00.002-05:00

We are frequently asked why we favor ‘value’ stocks over ‘growth’ stocks. In this article, we attempt to define growth and value stocks with two examples, provide an overview of the academic underpinnings that support value investing, explain why we believe that value investing is more intuitive than growth investing and conclude with why we still maintain growth stocks in our client portfolios.
Click here to view the full article.

David Ott
www.acrinv.com

Daily Insight: The Great Unwind, Durable Goods and New Home Sales

2010-04-26T07:44:00.002-05:00

U.S. stocks were able to shake off the increasingly early signs of government debt-related contagion in Europe as a great durable goods orders report and a bounce in new home sales – albeit from at least a 47-year low – helped the market focus on things more positive. The gains among the benchmark indices made for the fourth winning session this week and the 11th of the past 13.

Energy shares were the clear leader, up 2.29% on Friday, as the price of crude has quickly returned to $85/barrel. Eight of the 10 major industry groups closed higher. Telecoms and consumer staples were the only groups down on the session.

For the week, the S&P 500 added 2.10%; the Dow rose 1.68%; and the NASDAQ Composite gained 1.97%. The S&P 400 (mid cap) rallied 3.56% and the Russell 2000 (small cap) jumped 3.82%. The S&P 500 has now rallied 80% from the nefarious March 9, 2009 low of 666.

Greek government-bonds continue to get hit as Germany plays a game of chicken – a game Greece is going to win, but only in the short term. Germans don’t like bailing Greece out of their troubles because they’ll be on the hook for most of the cost; to begin with, Germans seemed fairly reluctant to go with this Euro System anyway, unwilling to give up their Deutsche Mark all the way up to the Euro’s initial adoption in 1999. Greek 10-year bond spreads have hit 626 basis points (that’s 6.26 percentage points above German bunds), which means a yield of 9.03%.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Home Sales, Inflation Watch, Jobless Claims and It's the Fed, Stupid

2010-04-23T07:45:00.002-05:00

Click here to read today's Daily Insight

Brent Vondera, Senior Analyst

Daily Insight: Mortgage Apps, Stimulating Default and EU Under Pressure

2010-04-22T07:37:00.001-05:00

U.S. major stock indexes ended essentially flat on Wednesday as the EU sovereign debt story weighed just enough to erase early-session gains. The Dow closed up slightly and the S&P 500 down a smidge. The tech-laden NASDAQ performed the best of the three majors; tech earnings are the most solid of all industries – financials profits are up the most on paper but it’s artificial.

Yesterday’s earnings reports were good for the most part, which offered support to the market. Again though, I can’t help but mention for a second day that multinational companies are reporting weak domestic growth; most of the profit growth is coming from overseas, currency translation and payroll cost-cutting. The financial company reports of the past couple of days showed that their profits are coming from big trading profits, thanks to Dr. Zero. I continue to believe that the banks are going to have a reality problem a couple of quarter out as the home sales reports will show distressed properties are making up a larger percentage of total sales – that percentage has been averaging about 35% and data from various states suggests it’s going over 40%; price declines will follow and that means banks will have to set aside more cash, which cuts into earnings. With 30% of home borrowers either underwater or with less than 5% equity, there is zero room for additional price declines.

On the EU sovereign debt problem, the relevance regarding the Greek financing issue is not that the country defaults on some payments per se, but that other EU countries have similar budget problems. Since the Eurozone is heavily dependent on government spending, the required and austere budget cuts will certainly be seen in their already very weak GDP readings. Further, I suspect that European banks hold large amounts of government debt and as those securities get whacked, so does the capital of those banks – as goes the capital so goes the lending.

The major industry groups were split with five up and five down. Industrials led the gainers and health-care the losers – the shares got hammered relative to the market, down 1.74%.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Is Eight Enough, Crude Reversal and Not So Confident

2010-04-21T07:48:00.001-05:00

U.S. stocks marched higher on good earnings reports, moving above the 1200 mark on the S&P 500. This puts the broad market within 4% of its pre-Lehman collapse level. The tech-laden NASDAQ Composite has already fueled past its pre-Lehman number of 2300, crossing the 2500 mark for the third time in a week so we’ll see if we can hold it this time.

Profit reports are looking good again this quarter, the second quarter of improvement following nine periods of decline; although the theme among the multi-nationals has been Asian growth, with sales from the Americas weak-to-flat relative to the year-ago period -- IBM and Coca-Cola’s results were the latest examples. Also, corporate cost-cutting via payroll slashing is the primary boost to profits. This massive cost-cutting is both good and bad. While it helps the profit story, it stings personal incomes – exclude the $365 billion in transfer payments over the past 18 months, which cannot be sustained anyway, and personal income is down 4% over the last year-and-a-half.

As we’ve discussed, this profit cycle should extend for a few quarters, but for it to prove the multi-year run that is usually the case we’ll have to see the final demand necessary to fuel top-line improvement; that means several quarters of above-average GDP that is required for strong job growth. The requisite household de-leveraging process once job growth picks up will prove a headwind for consumer activity. If stocks hold these gains, it will make the process easier; if not, then consumers won’t have that relative wealth effect that helps propel spending. For now, the more cars bought (as 0% loans and $0 down is all the rage again) and the more iPhones purchased by generations X and Y that just can’t do without their gazillion apps, the necessary de-leveraging is only delayed.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Europe vs. The Volcano, and SEC Vote

2010-04-20T07:29:00.001-05:00

U.S. stocks erased early-session losses after it was learned that the Securities and Exchange Commission’s (SEC) vote on pursuing a case against Goldman Sachs was not unanimous. The vote came in at 3-2, which means the SEC pursuit of the way Goldman has allegedly conducted itself may not be as vigorous as previously expected.

While many will say that it’s GS for the SEC not to pursue the case aggressively, the market also feared the short-term market ramifications of such action. But we shouldn’t put our guard down, as Congress and state attorneys general are there, in all their populist fury, to go after the entire financial industry by way of a new regulatory regime.

I do find it surprising the SEC voted this way, considering the several acts of serious malfeasance they missed over the past couple of years, or decades in terms of Madoff. One would have thought they’d go after this case, maybe even to overdo it, just to make a statement.

The early slide was largely led by basic material shares. China’s pullback on its stimulus, particularly on the loan front as they shift to more stringent credit standards and halt loans to those speculating within the housing market (third home buyers as they call them), has people worried about Asian demand a few months out. China’s very aggressive stimulus program, both in terms of outright government spending and in massive credit creation, has fueled the Asian economic bounce. But the market’s mid-day rally gave life to the commodity trade and basic material shares bounced back.

In the end, all 10 major industry groups close up for the session. Industrials were the laggard, essentially unchanged. Financials, Friday’s big losers, was the best-performing group, up 1.10%.
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Brent Vondera, Senior Analyst
www.acrinv.com

Eli Lilly (LLY) Earnings and Measuring the Costs and Impat of Healthcare Reform

2010-04-19T13:41:00.000-05:00

Eli Lilly (LLY) became the first Big Pharma firm to give some concrete numbers relating to the cost of reform.

LLY trimmed its 2010 earnings guidance to reflect a 35-cent (full-year) impact from U.S. healthcare reform. The company projected government rebates related to healthcare reform to reduce full-year revenues by $350 million to $400 million. The healthcare reform-related charges in the first quarter amounted to 12 cents, or 9% of EPS.

The charges were higher than analysts were expecting, but this will not necessarily be the case for all drugmakers. Roughly 20% of LLY’s total sales are to government programs Medicare and Medicaid, both of which received discounts from pharmaceutical firms in the healthcare bill. As more pharma firms report earnings, I think we will see that LLY’s high exposure Medicare and Medicaid creates a disproportionately large impact for the firm relative to its peers.

It will take several years for the volume created by newly insured patients to offset the costs associated with the healthcare legislation. At the same time, I expect LLY to be one of the harder hit firms in the industry.

Shares of LLY are basically flat on today’s earnings release, but they have trailed the broader market over the past year. The firm’s pipeline will not offset the revenue loss expected from looming patent expirations and it seems inevitable that LLY will need to acquire a late-stage drugs.

Without additional revenues, LLY will need to slash its attractive dividend. Of course, any M&A activity would likely lead to a reduction in the payout anyways. The bigger downside to M&A is that it has historically destroyed shareholder wealth for drugmakers.

These concerns are well-known and something I’ve covered before; I’d say the bigger takeaway from LLY’s results is that investors will now expect the same level of disclosure regarding the impact from healthcare reform. That’s better than nothing, right?

Peter Lazaroff, Investment Analyst
www.acrinv.com

Daily Insight: Housing Starts, Confidence, Korea and Goldman Not So Golden

2010-04-19T07:46:00.001-05:00

U.S. stocks ran into a little trouble on Friday as the IMF is headed to Greece, the latest consumer confidence reading erased three-months of gains, the potential for conflict on the Korean peninsula got a little hotter and Goldman Sachs is now officially under investigation for defrauding investors.

Pre-market trading, which was pointing lower very early Friday morning, weakened just before the open when South Korea stated there’s a high possibility the sinking of their warship last month was due to an external explosion – one would think if their ship ran into a mine or was hit by a torpedo that they’d know by now. But if it was external, it has North Korea written all over it. This concern extended into the official trading session.

But concerns on that front were suddenly overcome by an SEC charge that Goldman Sachs defrauded investors. The deal is Goldman stated a financial product they marketed that was tied to subprime mortgages, as the housing market was beginning to crumble, was structured by an independent, objective third party. It appears though that the product, a synthetic CDO, was not structured by an independent source, but rather the portfolio selection was influenced by John Paulson’s hedge fund who was betting the securities underlying the CDO would default. This resulted in new fears that ramifications from the financials chaos of late 2008 may not have completely blown over. More on this below the jump…

The market has become incredibly complacent, and while stocks improved from the session’s low point, the news out of Korea and yet another case of financial fraud may have reminded traders of the various risks that lurk in the marketplace today. There are always risks, but they are abundant right now and when the market is so complacent, as illustrated by the VIX index, its sets up for stocks to get rocked.

Friday we held in there pretty well, a 1.6% decline is not getting rocked in my view. Hopefully, Friday slapped enough people from their pretty little wonderland to lower expectations just enough so we don’t endure something that scares traders and makes a harmful move lower self-fulfilling. This still fragile economy will not respond well to such an event.
Click here to read the full Daily Insight.

Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Jobless Claims, Manufacturing, IP, and Housing

2010-04-16T07:06:00.000-05:00

U.S. stocks gained a little more ground Thursday, extending the winning streak to six sessions, as strong regional manufacturing reports and an upbeat earnings pre-announcement from UPS offset troubling jobless claims figures, the rolling concern over European sovereign debt, and the lowest UK consumer confidence reading since July 2008 that had pre-market trading lower.

The numbers out of the manufacturing sector are really very good, but that’s about all we’ve got right now. If we’re going to pass this ball off from government stimulus to something that can achieve just mild economic growth without all of this support then we’re going to need big employment gains.

The UPS report was a good one, at least in relative terms as we’re coming out of two years of depressed package volume, but it showed domestic activity remained weak. Package volumes rose 24% within countries outside of the U.S., and make no mistake this is driven by China’s huge stimulus efforts, but U.S. shipments rose less than 1%.

Just three of the top ten industry groups closed higher on the session, led by industrials shares. Information technology and consumer discretionary shares were the other two winners. Financials led the seven industry groups that fell, health-care yet again was near the bottom of the list as it held the penultimate spot. Regulation that will cap health insurer profits have obviously led to investor unease.

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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Mortgage Apps, Retail Sales, and Thanks to Dr. Zero...For Now

2010-04-15T07:38:00.002-05:00

U.S. stocks extended the latest winning streak to five sessions on Wednesday after getting a boost from a strong retail sales report and positive comments from JP Morgan’s Chairman/CEO. Oh, and a stocks received little more help from Dr. Zero as he told lawmakers that the recovery faces “significant restraints” – this pretty much assures no change in the next FOMC meeting’s language with regard to fed funds at virtual zero.

JP Morgan’s CEO Jamie Dimon stated the following: China is growing, India’s growing, Japan is growing, home prices have stopped going down, consumer income is up, consumers are spending, service and manufacturing indexes are up, inventories are still low, I could go on and on.” I guess he could but one’s got to question a few of those points.

Asia is certainly growing, but we’ll see what happens when China reins in their massive government spending and loan activity (and even now it’s mixed as China just printed 12% GDP but Japan pretty much remains in recession); home price activity is precarious at best and existing home prices have engaged in second-round slide that has brought the median price back to the cycle low’ consumer incomes are flat, and that’s only because government transfer payments as a percentage of total income are at record highs, excluding these temporary payments incomes continue to fall. While he’s correct on spending and manufacturing activity, it seems his other assessments are a bit misplaced. But he’s the Chairman/CEO of the second-largest bank by assets and I’m just this guy commenting on the data – I guess we’ll just have to wait and see how things play out.

Financials led the rally, with tech and consumer discretionary rounding out the top spots. Telecoms and health-care (again) were the only two industry groups to decline.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: NFIB, Trade, Buyers Show Up But Greece Pays, Intel Inside

2010-04-14T07:20:00.000-05:00

U.S. stocks shook off early-session weakness to gain ground for a fourth-straight session on Tuesday. The broad S&P 500 has jumped 15% over the past two months, bouncing off of the late-January pullback of 8%; the market has its eyes set on the pre-Lehman collapse level of 1250 – about 4% above yesterday’s closing price.

This 57-week rally from the 13-year low hit on March 9, 2009 currently stands at 77%, as measured by the S&P 500.

Consumer discretionary, technology and industrial shares led the gainers. Consumer stocks got a lift from the latest trade balance report that showed strong import activity in February; without fear of sounding repetitive, I’m highly skeptical of the idea that consumer activity will improve in a consistent manner – appears to be a minority view, but I’m fine with that.

The four industry groups that closed lower yesterday were energy, utility, basic material and telecoms.

On the EU sovereign-debt financing front, Greece sold $2.12 billion in 6-12 month Treasury bills on Tuesday and demand was super-strong with bid-to-covers at 7.67 for the six-month paper and 6.54 for 12 month – a figure approaching 3.00 is strong. But Greece had to pay up as yields came in at 4.55% and 4.85%, respectively. Dang, U.S. savers would love deposit rates even half these levels – sit tight, we’ll get them in time.

So the EU states that they’ll come to the rescue of Greece if they have trouble funding government debt, which means risk of default over the next 12 months is about zilch. I wonder what Greece would have had to pay without that backstop, 7-8% on 12-month paper? What will they have to pay when this debt needs to be rolled a year from now? Which begs the question: where will EU budget-deficit funding costs rise to when Italy and Spain run into trouble? Germany and France won’t be able to bail them out too, without driving their own borrowing costs higher. This story has only just begun.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: Living on a Prayer, Commodity Inflation Watch, Budget Statement

2010-04-13T07:17:00.002-05:00

U.S. stocks extended the latest winning streak to three days and the Dow, after facing afternoon rejection during a number of sessions over the past 10 trading days, finally closed above the 11000 mark for the first time in 18 months. This is now the third, I’m going to say secular, run through 11K after initially breaking through in May 1999.

A plan, this time with specifics (although it would take unanimous consent to implement), to bail out Greece from its debt financing problems helped stocks in pre-market trading. The hope that the first-quarter earnings season would post good results helped momentum just enough to hold onto half of the early-session gains – and the current earnings season will be a good one, it’s a couple of quarters out when things may get sketchy, as we’ll get to below.

First-quarter earnings season kicked off last night after the closing bell, but won’t begin in earnest for another week. Within three weeks time we’ll have about 30% of S&P 500 members in and a pretty good idea of how the season will turn out.

The fourth quarter of 2009 ended a nine-quarter string of declining earnings as ex-financial S&P 500 earnings per share rose 13.8%. This quarter the market expects 25%, and we should get that as industrials will finally begin to help out and consumer discretionary will have the easiest comparisons (remember what was occurring a year ago) in a very long time, if not ever. (Earnings results are matched against the year-ago period.)

Six of the major 10 industry groups led the broad market higher. Financials performed the best, with utility and technology shares not far behind. Basic material and health-care led the losers for the third-straight session. Telecom and consumer discretionary shares rounded out the sectors that ended in the red.
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Brent Vondera, Senior Analyst
www.acrinv.com

Daily Insight: mortgage apps, consumer credit and Fed speeches

2010-04-08T07:21:00.001-05:00

U.S. stocks stumbled a bit Wednesday after Fed Chairman Bernanke touched on a number of challenges the economy will have to deal with and a large decline in consumer credit raised concerns about the pace of future consumption. All in all though, especially since the Greece story remained in the headlines, stocks held in there pretty well.

All 10 major industry groups lost ground on the session, with telecom shares leading the decline by a large margin – the index that tracks these shares lost 2.34%, which was well-worse than the 0.59% broad-market decline. Energy and utility shares rounded out the three worst-performing sectors.

The relative winners were tech and health-care, down 0.21% and 0.42%, respectively.

The major indices were able to withstand the rather negative comments from Bernanke, his speech occurred around lunch and an hour later the broad market was hovering just below where we opened. It was the consumer credit report that had the larger effect on sentiment, as the relative slide occurred directly after that release.
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Brent Vondera, Senior Analyst

Daily Insight: Interest rates and FOMC minutes

2010-04-07T06:55:00.001-05:00

U.S. stock indices ended mixed on Tuesday as the S&P 500 and NASDAQ Composite gained some ground, while the Dow closed slightly lower; we’ll just have to wait for the third return to 11K in 10 years.

The broad market hovered around the cut line for most of the session as European government-debt concerns returned to hold sentiment back, but stocks caught a slight bid immediately following release of the FOMC minutes. (The FOMC is the Federal Reserve’s rate-setting committee and the minutes are the notes from their most recent meeting.)

The Fed talked about how they believe a lingering high jobless rate will curb the recovery and also trimmed their GDP estimates along with their inflation expectations. Traders heard that and read: ultra easy money will continue.

Stocks would have probably recorded a more substantial rise if not for renewed debt concerns in Europe – we’ve talked about how this issue isn’t going away. Right now the Greek government doesn’t like the fact that the IMF is involved, which means they’ll really (as opposed to just the old nod to EU officials) have to rein in spending. As a result, no one is totally sure there is a financial-aid package for Greece in place. Of course Germany and France, the two strongest economies within the Eurozone, will ultimately backstop Greece’s financial needs, but the issue is a bit more precarious than it was at least perceived to be just a week ago.

Financial, utility and basic material shares were among the six of the 10 major sectors that closed higher on the session. Telecom shares led the three sectors that fell; industrials ended the session flat.

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Brent Vondera, Senior Analyst

Daily Insight: ISM Service and Pending Home Sales

2010-04-06T07:15:00.002-05:00

U.S. stocks gained ground for a second-straight session as better-than-expected economic data juiced investor sentiment. However, while the broad market held just about all of its early-session gains, the Dow retreated a bit from the session high and the 11K mark remained elusive for at least another day.

Energy shares led the broad-market’s advance as the price of crude jumped well into the $86/barrel handle – here we go again. Basic material stocks were the next-best performing group as the commodity play rolled. Consumer discretionary shares rounded out the top performers – this one really has me confounded; how can the market completely ignore the headwinds higher energy prices have on an already burdened consumer.

We’ll see how stocks react to possibly rising interest rates, at least over the near term. Treasury yields advanced yesterday, moving closer to that 4.00% level on the 10-year – a closely watched level. I’m not sure a continued sell off on the long-end of the curve (prices go down yields go up) will act as a wall, halting the run in stocks, but with roughly $80 billion in government debt issuance this week things may just get interesting on the interest-rate front.

http://www.acrinv.com/20100406255/blog/daily-insight-ism-service-and-pending-home-sales

Brent Vondera, Senior Analyst

Daily Insight: March jobs report

2010-04-05T07:29:00.000-05:00

Nonfarm payrolls rose 162,000 in March.

Private-sector payrolls increased 123,000.

The unemployment rate held steady at 9.7%.

Specifics on the payroll report are after the jump.

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Brent Vondera, Senior Analyst

March 2010 Recap

2010-04-01T16:24:00.001-05:00

Equity markets finished the fourth quarter strong, as market participants celebrated the Federal Reserve’s commitment to keeping exceptionally low rates in place for “an extended period.”

Economic data was mixed throughout March. Investors were excited early in the month by February’s labor report, which showed payrolls dropped less-than-expected. The strength of the labor market is widely considered the key factor determining the pace of household spending. The jobs situation is lagging previous recoveries, though, and may be weighing on consumers, which was evident with the preliminary consumer sentiment index contracting.

Weak housing starts and softening home price indicators dampened sentiment a bit, but also provided additional reasons for the Fed to keep interest rates at emergency levels. Low inflationary indicators also supported accommodative policy, with consumer prices remaining flat month-over-month and capacity utilization well below its long-term average.

Inflation remains a concern in the future and the Fed is walking a tightrope with its exit plan, but equity markets appear content with the Fed’s direction for now.

All equity asset classes moved higher in March, led by domestic REITs. REITs continue to benefit from merger and acquisition activity, headlined by the bidding for General Growth Properties, which filed for the biggest real-estate bankruptcy in U.S. history.

Small cap stocks outperformed their larger counterparts. This is somewhat surprising given the fact that credit is still relatively tight for small caps. Smaller businesses are also more likely to be affected by the healthcare legislation passed by Congress in March.

Speaking of healthcare legislation, hospitals and drugmakers appear to be the biggest winners as they pick up a glut of new paying customers. Meanwhile the insurance industry is coming out of all this relatively unscathed. In the end, the most controversial proposals – a government-run insurance option and direct government negotiation on drug prices for Medicare – were eliminated from the bill.

In overseas markets, concerns about Greece eased as the bailout of the debt-ridden country gained clarity. Despite nice gains in March, international markets have underperformed the S&P 500 in 2010, with performance for U.S. investors in many developed markets hurt by the relative strength of the U.S. dollar.

Treasury yields rose to their highest levels since late last year as investor’s appetite for risk improved following last month’s volatility in the credit markets. After a bout of flattening at the beginning of the month, the curve steepened back up to finish where it started at 280 basis points spread between the 2-year and the 10-year, just 11 basis points shy of its all time high of 291 set on February 22. The Barclays Aggregate Bond Index was down 0.12 percent for the month, with corporate debt being the best performing sector in the index.

A lot was written this past month on the end of the “Greatest Bull Market in Bonds Ever,” with many analysts calling March 2010 the beginning of the next rate cycle. A rising rate environment will hurt longer-term bonds significantly more than shorter-term bonds; given our bias toward the shorter-end of the curve, we consider our portfolios well positioned to weather such an environment. The majority of bonds we hold will allow us to reinvest more quickly than if we were to buy longer-term debt and take advantage of higher yields.

Peter Lazaroff, Investment Analyst
Cliff Reynolds, Investment Anlayst

Daily Insight: ADP, Chicago PMI, and Q1 Results

2010-04-01T07:06:00.000-05:00

U.S stocks lost a little ground yesterday, falling back to the low-end of this range tight range (at least in terms of near-term standards) we’ve been in over the past 11 sessions. A disappointing employment survey got stocks off to a bad start as they hit the day’s nadir just 30 minutes into the session. The market did showed a little life by mid-day as the S&P 500 moved into positive territory, but retreated again in the final hour. With stocks closed tomorrow even as we get the March payrolls report, traders are just not willing to get in front of this data and hold those positions into the weekend.

It’s more than appropriate for the Exchange to close and observe Good Friday – don’t get me wrong I’m not at all inferring the market should open. Rather, the Labor Department should delay the employment report until Monday. The monthly jobs report is almost always released on the first Friday of the month, but this is the most market-moving data we receive and thus should be held until next week.

Only two of the major 10 industry groups closed higher yesterday, energy led the way and financials posted a slight gain. Consumer discretionary shares led the decliners, with technology and industrials rounding out the three worst performers.

Yesterday ended the first quarter and the major indices recorded another strong three-month period, marking the fourth-straight quarterly gain. Mid and small-cap stocks led the way, as the international indices lagged – you can see the results in the table below the jump via the YTD column.

For the quarter just ended, the Dow Industrials gained 4.11%; the S&P 500 added 4.87%; the NASDAQ Composite rallied 5.68%; the S&P 400 (mid-cap) surged 8.70%; the Russell 200 (small cap) jumped 8.51%. Overseas indices lagged as the main international index for developed economies rose just 0.22% and emerging markets added 2.11%
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Brent Vondera, Senior Analyst

Daily Insight: Case-Shiller and Consumer Confidence

2010-03-31T07:12:00.001-05:00

U.S. stocks wavered during the entire session. The major indices put their intraday highs and lows in before 10:30 CDT, then pretty much flat-lined until a little pop in the final hour of trading. The Dow Industrials was the best performer of the big three, but it was all due to one stock: 3M’s 3.5% jump accounted for 22 Dow points, which more than offset weakness from Boeing, Travelers, AT&T and IBM.

For the broad market, technology, industrials and basic materials led the S&P 500 to a fractional gain. Financials led the decliners. Utility and telecoms also closed lower.

The market is just kind of trading in this range of 1160-1175 on the S&P (10840-10955 for the Dow) as traders probably don’t want to get ahead of the March jobs report on Friday. Stocks will actually be closed on Good Friday.

It will be interesting to watch how the market reacts to what will be the best payroll numbers in more than two years. We’ve got a good shot at a 200K-plus increase; we’ll be watching the private sector readings as we’re expecting to get 100K from 2010 census hiring, which is only temporary employment. Will the market celebrate the good news if private-sector payrolls rise 100K? Or will traders worry that such a number will hasten some Fed tightening and sell off? I think we really need to see a substantial multi-month move in payrolls before the Fed signals they begin to mildly end ZIRP. We shall see.
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Brent Vondera, Senior Analyst

Market Minute: Interest rates and the bond market

2010-03-30T15:10:00.001-05:00

A colleague of mine asked me to touch on fixed income this week. Ask and you shall receive…

Bond funds have been extremely popular in the past 12 months, maybe even too popular. In 2009, equity mutual funds had net outflows of $35 billion while bond funds saw $421 billion of net inflows. So far this year, investors have placed about $89 billion with bond funds, or five times the rate in the first quarter a year ago. This is somewhat surprising given the powerful stock market rally over the last 12 months.

One explanation for the staggering bond flows could be the reality check investors got regarding their true risk tolerance. Pre-crisis, I commonly heard people insist they could handle more risk in the stock market or resist the idea that bonds play an important role in meeting long-term goals. If investors became more risk adverse following the crisis, then we should expect to see a spike in flows into bond funds.

A second explanation is that people got hungry for yield as they watched the stock market soar higher and their cash earned nothing. Chasing yield is a very dangerous game, especially under the belief that bonds can’t fall in value. But bond prices can fall if the Fed is forced to raise rates aggressively to fight off inflation, which seems like a reasonable possibility, and the interest rate shock would only be made worse by the fact that short-term rates are starting from zero.

I’m not suggesting this is any reason to sell all your bonds – I hope my readers stick to a more disciplined long-term investment plan– but it is worth discussing after seeing rising yields in last week’s U.S. Treasury auctions.

Rates for U.S. Treasuries were higher last week in part due to weaker demand from foreign investors such as Japan and China, but rates also reflect concerns about the massive supply of U.S. debt flooding the market and the inflationary effect of increased government spending. (You can read more about last week’s rise in rates in a post by Cliff Reynolds here.)

A sharp rise in long-term interest rates may be the biggest risk to both stock and fixed income markets today. In fact, I would expect to see a correction in the stock market if 10-year Treasury yields were to suddenly rise from today’s level of 3.87% to 4.5% in the near-term. That is because Treasuries are the benchmark for lending across the economy. Higher Treasury yields weigh on the economy by increasing mortgage rates, corporate borrowing costs, and interest on rising government debt.

I want to re-emphasize that I would only be worried about a significant near-term rise in rates. I say this because rates will go up at some point – government borrowing needs and the economic recovery make this inevitable. Nobody can know for sure when this will happen, although the Fed will telegraph the move by removing the phrase “extended period” from their view of the duration of “exceptionally low” rates.

Thanks for reading.

Peter Lazaroff, Investment Analyst

Daily Insight: Income & Spending, Dallas Fed, Profits

2010-03-30T07:07:00.001-05:00

U.S. stock futures were higher in pre-market trading yesterday and that upbeat sentiment flowed into the official session. The major indices held onto almost all of the early-session gains, unlike the past two days in which morning rallies were completely rejected in the afternoon.

A better-than-expected Economic Sentiment reading within the Eurozone and a surprise 4.2% rise in Japanese retail sales drove the day’s relative optimism. A good spending number for February in the U.S., even though it was not accompanied by an increase in income, kept that momentum going.

Energy shares led the way as the price of crude rose 3% to close at $82.36/barrel. Other outperformers were utility, health-care, industrial and basic material shares. The indexes that track technology and consumer discretionary stocks were the only losers on the session.
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Brent Vondera, Senior Analyst

Daily Insight: Another prevention plan, GDP and confidence

2010-03-29T07:24:00.002-05:00

U.S. stock indices ended mixed on Friday as the Dow and S&P 500 ended slightly higher, while the NASDAQ, mid and small cap indices failed to close above the cut line.

It was another session in which early gains were rejected as we headed into the afternoon session. Comments from former Fed Chairman Greenspan, calling the recent rise in Treasury yields the “canary in the mine” (regarding the government’s fiscal situation), may have been a factor weighing on investor sentiment. Stocks also had to deal with the downed South Korean naval ship along a disputed border with the North -- and naturally the rumors that follow.

Even though the S&P 500’s gain was only fractional, eight of the 10 major industry groups closed higher on the session. Basic material, consumer discretionary and industrials led the way. Health care and technology shares were day’s only losers.

For the week, the Dow Industrial gained 1.0%; the NASDAQ Composite rose 0.80%; and the S&P 500 added 0.50%. The gains marked the fourth-straight week of increase for all three indices.
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Brent Vondera, Senior Analyst

Fixed Income Weekly

2010-03-26T16:16:00.004-05:00

Rates rose significantly in a week dominated by poor Treasury auctions and public statements by Ben Bernanke and other Fed officials. The yield on the two-year finished the week 6 basis points higher at 1.05%, while the yield on the ten-year rose 16 basis points to yield 3.85%. The broad bond market was down .51% for the week. US credit followed stocks higher while MBS held steady ahead of next week’s end to the Fed’s mortgage purchases.

I have spoken a lot about yields being stuck in a range for the past 15 months or so, and much of the same is likely to persist until the market senses that the Fed is closer to the removal of emergency levels of liquidity. The graphs below show the current range for the 2-year and the 10-year.

The 2-year and 10-year are in two different places within their ranges. The ten-year sits at the top of its range while the 2-year is more in the middle. As a result we now have record levels of steepness and liquidity is still being heavily favored in the market as investors continue to guard against rising rates. Despite differing greatly now, 2 and 10 year yields are set to converge as the Fed begins to reverse monetary policy. This isn’t a revolutionary view. Short term rates stand to move higher when the Fed tightens, and long term rates may actually come down depending on how the market views the Fed’s stance on inflation. Right now, the Fed isn’t even considering inflation as an issue, which could prove troublesome if they aren’t able to recognize the effects of their policy soon enough. Inflation expectations according to breakeven yields on 10-year TIPS are holding steady at around 2.25%, essentially unchanged since the beginning of this year.

I’m not saying the current position of rates is unjustified. In my opinion it makes sense for rates to be where they are. Bernanke commented briefly this week on the meaning of the “extended period” language, stating that there is no set period of time to be assigned to those words. I didn’t expect to hear him say “extended period means 6 months”, but questions from house members forced him to talk more about the subject than he felt comfortable with I think.

Below is the excerpt from his prepared remarks detailing asset sales.

If necessary, as a means of applying monetary restraint, the Federal Reserve also has the option of redeeming or selling securities. The redemption or sale of securities would have the effect of reducing the size of the Federal Reserve's balance sheet as well as further reducing the quantity of reserves in the banking system. Restoring the size and composition of the balance sheet to a more normal configuration is a longer-term objective of our policies. In any case, the sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments and on our best judgments about how to meet the Federal Reserve's dual mandate of maximum employment and price stability.

In my mind his remarks telegraphed a removal of at least some of the longer-term securities on the Fed’s balance sheet (i.e. MBS, Treasuries and Agency debt), before an actual rate hike. He still maintained that reverse repurchase agreements, where the Fed would essentially lend out their securities for a predetermined amount of time, are still an option but talked more about actual sales more than he has ever before. In my eyes the MBS purchases were even more “emergency” than bringing the funds rate at zero, making it the logical choice to remove first. With that being said, there is no way to really know until they decide to move. Until then I will speculate.

Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight: Bernanke shifts market, jobless claims

2010-03-26T07:48:00.000-05:00

U.S. stocks rebounded yesterday morning as traders returned to dabble in some riskier assets after a 24-hour respite. The DJ Industrial Average got within 44 point of 11000 and the S&P 500 looked ready to gear up to tackle the pre-Lehman collapse level of 1250 as it moved past the 1175 mark at one point. But the rally was rejected after lunch and the major indices went into freefall in the final hour of trading to completely erase the earlier gains.

Fed Chairman Bernanke, during Congressional testimony officially intended to explain the eventual exit strategy, made it abundantly clear that this discussion in no way signals the Fed is ready to pull back on their extraordinary level of accommodation. In fact, he explicitly stated that the economy continues to require the support of a record low fed funds rate. These statements follow comments from other Fed officials on Monday that also suggested the Fed will remain on hold. Monetary tightening is a ways away and that’s ecstasy to stock traders.

However, that morning rally evaporated as people apparently read Bernanke’s text and noticed a little comment touching on actual sales of mortgage-backed securities when the Fed does begin to withdraw stimulus. What? Actual MBS sales, instead of just letting them pay down? Now, such action would really be a ways down the road, as doing so anytime in the near future would obliterate the housing market – and Bernanke was there to talk about an exit strategy so it shouldn’t be surprising that he brough this topic up. But just as traders find ecstatic delight in ZIRP, they view even the mention of asset sales by the central bank as anathema and this was probably behind the late-session pullback.

The third ugly Treasury auction in a row, this one being the issuance of $32 billion in seven-year notes, may have also played a role in the market’s reversal.

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Brent Vondera, Senior Analyst

Mortgage Apps, Durable Goods Orders, New Home Sales

2010-03-25T07:40:00.001-05:00

U.S. stocks pulled back a bit on Wednesday as sovereign debt worries continued after Fitch lowered Portugal’s credit rating, and warned of another to come, and the latest housing market data showed new-home sales slipped to an all-time low, for the second month in a row. An overall positive report on durable goods, although uneven with a number of components showing orders declined, wasn’t enough to offset the negatives.

Nine of the 10 major industry groups lost ground on the day, led by telecoms and consumer staples – strange for a traditional safe-haven like consumer staples to lead the declines on an overall down day for stocks, I don’t get that one. Financials were the only group to close in the black, boosted by Bank of America shares after the bank announced plans to expand in Beijing. I guess traders ignored the news that BofA will have to reduce principal values on more mortgage loans.

Treasury securities got clocked, the yield on the two-year jumped 11 basis points to 1.09% (which is hardly attractive but that’s a large one-day increase) and the 10-year yield soared 14 basis points to 3.83%. Tuesday’s $44 billion two-year auction was met by relatively weak demand, and that was followed by yesterday’s 5-year auction in which Treasury had to pay up in yield as demand was considerably weaker than prior auctions. We’ll see more than $100 billion in monthly government debt issuance until the cows come home, at some point that should cause yields to break through this very low-level range. (More on this below the jump)
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Brent Vondera, Senior Analyst

Tracking Volatility with the VIX Index

2010-03-24T15:32:00.002-05:00

Volatility, as measured by the VIX Index, has fallen to 17.5% so far in 2010. Often referred to as a “fear gauge,” the VIX moves up as investors buy bearish options (puts) on the S&P 500 and down when investors sell these options.

The VIX tends to drift between 10 and 20 under normal circumstances, but moved above 80 following the Lehman Brothers bankruptcy in November 2008. Since then, the VIX has returned to more historically normal levels – today it sits at 17.9 compared to the historical average of 20.3 – for several reasons.

For starters, there is a lack of participation in the options markets by institutional investors who are afraid of getting trapped in the event of a quick market movement – a symptom of the scars from the credit crisis. Internal risk management systems are also limiting banks from facilitating options trades as the return of capital trumps the return on it.

And we can’t ignore the influence that vast amounts of liquidity has in driving down volatility while pumping up risky assets such as stocks or corporate bonds. Other policy responses to the crisis have reduced price swings too. For example, the Federal Reserve bought up to $1.25 trillion in mortgage-backed securities (MBS) sold by agencies Fannie Mae and Freddie Mac, basically meaning that the Fed is the market for such debt. No surprise such a big buyer would help keep volatility under wraps.

Increased volatility could spell trouble for equities, but don’t become fixated on the VIX in hopes of predicting the market’s future direction. While options activity reflects market participants’ expectations of future market conditions, their outlook and sentiment can change at a moment’s notice.

A widely publicized study released this month by Birinyi Associates showed that the VIX “is a measure of current volatility with little or no predictive or indicative value regarding the course of the market,” but the study does suggest that high volatility may be a contrarian indicator. Birinyi Associates concluded that the contrarian value of low volatility is less clear.

This Wall Street Journal article suggests that the futures contracts on the VIX may be a better gauge for predicting stock market moves. This means that investors should be bullish when the futures are significantly lower than the VIX and bearish when futures are higher. Data from Bloomberg shows that July futures on the VIX are trading at 23.25, August futures at 23.40, and September futures at 23.60 – all considerably higher than the 17.91 level today, but still not what I would consider crisis levels.

What could be pushing futures on the VIX higher?

The Fed’s MBS purchase program ends this month, which could very well allow volatility to pick up again. Other looming concerns such as rising government debt levels or a potential overheating in Chinese markets could also provide impetus for bigger price swings. VIX futures may also be pricing in a pullback in the stock market following the strong run we've had over the past five weeks.

It’s hard to imagine the VIX continues to trend lower, but the pick-up in volatility that futures are predicting is relatively minor and not worth losing sleep over.
Peter Lazaroff, Investment Analyst

Daily Insight

2010-03-24T07:52:00.000-05:00

U.S. stocks gained ground for a second-straight session, pushing to a new 17-month high. The broad market hasn’t endured a significant sell-off (which I’ll define as more than a 1% move) in 20 sessions. The market appears to be strangely complacent as just one of the five down days during this 20-session stretch has been to the degree of 0.5% and three have been only fractional losses.

The National Association of Realtors reported that existing home sales came in a bit better-than-expected during February, showing activity fell 0.6% for the month. This followed record declines during the previous two months. Even though the headline figure beat expectations, the inventory data within the report suggested trouble lies ahead for home prices. As a result, stocks moved into negative territory following the report. However, comments from two Fed officials suggested that the central bank was likely to remain extremely accommodative for longer than the market had previously expected and that gave fuel to a rally that began around lunch and accelerated in the final 30 minutes of trading.

Specifically, it was the later of the two speeches, delivered by San Francisco Fed Banks President Janet Yellen, that was likely behind the rally late in the session. She stated: “The economy will be operating well below its potential for several years.” The market hears that and gets juiced that the Fed will keep monetary policy floored for well beyond a six month time frame.

Not surprisingly, commodity-related basic material stocks led the rally – the commodity trade rolls on dovish Fed comments. Industrials and tech were the other leaders. All 10 major sectors gained ground on the session.
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Daily Insight: The Cost of Entitlement

2010-03-23T07:36:00.000-05:00

U.S. stocks rallied shortly after the open and held the gains to the close. A rebound in commodity prices, helped by a lower dollar, overshadowed concerns that higher interest rates (India’s monetary tightening) and rising public-sector debt will derail the global recovery.

The rolling concern over European sovereign debt issues that was eminent in pre-market trading didn’t last long. To be specific, the worries lasted exactly 30 minutes into the regular trading session as that’s how long it took for stocks to rebound into positive territory – and for the dollar to give up its early-session rally and turn lower. As we’ve been talking about, the only thing the greenback has going for it right now is fear.

Consumer discretionary, basic material and tech shares led the way. Energy and utility stocks were the only losers out of the major 10 sectors. The price of crude reversed an earlier decline, but the shares didn’t follow suit.

It is interesting to watch consumer discretionary shares rally with oil over $80, pump prices inching closer to $3 (national avg. at $2.82), 10% unemployment and high household debt levels. The index that tracks these shares has doubled over the past year and is just 18% below the all-time high hit in 2007 (for perspective the broad market remains 25% below its peak). Something doesn’t exactly seem rational with this picture, if you ask me. Either job growth is going to come back with a vengeance and justify this move, or…well you know where I’m going with this.
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Brent Vondera, Senior Analyst

Fixed Income Weekly

2010-03-19T15:35:00.001-05:00

A fairly slow week was highlighted by comments from the FOMC and February’s CPI reading that flattened the curve as short-term yields and long-term yields moved inversely to each other. The two-year Treasury yield rose 4 bps to .99% while the ten-year fell 2 bps to 3.68%.

Consumer prices were unchanged in February from the previous month, versus an expected .1% rise, the first time the index didn’t print a positive change since last March when prices fell -.1%. The actual reading missing expectations by .1% isn’t huge news, but a larger trend of decreasing inflation expectations made its presence felt in the marketplace this week. Breakeven yield’s, which measure the spread between yields on TIPS and nominal Treasurys, fell steadily throughout the week. Ten-year breakevens fell 7 basis points to 220 as investors demanded higher real yields while nominal yields fell. Some of the movement on the long end of the curve is due to some positioning before next week’s $118 billion in Treasury issuance but words from the Fed this week also had an impact.

The “extended period” language was left unaltered, which indicates that the Fed intends to keep rates where they are for at least the next 4-6 months. A fed hike in early 2010 was a popular thought last fall, but any chance of that has been put off until the summer at the soonest. Implied probabilities point to a 28% chance of a hike to .5% by the August meeting, lower than the 50% chance the market was assigning to that at the beginning of the year. Regardless, removal of the “extended period” language will have to come first. If you follow the 4-6 month buffer between the removal of the language and the actual hike, the language will have to be dropped after the next meeting if we are to get a hike in the summer.

Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Plant some seeds in Monsanto (MON)

2010-03-19T15:10:00.002-05:00

I’ve mentioned recently that it is difficult to find bargains in the market today, but it may be time to plant some seeds in Monsanto (MON).

The stock market rally has left behind the seed giant as falling grain prices sapped demand for seed and profits from selling herbicides were squeezed by generic competition. Not only has MON lagged the broader market, but it has trailed its peers in the fertilizer and agricultural industries.

But MON has two game-changing products about to hit the market that can drive margins and market share gains for years. The first is SmartStax corn, which has the broadest array of genes available for fighting pests both above and below ground and for tolerating pesticides. The second is Roundup Ready 2 Yield soybeans, which promise higher yields (more beans per pod).

Success of these products will further expand MON’s dominance over the food chain and help win back investors frightened by the shrinking herbicide unit and regulatory concerns. As the saying goes: be greedy when others are fearful.

“Wait, did he just say dominance over the food chain?” Yes, I did.

World population is growing and appetites are growing in developing countries with rising wealth (see related article). With only so much land and water for farming, seed technology that improves crop yield is essential to the planet’s food supply. And unlike fertilizer, the market for genetically tweaked seeds still is largely underpenetrated outside the U.S.

When it comes to the U.S. seed market, MON has at least one of its patented genes in 90% of soybeans and 80% of corn. And competitors can’t seem to catch up, choosing to partner with MON rather than compete. Pouring 10% of sales into research and development, MON has an unmatched product pipeline that Credit Suisse estimates is worth $11 to $17 per share alone. Add this to an intrinsic value between $85 and $88 for the core business and the shares appear to be a steal.

Of course, those who plant seeds in MON shares today must be patient as the upside is limited until we see positive yield performance on the company’s newest products from this fall’s harvest, these results will drive longer-term acreage targets. But, given the decent valuation, strong product pipeline, and solid fundamentals in the agricultural biotech industry, MON represents a compelling long-term investment.

Peter Lazaroff, Investment Analyst

Healthcare stocks may rally on reform bill

2010-03-19T10:53:00.001-05:00

Bloomberg reports that U.S. health stocks are poised to rally if the overhang of uncertainty is removed by the passing of a healthcare reform. The argument in this article is extremely similar to a post of mine from January (see: Healthcare sector trending up).

The most visible positive catalyst for the industry is that the worst-case reform scenarios – a single-payer system or a public plan with a Medicare-linked fee schedule – are no longer a threat. Managed care companies like WellPoint (WLP) and UnitedHealth Group (UNH) stand to gain new customers as coverage expands to people who previously went without insurance.

A common concern for these insurers is that the government will restrict profitability by scrutinizing rate hikes as we’ve seen in recent months in California, but this concern is not justified. The fact that is important to consider is the cap Congress proposes to put on the medical-loss ratio – the percentage of premium revenue used to pay patient bills – is well above the industry’s historical average, which means that they will not be impinging on profitability as much as feared.

Overhaul or not, health insurers have always found ways to make money and preserve profitability despite government regulation. I don’t expect that to be any different this time around. Managed care, as well as pharmaceuticals, are still looking very cheap relative to the rest of the market, and removing the uncertainty surrounding reform will provide a catalyst to expand valuations throughout the healthcare sector.

Peter Lazaroff, Investment Analyst

Daily Insight: Jobless Claims, CPI, Philly Fed

2010-03-19T06:17:00.001-05:00

U.S. stock indices ended mixed as the Dow and NASDAQ gained ground, while the broad S&P 500 closed fractionally lower. Mid and small cap stock indices also closed to the downside.

The broad market bounced between gain and loss on several occasions, as traders were conflicted by the positive of a strong manufacturing report yet the negatives of increased jobless claims and speculation the Fed will move to raise the discount rate – I wouldn’t call that a negative but traders don’t seem to like it much.

The discount rate is the rate at which banks can borrow from the Fed. They last raised the rate on February 18 as they are in the process of normalizing the spread between the discount rate and fed funds – normally disco is one full percentage point above that of fed funds, but the spread was cut to 25 basis points during the crisis and now stands at 50 basis points above fed funds. Now, it’s not like the market sold off on this speculation, the S&P 500 was essentially flat (but then again the rumor was fairly silly as it is unlikely the Fed would leak this news), but if traders are going to get a bit antsy about an increase in the discount rate, what’s going to happen when the Fed eventually begins to increase fed funds?

The 10 major sectors within the S&P 500 were split as five gained ground, while five declined. Industrials’ and health-care led the gainers; energy and financials led the declining sectors.

The Dow was boosted by shares of Boeing, 3M and IBM, which accounted for 60% of the index’s gain.
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Brent Vondera, Senior Analyst

Daily Insight: Dollar, EU Second Thoughts, Mortgage Apps, PPI

2010-03-18T06:56:00.002-05:00

U.S. stocks gained ground for a third-straight session, and the only two down days of the past 15 sessions were nothing more than fractional declines, on the heels of Tuesday’s Fed statement – yesterday’s reported decline in producer prices for February only reinforced the fact that the Fed won’t feel pressure on the inflation front to remove their unprecedented level of accommodation anytime soon. (Not that the Fed would be focused on inflation if it were a threat, not with 10% unemployment, banks that need a super-steep yield curve and a housing market that remains beaten down…but this is for another discussion I guess.)

The broad market did give back about a third of its earlier gains late in the session, but held on to record solid performance.

Energy shares led the advance (first time for that in a while) along with financials and materials. All 10 major sectors gained ground on the session, but there were clear laggards as utilities and health-care shares were the deepest under-performers.

The Dow Industrial Average followed the S&P 500 in making a new 17-month high, surpassing what had been the recent high of 10,725 hit on January 19. Shares of Exxon, Chevron and Caterpillar led the Dow higher – energy stocks had conspicuously lagged the broad market over the past couple of months, but with crude now testing $83/barrel, they’ve found a bid.
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Brent Vondera, Senior Analyst

Daily Insight: Import Prices, Housing Starts, FOMC Statement

2010-03-17T06:51:00.002-05:00

U.S. stocks gained good ground on Tuesday after S&P affirmed their credit rating on Greek government debt of BBB+ (they had threatened to lower that rating) and the EU signaled they’d sidestep “no-bailout” rules and provide emergency loans to that government. The market rally accelerated in the afternoon after the Fed confirmed the rate on fed funds will remain floored for an extended period (yeehaw!) and provided the impetus for traders to push past that 1150 market on the S&P 500 – had been stuck there for three sessions. The broad market sits at a new 17-month high.

Basic material, financials and industrial shares led the advance. All 10 of the major S&P 500 sectors gained ground on the day, but consumer staples and health-care (the traditional area of safety) along with telecoms were the laggards.

And speaking of commodity-related basic material shares, the price of oil is back above $82/barrel this morning – call it a Bernanke bounce. I’m watching for the price to breach $85, which hasn’t occurred since economic mayhem began in late 2008. At some point the market is going to view higher energy prices as another noose around the consumer’s neck. In quick order we could have both oil and stocks at fresh 17-month highs, both are unlikely to move higher in tandem for very long.

Sovereign debt default concerns eased again yesterday, here’s the ebb and flow we’ve been talking about, as European finance ministers laid out unspecific groundwork for a financial lifeline to Greece. If Greece runs into trouble rolling their debt, EU officials will provide emergency loans as members pool funds. The meeting didn’t provide an actual euro amount of these potential emergency loans.
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Brent Vondera, Senior Analyst

General Electric (GE) to raise dividend in 2011

2010-03-16T14:15:00.000-05:00

General Electric (GE) CFO Keith Sherin told investors the company would like to grow the dividend in 2011. Sherin said losses and delinquencies from GE Capital are going to peak sometime in 2010, which could allow for “a real earnings snapback,” going forward.

Substantial improvement to the leverage ratio and GE Capital, vastly improved capital market conditions, and projected earnings of $23 billion over the next two years support the idea of hiking the dividend. The company’s equipment and service and equipment backlog stands at $175 billion and is “slowly turning.”

In other news, financial reform proposals put GE under the Federal Reserve’s regulation, but do not force a break of the parent company and the finance unit. It appears GE will be able to keep its controversial industrial loan and thrift banks based in Utah.

The market seems to finally be warming up to GE and I feel vindicated.

Peter Lazaroff, Investment Analyst

Fixed Income Weekly

2010-03-12T15:32:00.001-06:00

Treasurys were slightly lower across the curve after a quiet week of trading. The curve was 4 basis points flatter at end the week at +275 bps, 17 bps under the all time record set on Feb 22.

A strong credit market last week was followed up by heavy issuance of corporate debt this week. According to Bloomberg, some $30 billion in corporate bonds were issued by close of business Thursday, bringing the year to date total to just shy of $200 billion. Credit spreads have been steadily moving lower while Treasurys have remained in a tight range. CFOs are definitely aware of this and are taking advantage of the environment to raise cheap capital. And thanks to today’s news that Obama plans to nominate San Francisco Fed President Janet Yellen to Vice Chairman of the Federal Reserve, one of the most dovish of the 12 Fed Presidents, companies will likely see better chances still to borrow cheaply. The term “dovish” is used to describe those who favor easy monetary policy, as opposed to “hawkish” policy makers, who traditionally lean toward tighter monetary policy. The effect of ZIRP on the cost of debt is two-fold. Rates are low, and as investors stretch out to grab more yield in the face of measly low-risk returns, spreads will continue to tighten as long as rates stay here.

The FOMC meets next week and is expected to stand pat on rates, but all eyes will be reading the comments that accompany the rate decision. Namely, “the exceptionally low/extended period” section. Not much is being said one way or another on that, but I expect to hear more speculation early next week. I don’t think the committee is ready to remove them yet, but we are certainly closer than we were in January.

Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight: Jobs, Trade Balance, Household net Worth

2010-03-12T07:26:00.002-06:00

U.S. stocks closed smack-dab on the 17-month high Thursday (1150 on the S&P 500, initially hit on January 19) to fully erase the 8.1% pullback the market ran into a month back. A late-session surge brought the market out of negative territory, where it had been for virtually the entire day, to match that near-term high.

Jobless claims that remain stuck at high levels and foreclosure filings that continue to rise at a pace of 300K per month couldn’t stop a spate of optimism that banks have put damaging loan quality behind them. That’s a dangerous assumption in this environment. But hey, it sure feels good.

As a result, financials led the market higher with consumer discretionary shares being the next best performing sector. Basic material stocks participated in the advance for the first time in three sessions as the U.S. dollar lost ground.

Nine of the 10 major industry groups rose yesterday. Energy was the sole loser.
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Brent Vondera, Senior Analyst

Daily Insight: Crude Oil, Mortgage Apps, Wholesale Inventories

2010-03-11T06:58:00.000-06:00

U.S. stocks gained ground for a second day on Wednesday, and if not for Monday’s fractional decline the broad market’s re-rally would be two weeks in length. As a result, the S&P 500 has inched closer to the 15-month high hit on January 19.

The tech-laden NASDAQ Composite led the way. Mid and small-cap indices also out-performed the broad market. Shares of Travelers, Chevron and 3M weighed on the Dow Industrial Average, which lagged the other major indices -- a big day from Boeing (added 17 Dow points) kept the index in positive territory.

Financials, tech and energy were the leaders for the session – although as mentioned above Chevron didn’t follow other energy names. Telecom, consumer staples and basic material shares were the three of the 10 major sectors that closed lower on the day.

On the sovereign debt problems over in Europe, former European Commission President Romano Prodi stated: “For Greece the problem is completely over. I do not see any other case now in Europe.” I don’t think comment on those remarks is necessary.
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Daily Insight

2010-03-10T07:39:00.001-06:00

U.S. stocks gained some ground on Tuesday amid growing optimism an improving economy will justify an extension of the year-long market rally, or so it was written by the financial press. Stocks were considerably higher for most of the session, but slid to negative territory late in the day before bouncing back above the cutline 25 minutes ahead of the closing bell.

As stocks grind higher and attempt to break past the near-term highs hit in January, the latest NFIB small business survey illustrated that small biz owners are not so ebullient about things and the IBD Economic Optimism reading for March suggested that things are not quite right with the world. Both surveys fell. The NFIB survey remains stuck at a level that’s well below the marks hit during the past two economic contractions and the Personal Financial Outlook segment of the IBD survey fell to the lowest level since February 2009 – a period when everything but the safest of assets was getting hammered. More on the NFIB report below the jump.

News from Cisco Systems that they’ll roll out a heavy-duty router capable of 12 times the capacity of rival equipment helped boost information technology and telecom shares. The router will allow internet providers to carry data traffic at speeds 100 times faster than most home connections today and able to direct traffic based on the priority of the data – this thing is all about video.

Basic material, utility and consumer staples stocks were among the session losers.

The dollar rallied after Fitch Ratings warned about deteriorating credit quality In Europe, which prompted traders to seek refuge in the greenback as they sold euros and pounds.

Read the rest of today's Daily Insight on our Website

http://www.acrinv.com/20100310224/blog/daliy-insight-3-10-2010

Is the market fairly valued?

2010-03-09T16:16:00.003-06:00

It’s the one year anniversary of the S&P 500 lows, and what a difference a year makes! The S&P 500 is up over 68% in the last 12 months, but clearly the tremendous opportunities that were in place a year ago are no longer there.

There are two market conditions, however, that will allow investors to take advantage of opportunities. The first is that volatility is dramatically lower. As measured by the VIX index, volatility is nearly 80% lower than it was at the time of the Lehman Brothers bankruptcy.

The second favorable condition is that correlations between assets and within markets have come down. When correlations were extremely high, and everything was going down at the same time, the only thing that mattered to investors was to have as little risk exposure as possible.

Lower volatility and lower correlations across different asset classes presents the opportunity for investors that do their homework to generate good returns. That means looking at fundamentals such as earnings, cash flow, and dividend payouts. It also means identifying long-term trends that will cause specific sectors to outperform. For example, the Technology and Industrial sectors are positioned to perform well in 2010.

But are stocks way ahead of the economy? Is the good news already baked into stock prices?

Clearly the stock market is a forward-looking mechanism that moves in advance of the economy, but it hasn’t necessarily moved too far at this point.

Economic data over the past few weeks makes the double-dip scenario seem less likely, with new orders for equipment, retail sales, and even things like hotel stays pointing to a brighter economic climate. The jobs numbers are still bad, but have shown improvement. More importantly, many individuals are feeling less uncertain about their job prospects.

Meanwhile, corporations are reporting strong cash flow and balance sheets look relatively healthy. We are starting to see businesses buy back stock, raise dividends, and increase investment for future growth – all of which are positive signs.

We always hear about historically high P/E ratios (here is a good story in today’s Wall Street Journal), but when the market is measured by cash flow (P/CF) the S&P 500’s valuation is 37% below the 12-year average and half of its valuation in 2007. P/CF has increased from roughly 4.5 in March 2009 to 8.2 today. With data going back 1998, the CF multiple has never fallen below 8.0 prior to 2008.

I believe the S&P 500 will finish 2010 somewhere between 1200 and 1250, 5% to 9% above today’s levels, but I would be concerned around 1300. Notice that I say “in 2010.” There are many uncertainties beyond 2010 that are keeping investors at bay. Because the market is forward-looking, it is affected by how far investors are willing to look into the future, which depends on their level of comfort and safety. One year ago, investors could barely look a week into the future. When a bull market is under way, investors are willing to look 18 to 24 months into the future to discount future earnings.

Some may argue that fair value is 20% below where the market stands today. I agree that buying stocks at prices 20% lower than today's would better compensate for the long-term risks facing the U.S. economy; however, I am not selling stocks because waiting for this event to occur could take several years. Markets are historically "overvalued" for extended periods of time. At the same time, ignoring the significant risks at hand is not prudent behavior either. Expectations must remain reasonable.

One year ago, investor sentiment and psyche was quite low among both individual and institutional investors. One year later, the easy money has been made, so it's important to remember that the recovery will be slow and bumpy as the economy moderates.

- Peter Lazaroff, Investment Analyst

Daily Insight: Dollar Strength on Weakness...and Policy

2010-03-09T07:49:00.001-06:00

U.S. stock indices ended mixed on Monday as the Dow and S&P 500 closed technically lower (essentially flat), while shares of Cisco Systems helped drive the NASDAQ Composite into positive territory.

Stocks really need some sort of catalyst at current levels, the broad market has basically recouped the 8% slide that occurred during the three weeks ended February, and we were without an economic release to provide that boost. There were additional comments out of Europe over the weekend that offered the clearest evidence Germany and France would be at the ready to help Greece refinance their debts if needed, but this was already baked into last week’s trading.

(I did found it interesting to read that the Greek Prime Minister excoriated “unprincipled speculators” yesterday for threatening to bring a new global financial crisis. He’s referring to the CDS market – in short, CDS is just insurance against default. This market can be a bit screwy, particularly the naked sort – not to be confused with the naked-Rahm that’s allegedly found loitering in Congressional showers. Naked CDS is when someone is using this derivative to bet for or against default, but has no direct exposure to the underlying debt. But look, speculators wouldn’t be betting against Greece in the first place if the government hadn’t promised benefits they can’t possibly afford. Get your finances in order and you wouldn’t be dealing with this problem, which should be a lesson to all governments.)

Telecom, consumer discretionary, tech and financials were the sectors up on the session. Tech and telecoms were boosted by news that Cisco Systems will unveil new tools to help build systems to increase download speeds. The index that tracks financial shares was most likely helped by news that AIG was able to sell another of its premier units. This must have offset talk that banks are going to have to take much more losses on mortgage loans, which to this point have been valued on the prayer that housing is going to make a sustained comeback sometime in the near future.

Industrial and health-care shares led the six major sectors that declined on the session.

So we’re at the one-year mark of the nefarious intraday low of 666 on S&P 500 and the closing 13-year low of 676 by day’s end on March 9, 2009. The broad market has jumped 68% from that low, which means it’s recouped 52% of the value lost from the October 9, 2007 all-time high. The chart after the jump takes us back to that October 2007 all-time high.
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Brent Vondera, Senior Analyst

Daily Insight: February Jobs Report

2010-03-08T07:37:00.000-06:00

U.S. stocks got a boost after the latest jobs report showed less payroll positions were lost than White House economic adviser Larry Summers had set the market up to expect, and more importantly that we’re likely very close to some mild monthly increases in employment. Now, we’re going to need 300K-plus per month for more than a year to bring the jobless rates down substantially (don’t forget among others waiting on the sidelines there are 2-3 million May graduates readying to enter the job market), but additions are additions and it looks like they’re around the corner.

The market also got help from a couple of Fed officials who stated the central bank needs to keep rates low until the recovery picks up (I thought the recovery was gaining steam; that’s what we heard from the last FOMC statement). ). Federal Reserve Bank of Chicago President Charles Evans stated he needs to see “highly sustainable” growth before supporting steps toward tighter monetary policy and St. Louis Fed Bank President James Bullard stated policy makers want to remain “very accommodative.”

Financials led the way on those Fed comments and energy was next in line as the price of crude jumped to $81.50/ barrel – wholesale gasoline rose to $2.27/ gallon, highest since October 2008; it appears that $3 retail is on its way.

For the week, the broad market gained 3.10% and is now within 1% of its 16-month high touched on January 19. The Dow Industrials added 2.33% for the week and the NASDAQ Composite jumped 3.94%. Small-cap stocks led the week’s advance, up 5.96% -- and have led the market during this nearly one-year rally from the March 9, 2009 depths. Mid-cap stocks added 4.35%.
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Brent Vondera, Senior Analyst

Fixed Income Weekly

2010-03-05T15:43:00.002-06:00

Bond traders sat on their hands for most of the week, waiting for two big news releases, the prepayment speeds for Freddie MBS last night, and the jobs report this morning. For the week the curve was slightly flatter, falling 1 bp to 279 basis points 2s to 10s. Credit tightened after being flat last week, mostly on today’s positive news. Markit’s current CDS index stands at 85.6, 9 points higher than the multi-year lows set in January. CDS is quoted as the cost of default insurance, so the lower the better.

The curve actually sat much flatter before the heavy selling on the long end after this morning’s jobs report, which showed business cut 36,000 payroll positions, better than the 68,000 expected. The labor participation rate ticked up slightly from 64.7% to 64.8% and the unemployment rate held steady at 9.687%. The big story leading up to the release was that severe weather was going to put the hurt on the data. The effect of things like this is impossible to accurately measure, but the market was ready to see a terrible number, and ignore it, but instead we saw a better than expected number, and stocks rallied like a Subaru.

Prepayment speeds are usually a non-event, but Freddie Mac purchased every loan that was at least 120 days delinquent from their mortgage pools in February, so March FHLMC speeds were expected to skyrocket. Freddie MBS underperformed Treasurys in early trading, but buyers stepped in to prove the selloff was a little unjustified considering overall speeds may actually slow down going forward due to the cleanup. Fannie Mae is expected to follow Freddie’s lead in the next few months, but will buy only “a substantial portion” of their 120+ delinquent loans. Fannie Mae is considered to have more problems compared to Freddie, but although Thursday’s release gives some insight into what will come, it by no means answers the market’s questions on what is to come with FNMA.

Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

2010-03-05T08:23:00.002-06:00

U.S. stocks were able to shake off another very weak home sales report, rallying in the afternoon to propel the broad market’s (S&P 500) winning streak to five sessions. The Dow and NASDAQ Composite posted their fourth gain in the past five days.

A better-than-expected increase in retail sales for stores open at least a year (known as chain-store sales) was really the best news yesterday and probably helped to offset the day’s other economic releases, which weren’t exactly helpful. The latest data on pending home sales suggested that the housing-market weakness of the past couple of months will extend into February and March.

The jobless claims data had to be viewed as a net negative – while initial claims fell, they remain at an elevated level and continuing claims are stuck at unprecedented levels. Nonfarm productivity for the most recent quarter posted a very high reading, but only because firms have kept payrolls and hours worked to a minimum. More on all of these releases after the jump.

Energy and health-care shares were a drag on the market. Financials were the best-performing sector as some members of Congress look to dilute the proposed new regulations on the industry and delay its inception.
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Brent Vondera, Senior Analyst

Pfizer (PFE) bids for generics business

2010-03-04T15:30:00.000-06:00

Oh, Pfizer. You just love acquisitions, don’t you?

Pfizer has reportedly bid $4 billion Euros (or roughly $5.4 billion U.S. dollars) for German generic drugmaker, Ratiopharm. This acquisition would thrust PFE into the big leagues of generic drugs with annual sales of roughly $11 billion compared to the biggest player, Teva Pharmaceuticals (TEVA), which had $13.9 billion in 2009 revenue.

I figured Pfizer would want to focus on integrating the massive Wyeth acquisition, which cost them more than $65 billion, before prowling for additional acquisitions to combat patent losses. The price tag doesn’t really concern me because Pfizer has plenty of cash and investing in a generics business makes some sense. In addition, global scale is critical to generics, so buying the top manufacturer in the EU’s largest market (Germany) is wise.

I suppose my main concern is the vastly different economic of generics compared to the Big Pharma model. Integrating a business with intense cost competition will be more complicated than just writing a big check and eliminating overlapping business costs.

Another concern is that annual generic sales totaled just $83 billion, according to IMS, while PFE alone generates more than $60 billion with much more attractive margins. Significant patent cliffs mean $150 billion in annual sales will go generic by 2014, but growth will then slow substantially.

I guess Pfizer is shrinking it research spending for a reason: they are going to purchase future revenues for the foreseeable future. Ok, so PFE is officially no longer a growth stock. That’s no big deal if they keep paying a fat dividend (current yield of 4.17%) and find ways to grow the dividend at a meaningful rate.

While on the topic of PFE, I should acknowledge that earlier this week an experimental Alzheimer’s treatment, Dimebon, failed to show effectiveness in a large late-stage study. This is one of the drugs I mentioned in this post as a catalyst for 2010 performance. In short, the results were very disappointing to investors.

Peter Lazaroff, Investment Analyst

Daily Insight

2010-03-04T07:37:00.000-06:00

U.S. stock indices ended mixed on Wednesday as some legislative concerns and a cautious economic report from the Fed offset better-than-expected results from the service sector. The major indices ended the session essentially flat with the Dow Industrials and NASDAQ Composite slipping, while the broad S&P 500 ended fractionally higher.

Things were going pretty well as somewhat upbeat sentiment in pre-market futures trading flowed into the official session. However, the gains evaporated shortly after lunch, right around the time of President Obama’s press conference urging lawmakers to vote on health-care overhaul (which means they’ll choose reconciliation – so the hurdle is just 51 votes in the Senate) and the Fed released its latest Beige Book – that report expressed concerns over the real estate market and wasn’t particularly cheery on the labor market either.

Basic material shares were the best-performing sector for a third-straight session. Health-care was the laggard, leading the three of the 10 major sectors that fell on the session.
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Brent Vondera, Senior Analyst

Daily Insight

2010-03-03T07:31:00.002-06:00

U.S. stocks extended the latest winning streak to four sessions on talk of more acquisitions to come, Qualcomm’s announcement that they’ll begin a $3 billion stock buyback program and increase the dividend, and Indian manufacturing remained in expansion mode for an 11th straight month.

Companies are sitting on record levels of cash, roughly $1.18 trillion for S&P 500 members, and early signs suggest they’ll deploy that cash in a manner that boosts returns for shareholders via buybacks and dividend hikes. (S&P 500 members’ cash levels jumped $518 billion over the past year after slashing capital spending by 43%. Excluding financials, corporate cash stands at $820 billion, up 27% over the past year.)

Firms see the environment as challenging and are not confident profits alone are going to drive share prices higher. Certainly, dividend payouts will need to increase as the coming tax-rate hikes on dividend income will erode after-tax returns. The two plans being pushed: hike the dividend-income tax rate from the current 15% to 22.9% (20% + 2.9% Medicare tax) or drive the rate to the investor’s marginal tax rate – the former having the most support.

Of course, if profit growth does not become durable then this strategy becomes a negative for job growth. Firms will not spend cash on both areas unless the revenue and income is there to support it. They’ll continue to seek profit-enhancing productivity gains via reduced payrolls.

The Dow average was held back by the index’s tech names -- IBM, Microsoft and Hewlett-Packard.

Along with information technology, telecom and consumer discretionary shares were the three of the major 10 sectors to lose ground on the session. Basic material, energy and utility shares handily out-performed the market.
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Brent Vondera, Senior Analyst

Daily Insight

2010-03-02T07:36:00.001-06:00

U.S. stocks started the month off on a high note, propelled by a number of acquisitions as Prudential will buy one of AIG’s crown jewels (their Asian life insurance business) and two pharmaceutical/biomedical deals that juiced mid and small-cap stock indices.

Most overseas bourses performed well the night before, which also offered a boost to the U.S. market, on the weekend’s news that the EU is readying a Greek bailout. Finance ministers will continue to state that they’ll hold Greece’s feet to the fire with regard to austere budget constraints, but as the Greek government get closer to the necessary bond sales needed to roll maturing debt the EU will remove this rhetoric even if the German populace is steadfastly against a bailout – Germany being the EU’s stalwart and major force in the bailout.

Consumer discretionary shares led the broad market higher after the latest personal spending data came in a touch better-than-expected. Utilities, which have had an especially hard time since the end of 2009, was the second-best performing S&P 500 sector. Information technology and basic material shares rounded out the best performing groups.

Financials were the day’s relative loser after HSBC, Britain’s largest bank, reported setting aside higher provisions to guard against a rising non-performing loan count.
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Brent Vondera, Senior Analyst

February 2010 Recap

2010-03-01T15:46:00.001-06:00

After enduring an 8.03% drop from Jan. 19 to Feb. 8, the S&P 500 posted a solid monthly gain despite concerns about sovereign debt and lackluster economic data.

January retail sales data showed that U.S. consumers are starting to pull more of their weight, but a surprising increase in initial jobless claims and disappointing durable goods report near the end of the month kept investors expectations for the economy tempered. Housing data didn’t help either, with sales of previously owned U.S. homes falling 7.2% in January to a seven month low.

More important to the markets was the Federal Reserve raising the interest rate it charges banks for emergency loans and reaffirming that broad tightening of credit was not imminent. In addition, core consumer prices fell for the first time since 1982, leaving room for the Fed to keep rates relatively low if necessary.

The MSCI EAFE index posted a small loss of 0.65% on weaker-than-expected European Union GDP data and concerns surrounding Greece’s debt problem. The MSCI Emerging Markets Index squeaked out a 0.34% gain in the face of China removing economic stimulus. The bright spot among international areas was the MSCI Pacific Ex-Japan Index, which posted a 3.12% gain on strength in Australia.

Domestic REITs outperformed all other asset classes amid merger and acquisition activity. Multiple bids were made public for General Growth Properties, which filed for the biggest real-estate bankruptcy in U.S. history after amassing $27 billion in debt during an acquisition spree. Simon Property Group offered $10 billion and Brookfield Asset Management, which owns roughly $1 billion in General Growth debt, offered $2.63 billion for a 30% stake. General Growth is holding out for a higher bid, which led REITs to advance further.

Rates were barely lower for the month, falling just a few basis points across the curve, while news in bond land was dominated by sovereign credit issues overseas. Corporate spreads domestically were tighter by a few beeps compared to the end of January, despite widening out mid-month to levels not seen since November.

Daily Insight

2010-03-01T07:22:00.001-06:00

U.S. stocks bounced between gain and loss on a couple different occasions Friday, ending the session slightly higher. For the week, the broad market ended essentially flat, down just 0.4%.

A strong regional manufacturing report offered the greatest boost to the market. a revised GDP reading that came in a bit higher than previously estimated may have helped a little too but the increase was mainly due to a downward revision on the inflation gauge tied to the report – nominal GDP was unchanged from the initial estimate, more on that below the jump.

The January existing home sales report kept the day’s gains to a minimum as sales posted the second-largest monthly decline on record; the largest decline occurred in the previous month.

Financial and industrial shares led the broad market higher. Bank stocks helped propel the financials after Barclays recommended buying shares of JP Morgan. I don’t know, JP Morgan is one of the best-run banks out there but the fourth-quarter FDIC report on the industry didn’t paint a pretty picture for the industry. The coverage ratio among insured banks slipped again last quarter to a level that is less than half where it was a few years ago when loan quality was strong – trouble lurks if loan quality fails to improve markedly, and quick.

Utility and consumer staples were the losers on the session, being the only two of the top 10 sectors to close lower on the session.
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Brent Vondera, Senior Analyst

Fixed Income Weekly

2010-02-26T16:04:00.000-06:00

The bond world has been a busy one lately. The situation in Greece has been very volatile, which is understandable considering the conflicting opinions in the market and the “contagion” type effect a Greek default could have within the Eurozone and beyond. Chairman Bernanke’s testimony was as expected, but still meaningful as Big Ben confirmed the need for exceptionally low interest rates for a considerable amount of time, in addition to the importance of the Fed’s role as the primary regulator of the banking system.

Treasuries have been fighting two separate battles. One is Fed policy. The short end has been bouncing around within a tight .7%-1.1% range for 6 months now. The hike in the discount rate last week brought about a kneejerk move higher in short-term yields, but after much nay saying by policy makers they have settled down to just about where they were before the Fed made the change. The Fed remains very unconcerned with current levels of inflation, Q4 PCE was 1.6% annualized versus 1.4% in Q3, but longer term effects of current policy have the market demanding much higher yields on the long-end, which explains the record high spread between 2s and 10s of 291 basis points on Monday.

Secondly, the budget/credit/currency issues in Europe are pushing money into dollars, and in turn Treasurys. It’s the typical safety trade really. It sure helped with the $126 billion the Treasury had to sell this week, which all traded through the “when issued” yield, a sign of better than expected demand.

Next week is full of more Fed speak, which should get the market jumpstarted after closing on a very quiet note (relatively) this week.

Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Weekly Roundup: ESRX, MON, RIG

2010-02-26T15:33:00.001-06:00

Express Scripts (ESRX) +5.89%
Investors bid up ESRX shares following 2010 guidance that suggested the integration of WellPoint’s NextRx unit is ahead of schedule.

The acquisition of NextRx gave ESRX the scale to compete with its biggest competitors in the pharmacy benefit manager (PBM) industry. PBMs negotiate drug prices with manufacturers and retailers on behalf of clients.

ESRX’s proven track record of successfully integrating acquisitions and the firm’s outlook that suggesting synergies associated with the transaction are likely to come earlier have lifted investor confidence in the firm’s ability to achieve above normal earnings growth over the next few years.

ESRX and other PBMs are positioned to benefit from positive trends such as the aging population, healthcare cost containment efforts, and increasing customer acceptance of mail-order pharmacies. More important, though, is the looming patent cliff in 2011 and 2012 since ESRX earns profit margins when customers use generics over brand-name pharmaceuticals.

ESRX’s fourth quarter income rose 8%, including one-time charges from the NextRx acquisition, helped by an increase in the use of generic drugs to 69.1% from 67.3% helped push margins higher.

Monsanto (MON) -7.10%
MON lowered its second quarter profit outlook as the late 2009 harvest is shifting purchases to the second half of the year.

MON also said the two new products they are counting on to drive earnings this decade may be planted on 20% fewer acres in 2010 than previously forecast. Farmers are trying the new products in the numbers expected, but on fewer acres. MON said the shortfall may reduce earnings by less than 5 cents a share.

The two products of topic are Roundup Ready Yield soybeans, which increase yields 7% to 11% from the original product introduced in 1996, and SmartStax corn seed, which has eight genetic changes (traits) that resist bugs and tolerate herbicides.

MON shares have been crushed this year, but I think sell-off is not justified. The SmartStax corn seed is a true game-changer that can drive margins as well as market share gains for the firm’s corn business in coming years. As for the soybean product, China recently gave import approval to Roundup Ready 2 Yield soybeans, which paves the way for large-scale commercial introduction of the product.

Longer-term, MON’s success comes down to its powerful research and development efforts – the firm plows 10% of sales into R&D – and their elite production and distribution capabilities.

Transocean (RIG) -5.30%
RIG’s earnings trailed consensus amid decreasing demand for rigs. Only 69% of RIG’s fleet was working during the fourth quarter, down from 90% a year earlier.

Utilization declined in six of seven rig categories, more than offsetting the 18% increase in the fleet’s average daily lease rate. Idling rigs, even for a few days, directly hits the bottom line since the day rates (or rental rates) are so substantial.

The market is down on RIG shares after this report, but the company’s superior free-cash-flow generation and above average earnings visibility versus its peers should not be ignored. RIG management has made it clear they plan to return significant cash to shareholders through dividends and buybacks over the next two to three years.

Last week, RIG announced a $3.2 billion share-buyback program as well as the issuance of a $1 billion special dividend. Instituting a buyback program rather than paying out a larger dividend at this juncture gives the company financial flexibility for opportunistic acquisitions.

The potential for a jackup spin-off could also help support shares in the near-term.

--
Peter J. Lazaroff, Investment Analyst

Daily Insight

2010-02-26T07:20:00.001-06:00

U.S. stocks pared fairly large early-session losses thanks to an afternoon rally that sent the S&P 500 higher by 1.5% from the day’s low. The broad market failed to make it back to the cut line and all 10 major industry groups decline on the session but I think we can call this one a moral victory – for perspective, the Dow was off by as much as 188 points at the day’s worst. Mid and small cap indices managed fractional gains.

Things got started on a bad note as futures were pointing lower due to concerns over growth prospects in Europe and the likelihood that sovereign debt woes would spread throughout the zone. Also putting the hurt on morning trading was the latest report on jobless claims, which showed the uptrend has extended to seven weeks now. Initial claims have just about returned to the 500K mark – peak levels of the last two economic contractions.

But around 1:00CST stocks staged a comeback, which was also right around the time Bloomberg News reported that the Obama Administration may ban all foreclosures until they have been screened and rejected by the government’s Home Affordability Mortgage Program, or HAMP. We discussed this proposal to halt foreclosures in Wednesday’s letter, so I won’t get into it again here.

Telecommunication and financial shares led the decline. Consumer-related and health-care shares were the relative winners, but still down for the session.
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Brent Vondera, Senior Analyst

Daily Insight

2010-02-25T07:51:00.001-06:00

U.S. stocks were able to shake off an ugly housing report and snap a two-day losing streak after Fed Chairman Bernanke stated that it’s necessary to keep the fed funds rate “exceptionally low” in an attempt to spur demand.

Bernanke was on Capitol Hill yesterday providing his semi-annual testimony on the economy and monetary policy, an event officially termed Humphrey-Hawkins testimony although few still call it that these days, and that’s when he reiterated the economy still needs a record-low level of fed funds. That comment reversed a market retreat that had followed the release of new homes sales for January, which we’ll get to below.

Nine of the 10 major industry groups gained ground on the session, led by financial, consumer discretionary and technology shares -- the sole loser on the session being basic material shares.

Basic materials have been down for three sessions now, and the fact that they lost ground again on Wednesday when the overall market was up shows that the mid-session rebound in stocks was all due to the easy-monetary policy trade rather than upbeat sentiment on the potential for economic growth.

Normally, when the Fed reiterates they’ll keep rates at record lows for an extended period commodity-related material stocks are among the leading performers. But people are losing faith in a durable expansion (whether we’re talking global or domestic) and that’s invoking some profit taking within this sector, which has pretty much been in play since mid-January.

I’m not even sure traders want to be buying stocks at this level, but they feel this is the only place to deploy money because of the Fed-induced puny yields within the low-risk sphere – which is precisely a major part of the Fed’s agenda.
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Brent Vondera, Senior Analyst

Daily Insight

2010-02-24T07:42:00.001-06:00

U.S. stocks ran into some trouble yesterday following the latest consumer confidence report. The market started the session off about flat but once that confidence reading came out and spurred concerns that the global recovery will be lackluster things kind of fell apart.

Market sentiment appears to be increasingly mercurial. We have these weeks in which the market believes the recovery is going to be normal, both in terms of degree and duration, followed by stints of concern.

The former mentality, in my view, is one that’s distorted by ultra-easy monetary policy and unprecedented levels of global government stimuli. A recent viewing of the 1980s classic (ok, maybe not a classic) “Back to School” reminded me of a Dylan Thomas poem, and indeed the equity market doesn’t want to go gently into that good night, but rages against the dying of the light...I paraphrase. Yet we must acknowledge that debt-driven recessions don’t simply fizzle out as the aftermath drags on – its takes time for the de-leveraging process to play out.

Further, the severity of these types of contractions occurs so quickly that the government response is over-bearing and carries with it additional problems, particularly by delaying the inevitable and the misallocation of resources that result – adverse implications follow and they show up in a lack of business confidence and employment.

These are the realities with which the market is currently entangled, mistakenly euphoric by the distortive actions of government only to be occasional reminded by realities on the ground. We need end consumer demand to take over from the inventory cycle and government stimulus, yet this confidence reading was a stark reminder that we’re really nowhere near this scenario.

Troubles in Europe isn’t helping matters as those economies appear to be losing steam. The German economy unexpectedly stalled in the previous quarter and that is weighing on the entire euro-zone, not to mention their sovereign debt issues.

All 10 major industry groups declined on the session, led by financials (yesterday’s best performer), basic material and energy shares.
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Brent Vondera, Senior Analyst

Currency Swaps

2010-02-23T15:45:00.000-06:00

Currency swaps have been getting some attention recently in relation to Greece entering such agreements to conceal the extent of its budget deficit.

In its simplest form, a currency swap is an over-the-counter derivative in which two parties agree to exchange streams of interest payments in different currencies. A country or corporation typically enters into a currency swap when they borrow money in foreign currency and are concerned about foreign exchange fluctuations.

For example, if a country like Greece borrows dollars in the U.S., then they have to repay that debt in dollars. If the dollar strengthens against the euro, then Greece’s debt burden would increase. As a result, Greece might prefer to repay the debt in Euros, and currency swaps are an easy way to do that.

In a plain vanilla swap, two parties exchange principal amounts at the beginning of the swap – the principal amounts are set so as to be approximately equal to one another given the exchange rate at the time the swap is initiated. Then, at intervals specified in the swap agreement, the parties will exchange interest payments on their respective principal amounts. At the end of the swap agreement, the parties re-exchange the original principal amounts – the principal payments are unaffected by exchange rates.

Greece’s swaps were not the plain vanilla kind that are designed to help manage debt, but instead were customized swaps designed to generate cash. In this instance, one party agrees to exchange money up front in return for higher payouts in the future. This sounds an awful lot like a loan, right? Yet these currency swaps are not accounted for as loans on the books of the national government.

It’s pretty easy to understand investors’ fears considering Greece has been hiding huge long-term liabilities from creditors. It’s even scarier to think about all the other countries that may have potentially entered into similar contracts.

Peter J. Lazaroff, Investment Analyst

Daily Insight

2010-02-23T07:14:00.001-06:00

U.S. stocks bounced between gain and loss on several occasions Monday, failing to ultimately hold onto an afternoon session rally as energy and basic materials shares sent the broad market lower in the final hour.

Dovish comments from the ultimate monetary dove Janet Yellen – President of the San Francisco Fed Bank – helped bank stocks as she stated the Fed will need to keep rates very low as the economy will operate below potential for the next two years. Yellen is not a current member of the rate-setting FOMC.

Financial and industrial shares were the only gainers among the 10 major sectors. As mentioned above, energy and basic material shares led the decline, along with utilities.

Oil prices advanced past the $80/barrel handle again, just two weeks back it looked as though crude was going below $70. The index that tracks energy stocks didn’t follow this move in crude though as shares of Schlumberger (which makes up roughly 6% of the index) weighed on the measure. The oil-services giant announced it would purchase Smith International in an all stock deal. Schlumberger shareholders didn’t like the premium the company decided to pay for Smith, so sent the stock lower as a result.

Volume was lackluster yet again as just 905 million shares traded on the NYSE Composite. That’s 21% below even the weak average volume of the past six months and 35% below what was considered the norm a couple of years back.
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Brent Vondera, Senior Analyst

Daily Insight

2010-02-22T07:49:00.001-06:00

U.S. stocks shook off pre-market jitters and an early-session decline to extend the latest winning streak to four days. The latest report on mortgage delinquencies and a better-than-expected CPI reading provided the impetus to push stock prices higher.

The headline delinquency figures for the fourth quarter looked good, in a relative sense. The report showed mortgages that are at least 30 days late improved on a quarter-over-quarter basis, although mortgages that are 90-days late deteriorated, more on that below.

The CPI data helped to ease concerns that the Fed will earnestly begin the Great Unwind sooner than was previously expected. Pre-market trading showed a significant degree of unease following the Fed’s surprise discount rate hike after the bell on Thursday (at least in terms of timing, Bernanke has telegraphed this was coming). The tamer-than-expected CPI print, namely the negative reading on core CPI (a worthless indicator right now in my view but the Fed continues to give core inflation readings -- which exclude food and energy prices -- the most merit), offered support the fed funds rate won’t be hiked anytime too soon.

It was a good week for stocks. The market was open just four days due to Presidents Day and the broad market was up in all four, ending the week higher by 3.13% and erased most of the late-January/early-February losses. As we open this morning, the S&P 500 is just 3.56% below the 15-month high hit on January 19.

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Brent Vondera, Senior Analyst

Weekly Roundup: LLL, WLP, CERN, WMT, WAG

2010-02-19T15:44:00.001-06:00

L-3 Communications Holdings Inc. (LLL) +3.33%
LLL agreed to buy Insight Technology Inc. to add night-vision goggles and thermal-imaging systems to its already diverse defense portfolio. The acquisition will be completed in the second quarter and will immediately add to operating results. Insight, which also makes laser aiming devices and laser rangefinders, is expected to have about $290 million in sales in 2010.

Just last week, LLL’s CEO Michael Strianese said the company had “plenty of dry powder” for acquisitions with about $1 billion in cash as well as access to credit. The purchase will be an all cash transaction, but the terms are yet to be disclosed.

LLL has a strong history of acquiring cutting-edge technology and his built a stable position in the defense industry thanks to its diversified product portfolio – LLL has about 2,000 contracts with no single contract accounting for more than 3% of total revenue.

The Pentagon’s budget is slated to increase by 3.4%, not including money for the wars in Iraq and Afghanistan. In particular, the Pentagon’s procurement budget is set for a 7.6% increase with command, control, and communications systems expected to see a boost. This will directly benefit firms like LLL and Harris Corporation (HRS).

WellPoint Inc. (WLP) -0.86%
WLP shares fell this week amid the company’s Congressional testimony over proposed premium increases in California. WLP said in a statement the pervious earnings forecast for 2010 is now subject to the “ability to secure and maintain sufficient premium rates.”

The health insurer has postponed premium increases of as much as 39% for two months so that California’s insurance commissioner could review the plan after it was heavily criticized by state officials and the Obama administration.

The recession and difficult labor market is leading younger, healthier individuals to forgo insurance, skewing the mix of policy holders toward the elderly. This dynamic and rising medical costs are the basis for WLP’s premium increases. Insurers were banking on federal legislation to help contain rising healthcare costs, but there is little choice but to raise rates since the healthcare bill has stalled.

Cerner (CERN) +3.00%
After a rough start to 2010, CERN has rebounded a bit in the past few weeks. Some of the bounce may be attributable to investors taking positions after the sell-off in January – the stock fell 8.22% for the month. CERN also reported earnings late last week that should a strong rebound in systems sales during the fourth quarter, which suggest the healthcare IT environment is improving.

Also lifting sentiment was various analyst upgrades for both CERN and fellow healthcare IT firm Quality Systems Inc. (QSII).

Additional content from this week:

Peter J. Lazaroff, Investment Analyst

Fixed Income Weekly

2010-02-19T15:26:00.001-06:00

The Fed took the market by a bit of a surprise after Thursday’s close when they moved the discount rate higher by 25 basis points to .75%, in addition to lowering the maximum term from 28 days to overnight. Before the crisis the spread between fed-funds and the discount rate stood at 1%, Thursday’s move brings the spread to about .65% if you use the current market fed-funds rate of 14 basis points. The reason for the 100 basis point spread during normal times is to penalize banks for going to the Federal Reserve for funding and encourage banks to get funding from other institutions through the fed-funds market. The spread was lowered in March of 2008 to lessen the strain on banks and provide a cheap source of liquidity for banks unable to obtain funding through fed-funds.

The short end sold off hard immediately after the release, gaining about 10 basis points in yield in the few hours following the announcement, but eased off the lows a bit in Friday’s trading. I don’t think that this move was meaningless, but it’s pretty close. The jump in rates was from the low end of the .8% to 1.1% range on the 2-year that we’ve been in for a while, and should expect to be in for at least the first half of 2010. As far as this move telegraphing an adjustment to the fed-funds rate goes, we still haven’t seen anything substantial from the Fed. Sure, Thomas Hoenig became the first dissenting vote last meeting when he urged to committee to remove the “extended period” language from the statement, but Thursday’s test will be followed by many more before a real move is made.

Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

2010-02-19T07:40:00.005-06:00

U.S. stocks rose on Thursday, staging another nice session and bringing the winning streak to three. A nice headline Philly Fed reading outweighed much worse-than-expected jobless claims data.

A strong earnings report from Hewlett-Packard also helped to boost the market. The largest personal computer maker beat profit and sales estimates during the fourth quarter – although operating earnings (which removes one-time items that either boost or depress profits) did miss estimates by 4.4%; this is the number we watch. Total sales rose 8% thanks to a 41% jump in sales to the BRICs (Brazil, Russia, India and China) – undoubtedly fueled by China and their massive stimulus program.

Hewlett enjoyed increased market share, holiday spending and business outlays as firms had unspent equipment budgets at the end of 2009. This is something we talked about last week, I think it was; firms were unwilling to spend during most of 2009 and as November and December arrived they uses those funds to replace aging equipment. We’ll need to see a comparable follow through in the first quarter to confirm that something exciting is occurring on the business spending front.

Earnings results from Wal-Mart that missed its projection partially offset the good report from Hewlett. Wal-Mart reported that sales for stores open at least a year fell 1.6% in the three months ended January 31. CEO Mike Duke warned that sales will be “more challenging” in the current quarter and. Some people saw the WMT news as a sign consumers are trading up to a higher price point. I’m not sure about that one with 9.8% unemployment and 17% under-employment, but we’ll see.

Basic material shares led the broad market higher, followed by industrials. Nine of the 10 major industry groups closed higher, telecoms being the only loser.

Market Activity for February 18, 2010
Greenback

The U.S. dollar rallied on concerns out of the EU (those sovereign debt issues) and the continued flee from the euro. The situation remains such that the dollar only catches a bid on bad news and investors are certainly fleeing the EU currency, which has gotten smacked by 10% since December. But later in the session the greenback gave up those gains as the euro caught a bit of a bid – speculation that the Swiss engaged in some currency intervention, selling their franc to halt its gains and this meant buying some euros.

While the dollar erased early-session gains it remained above the 80 handle on the Dollar Index (DXY). If it holds here it will help to contain the inflation readings over the subsequent months, particularly with regard to import price inflation that has become a bit frothy of late. After the bell the dollar rallied hard on news the Fed raised the discounts rate, more on this below.

This dollar boost also has ramifications for multi-nationals. Global growth is still not strong enough to boost multi-national company sales without help from a lower currency value – a lower dollar value makes our goods cheaper to overseas buyers. (I am in no way advocating that policy makers move to put pressure on the dollar, they’ve done enough harm to the greenback with an insane level of government spending and the Fed’s ZIRP. You can’t create a prosperous environment by kicking your currency into the dirt, even if it does help in the short term.)

If the U.S. dollar continues to rally on euro woes, and the current belief that Fed tightening is on the way, then this is going to do some damage to profit expectations a couple of quarters out.

Jobless Claims

Well, so much for that decline in claims last week. The Labor Department reported that initial jobless claims rose 31,000 to 473,000 in the week ended February 13 after falling 41,000 to 442,000 in the previous week. Economists had expected claims to fall to 438K.

So you look at the past two weeks and initial claims are down 10,000 but the level remains well above 450K. The previous week’s decline brought excitement that initial claims would crash below the 400K level but that seems a bit premature now. (The 400K level is important because it always signals at least mild monthly job growth.)

The four-week average on initial claims fell 1,500 to 467,500.

Overall continuing claims resumed their move higher too. Standard claims, those that last the traditional 26 weeks, came in unchanged from the week prior.

However, Emergency Unemployment Compensation (EUC) rose 274,000. Over the past six weeks EUC claims have jumped 707,000.

Neither the initial nor the continuing claims data suggest the labor market in improving to a point in which we’ll see job growth, much less statistically significant job growth. I’ve been expecting to see mild job growth beginning in February or March (meaning monthly growth of at least 50K). These numbers aren’t offering much confidence in this call.

We need job growth to keep things going, to get final consumer demand trending higher. Without it, the inventory-led GDP boost we’ve seen is going to fizzle out in short order.

Producer Price Index (PPI)

Producer prices rose 1.4% in January according to the Labor Department, which outpaced the 1.0% rise that was expected. The increase was mostly due to the fuel components as the ex-energy reading rose just 0.3%. But energy sort of matters as it makes up between 8-12% of disposable income for most households. It’s ridiculous for the Fed to use an inflation gauge that excludes food and energy as their desired tool for tracking price activity.

The overall energy component rose 5.1% for the month, boosted by an 11.5% jump in gasoline. Overall consumer goods rose 1.8% in January and are up 18.4% at an annual rate over the past three months. Gasoline and residential electricity are two components within the consumer goods segment.

Over the past 12 months the PPI is up 4.6%, quite a turnaround just three months removed from an 11-month streak of PPI decline.
Philly Fed

The Philadelphia Federal Reserve Bank’s gauge of factory activity within their district rose to 17.6 in February (in line with expectations) from January’s 15.2. This follows a good headline figure from the Empire index (New York-area manufacturing) so the month is off to a good start. Like Empire though, some of the sub-indices suggest factories aren’t going to be quick to hire workers.

The new orders index jumped to 22.7 from 3.2 in January – this is the highest reading since April 2006. Inventories rose to 3.2 from -1.6 -- a similar level of improvement showed up in Empire. The employment data was mixed as the number of employees gauge rose to 7.4 from 6.1, yet the average workweek index fell to 1.6 from 4.2 – that divergence doesn’t make sense and one questions which reading is providing the right picture.

Among the components we’re watching most closely for clues of future hiring, the readings weren’t quite as good. The unfilled orders index fell big time, dropping to -7.5 from 3.6; the delivery times index declined to -2.1 from 6.6. We need these reading to trend in positive territory for several months as it would show that factories are having difficulty keeping up with orders. So long as they are not, which is what negative readings suggest, manufacturing employment is unlikely to move higher.

Maybe the big new orders reading will provide the work needed to stretch current workers and send the unfilled orders and delivery times gauges higher over the next couple of months. Households are saddled with high debt levels and those liabilities have to be paid down to some extent before this economy can return to normal – to state the obvious, that takes employment growth.

For now manufacturing activity is looking good, a rebound that began 5-6 months back, as inventories had been slashed at record levels and firms are rebuilding those stockpiles a bit.

Fed Timing Surprises the Market

The Fed chose to raise the discount rate by 25 basis points to 0.75% last night after the market closed. (This is the rate banks are charged to borrow directly from the Fed.) They also returned the term of these loans to overnight from 28 days. This move gets the discount rate closer to its normal 100 basis point spread over fed funds

This move by Bernanke is not a surprise as there has been talk of such action for a couple of months and they laid this out in their minute release on Wednesday. The timing is a bit interesting though. This change is intended to encourage financial institutions to rely more on money markets rather than the central bank for short-term liquidity needs.

It will be interesting to watch how the market perceives this move, possibly expecting the total exit strategy to occur sooner than formerly expected. This is a test by the Fed, testing to see how the market reacts; I still think they’ll be slow to move with regard to actual tightening – raising the fed funds rate. Former Fed Governor Laurence Meyer is predicting fed funds won’t rise for the first time until mid-2011.

For past issues of Daily Insights and other daily publications please visit: www.acrinv.com/blog

Have a great weekend!

Brent Vondera, Senior Analyst

Wal-Mart Stores (WMT) hurt by deflation and lower traffic

2010-02-18T16:13:00.000-06:00

Wal-Mart Stores (WMT) dropped 1.09% today as fourth-quarter revenues missed expectations and soft guidance left investors unenthused.

The impact of deflation on operations is becoming increasingly obvious for a company that has traditionally been a back-door dollar play – WMT buys goods from foreign countries where the dollar is strong and sells them in the U.S. The company spent a good part of last year downplaying the impact of deflation in food and in other areas such as consumer electronics, but deflation cannot be ignored. Still, WMT has not publicly addressed with how it is dealing with this issue.

A decrease in traffic during the quarter was also responsible for disappointing results. I can’t help but assume some of the traffic decline is due to consumers trading. WMT’s low price advantage has been crucial in attracting recession-stricken consumers, but increasing signs of stabilization threaten to reverse this trend. Comparing WMT’s results to those from high-end grocer Whole Foods (WFMI) earlier this week makes the trade-up case even more compelling. WFMI raised its full-year forecast amid more store traffic and increased number of items per sales ticket.

Consumer sentiment won’t be going gangbusters until the unemployment rate moves significantly lower, but still investors should be less focused on WMT’s low-cost position and pay more attention to the company’s international sales.

Much of the company’s future leans on their international success. International operations have grown to roughly $100 billion in annual sales from nothing 20 years ago, but much of that growth came from directly acquisitions. And while international sales are growing faster than those in the U.S., profitability is lower – international operating margins are 5% and 7% in the U.S. An even bigger concern is that WMT has not been able to show the economies of scale or explicit synergies that were always the rationale for such expansion.

--

Peter J. Lazaroff, Investment Analyst

Daily Insight

2010-02-18T07:36:00.003-06:00

U.S. stocks closed higher on Wednesday after a better-than-expected industrial production reading offered evidence that the global recovery in gaining momentum.

Earnings results from Deere & Company whipped very weak estimates and this was also portrayed as having a positive effect on the market. Deere’s revenues did fall 6% for the quarter but the company also upped its revenue forecast for all of 2010. Still, overall S&P 500 fourth-quarter profit growth actually dipped a bit to 12.4% from 12.6% as of Tuesday so I’m not sure that one company truly had much impact on the market.

The broad market fluctuated during the 30 minutes that followed the release of the FOMC minutes from their January 26-27 meeting, but returned to the pre-release level an hour later – so those comments had zero effect. The same can’t be true for the bond market, which sold off – the yield on the 10-year Treasury rose 7.75 basis points.

The industrial production number surely was the primary driver. Certainly, the mortgage applications and import price data didn’t help and I really doubt housing starts, which remain floored, offered much impetus either.

Even if housing starts were flying high, I don’t see how it excites investors as housing market demand/supply is far from equilibrium. While higher home building would boost GDP in the current quarter, it would only subtract from growth in subsequent periods as the coming shadow supply (seriously delinquent loans that are being held from the foreclosure process) will eventually hit the market and drive construction down again…unless the government just buys these mortgages and allows the delinquent borrowers to remain in the home, which I lament isn’t such an outrageous statement these days.

Market Activity for February 17, 2010
Mortgage Applications

The Mortgage Bankers Association reported their applications index fell 2.1% for the week ended February 12 after the 1.2% decline in the week prior. Both purchases and refinancing activity dragged the index lower.

Purchases fell 4.0% after dropping 7.0% in the week prior. Refinancing activity slipped 1.2% following a 1.4% pick up in the prior week. The rate on the 30-year mortgage remained unchanged, averaging 4.94% for the week.

Import Prices

The Labor Department reported that import prices jumped 1.4% in January (and increase of 1.0% was expected) largely due to energy prices, but ex-petro import prices rose 0.6% for the month so it was more than just fuels driving the reading higher.

The petroleum segment jumped 4.8% in January and has nearly doubled over the past year, up 95.5%. Food and beverage was up 1.3% and these import prices have begun to get juicing over the past three months, up 11.3% at an annual rate. Industrial supply prices jumped 3.8% in January and have rocketed 31% past three months at an annual rate.

For import prices overall, the index is up 11.5% from depressed levels of a year ago. The index is still down 15% from the peak hit in July 2008 (driven by that summer’s commodity price spike -- oil at $145/barrel) and is back to levels just before that period.

Housing Starts

Builders broke ground on 591,000 units at a seasonally-adjusted annual rate in January following an upwardly revised 575,000 in December. The January results were pretty much in line with expectations.

We don’t exactly need more housing units coming onto the market; it would be nice to see job growth come back, debt levels paid down and income growth take place first. This would set up for better conditions within the housing market. That said, roughly 600K units at an annual rate is close to zero in relative terms as the readings remain near record lows – the data goes back to 1959.

Recall the foreclosure figures we touched on again yesterday – 300K foreclosure filings a month, 2.8 million in 2009, another 3 million in 2010, a current distressed loan balance of $450 billion. We’re talking about three years before this inventory (both actual and shadow) clears, according to S&P. So any home building only extends the time to which the housing market can normalize.

Building permits, a gauge of construction over the next few months, fell 4.9% in January after a 10.9% jump in December.

Industrial Production

The Federal Reserve reported that industrial production (IP) rose 0.9% in January (an increase of 0.7% was expected), marking the seventh month of increase. The manufacturing segment, which accounts for 80% of the IP index, drove the figure this time – last month IP only rose thanks to a historically outsized 6.3% jump from the utility segment, a function of colder-than-normal weather.

The manufacturing segment looked strong in January as production rose 1.0% after a -0.1% slip in December. Motor vehicle and electronics production drove the segment.

Utility production rose 0.7% last month. The mining component rose 0.7% after a 0.2% production decline in December.

Industrial production is up 0.9% over the past year thanks to this seven-month streak. Prior to this rebound, IP fell in 17 out of 18 months.

Capacity utilization rose to 72.6% from 71.9% in December, marking the seventh month of improvement off of the record low of 68.3% in June -- the 40-year average is 81%. We’ll watch for the reading to hit 78%, which has taken between 12-24 months to rebound to depending on the recession -- this is the level that accompanies significant job growth. It took capacity utilization 12 months to hit 78% from the cycle low of 70% following the 1982 recession; it never dipped below 78% during the 1991 recession; and took nearly 24 months to accomplish from the cycle low of 73.5% following the 2001 downturn.

FOMC Minutes

The minutes from the January 26-27 FOMC meeting revealed that policy makers debated how and when to shrink the central bank’s $2.26 trillion balance sheet , with some pushing to start selling assets in the “near future.” (Just for clarity, when we talk about the Fed’s balance sheet it refers to the securities they hold as they purchased various assets in order to pump money into the system and create a lower interest-rate environment.)

I’ll believe that they’ll sell assets, like longer-dated Treasury bonds and mortgage-backed securities (MBS) when I see it – the discussion probably took place as lip service to the market as an attempt to keep inflation expectations moored. They can’t even find the muster to raise the fed funds rate to 0.75%-1.00% and we’re supposed to believe a debate took place on asset sales, please. Gradual asset sales would risk a significant jump in mortgage rates and crush the housing market. (These comments, even if actual asset sales are unlikely anytime soon, will likely push forward the markets tightening expectations, as evidenced by the pop in Treasury yields after the minutes were released.)

The FOMC declared the economy was in “recovery” for the first time and affirmed it would end liquidity backstops and MBS purchases.

On the FOMC’s signal as to how long the fed funds rate would remain floored, we knew there was a lone dissenter via the statement following the conclusion of the late January meeting, but the minutes repeated that KC Fed Bank President Hoenig opposed keeping the phrase “an exceptionally low level of federal funds…for an extended period” for something that suggests they may raise rates soon. The market believes that the fed funds target will not rise a smidge for another six months so long as they keep this phrase intact. Hoenig wanted the Fed to be more flexible, give themselves a little more leeway with adjusting the rate gently higher.

On their forecasts, policy makers also raised the low end of their 2010 economic growth range to 2.8%-3.5% from 2.5%-3.5%, but raised the low-end of their unemployment range to 9.5%-9.7% from 9.3%-9.7%. They believe that core inflation (which excludes food and energy prices) will range 1.1%-1.7%.

For past issues of Daily Insights and other daily publications please visit: www.acrinv.com/blog

Have a great day!

Brent Vondera, Senior Analyst

Walgreen Co. (WAG) Buys New York Drugstore Chain

2010-02-17T15:21:00.000-06:00

Walgreen Company (WAG) announced that it will acquire New York-based Duane Reade, giving WAG a leading position in the nation’s biggest pharmacy market. At a price of $1.075 billion, including the assumption of Duane Reade’s debt, WAG will acquire Duane Reade’s 257 stores, which generate the highest sales per square foot in the retail drugstore industry nationwide.

WAG expects the transaction to be dilutive to earnings in the first 12 months after closing before becoming accretive going forward. WAG anticipates meaningful distribution and purchasing efficiencies as well as back-office synergies that could amount to $120 million and $130 million in the third year after closing.

The true value of Duane Reade is their presence around the lucrative New York City market – no doubt about it. From what I have read, everyone seems to hate Duane Reade’s staff and customer experience, but the chain also seems to carry to unambiguous title of most convenient drug store in the market place. This makes the company a perfect fit for WAG’s strategy.

WAG has used its free-standing stores in prime locations as the backbone of their growth strategy for over the past decade – WAG has a store within five miles of 70% of U.S. households – benefiting from the fact that people fill their prescriptions where it is most convenient. Because New York real estate is difficult (expensive) to obtain, an acquisition like this is the only way to build a powerful position in New York.

It’s also worth noting that the acquisition represents another step away from its historical focus on organic growth. After years of rapid expansion, WAG has significantly slowed new store openings to focus on remodeling and scrutinizing its merchandise to enhance consumer experience and convenience. Management’s goal is to increase their customers’ average basket size by one item.

I think this is a nice move by WAG, but it doesn’t dramatically change my opinion of the company. If they ever consider purchasing or signing a long-term deal with a pharmacy benefit manager (PBM), then that would be a different story.

Peter J. Lazaroff, Investment Analyst

Daily Insight

2010-02-17T07:18:00.006-06:00

U.S. stocks gained good ground, although the market remains stuck below the midpoint of the latest range, after the NY Fed Bank reported faster-than-expected factory activity in February. Commodities rallied, with oil jumping the most in four months; the dollar declined.

I came in yesterday morning thinking dollar strength (on euro concerns) would cause pre-market enthusiasm to evaporate as the day wore on. But the opposite occurred, as the dollar weakened and stocks gained momentum as the day progressed.

Energy, basic material and financials shares led the advance. All 10 sectors were up on the session, even the worst-performer – health care – gained nearly 1%.

With roughly 80% of S&P 500 members reporting fourth-quarter profit results to this point, ex-financial operating earnings are up 12.3%. Top line growth, revenues, were up 3.8% for the quarter.

We’ll need to see 5-7% revenue growth for an extended period if we’re going to get both job and profit growth; if firms don’t see top line improvement they won’t hire. Remember the only reason profits are up is because of the slashing of costs via massive payroll cuts. We’ll need big monthly job growth to get this unemployment rate down to even the heightened level of 8% over the next 15-18 months.

Market Activity for February 16, 2010

Empire Manufacturing

The New York Federal Reserve Bank’s factory activity gauge posted the highest reading since October (and the best print since October 2007 outside of that more recent high).

The Empire Manufacturing index accelerated in February, posting a reading of 24.91 (a reading of 18 was expected) after January’s 15.92. The sub-indices of the report were mixed.

This was a strange report. The big increase on the headline reading and you’d expect to see all of the sub-indices posting significant acceleration, but it wasn’t the case.
It was almost completely boosted by the inventory gauge. While this is good, as we’ve been worried that business caution will keep firms from rebuilding stockpiles and therefore hold economic growth from a level that gets some job creation going, it is also important to see the other components follow suit.

That inventory gauge rallied big time, posting a reading of 0.00 for February after -17.33 in January – this ends 17-straight months of negative readings.

The average workweek also posted a nice gain, accelerating to 8.33 from 5.33 in January. Again, this is good news. While it will take larger average workweek readings to get job growth going, the trajectory is helpful. The number of employees rose to 5.56 from 4.00, so a little help there.

Unfortunately, the new orders index (indicator of future factory activity) decelerated to 8.78 from 20.48.

Further, the unfilled orders gauge rose only slightly to 2.78 from 2.67 and the delivery times gauge fell to -6.94 from 6.67; the former remains stuck in lackluster territory and the latter is not even close to where we need it to be. These are very important gauges, as we’ve been talking about for some time, as it shows that factories are still not having trouble meeting orders. It is essential for orders to overwhelm the much lower level of labor resources due to the slashing of payrolls, until it does you can forget about a meaningful increase in employment.

So, the headline reading is very good, but all due to the inventory gauge. While we need inventory rebuilding to catalyze growth, we also need job growth in order for final demand to take hold. Without final consumer demand the economic boost from the inventory dynamic fizzles out two-three quarters down the road and that means economic growth does too.

Treasury International Capital, or TIC, Report

The Treasury Department reported that foreign purchases of U.S. securities during December came in at half the level of the previous month, but that previous reading was one of the largest ever.

Net foreign security purchases rose $63.3 billion in December after November’s $126.4 billion increase. Net purchases of Treasury securities rose $70 billion, following November’s $118.3 billion increase; net buying of agency paper came in flat, no change, after a $5.6 billion increase in the previous month; net buying of corporate bonds fell for a fifth-straight month, down $7.9 billion after -$4.6 billion in November; buying of U.S. equities rose $20.1 billion after a $9.7 billion increase in the month prior.

These numbers are outdated, as it takes time to compile the data. Still, it is important to watch the trend – particularly these days as we’ll need big foreign demand for Treasury securities as we’re issuing record levels of debt -- $2.4 trillion in debt issuance this year alone, yow!.

The December data showed that China was usurped as the largest foreign holder of Treasury securities, Japan has returned to being the largest holder. China reduced their Treasury holdings by $34 billion, while Japan picked up an additional $11.5 billion. In the months ahead, we’ll see if China picked up more Treasuries in January and February due to the European debt and currency markets getting hit.

NAHB Housing Market Index

The National Association of Home Builders gauge of builder sentiment rose to 17 in February from 15 in the previous month. Readings below 50 means most respondents consider conditions as poor.

Rising foreclosures are adding to inventory and are do so in an aggressive manner at some point in the not-too-distant future. The government is offering lenders cash incentives to modify loans, but this is only delaying the inevitable – as we’ve talked about for several months now – as a very high percentage of those modified mortgages are back in default 2-3 months later, as you can see via the “recidivism” chart below. (S&P calls modified loans “cured” loans)

A record 3 million homes will be repossessed this year, according to RealtyTrac, up from 2.82 million in 2009 . Foreclosure filings rose 15% in January and have exceeded 300,000 per month for 11-straight months.

The NAHB’s gauge of prospective buyers held at a reading of 12 last month. Continued low interest rates, meaningfully lower home prices, and the home buyers’ tax credit are not enough to get things moving for the market. It will ultimately take significant job growth to propel the housing market into a durable rebound, and even then it will still have to contend with coming supply from all of these foreclosures.

Have a great day!

Brent Vondera, Senior Analyst

Daily Insight

2010-02-16T07:16:00.000-06:00

I wasn’t in on Friday so I don’t know what drove the market throughout the session. What did occur is the broad market closed the session lower, but just mildly as the S&P 500 recouped nearly all of its early-session losses. The NASDAQ Composite along with mid and small cap indices closed higher.

The day’s economic releases probably has a net positive effect on investors after the early losses, the session’s low point was put in just an hour into trading. Things began to improve by late-morning and more or less held that mid-day momentum.

Information technology was the only sector of the 10 majors to close higher on the day. Industrials and utility shares led the market lower as they were the worst performing sectors.

The un-Summit

I think the market was expecting the typical conclusion following the EU’s summit – discussions on how to provide aid to Greek’s budget problems. But that’s not what they got as the Euro-zone’s finance ministers stated there wouldn’t be an announcement of a detailed bailout. The market could begin to question the EU commitment over the next couple of weeks.

We’ll watch as this plays out. Frankly I like that the EU is holding Greece accountable for its reckless budget decisions – they have to do the heavy lifting here. But the Greeks, specifically the public unions, are not going to take this lying down, they’ve become too accustomed to government largess, handouts and public-sector wage growth that is likely significantly disconnected from market realities.

I really hope the EU isn’t attempting to play a game of chicken with the markets, thinking that just because they are talking about the subject public sector funding problems won’t arise; they’ll end up losing if they do. And this is about much more than just Greece as the political response to the very tough 2008-09 recession has heavily strained budgets for most Western countries. This is a bailout crazed environment, traders want to see anything that extends the rally in the short term; if they don’t get it, things may get ugly.

However, if they are serious about playing hard ball with Greece, the EU finance ministers that is, things may still get sketchy in the short term, but at least it should set up for government budget improvements that make a heck of a lot more sense for long-term economic growth potential. One thing that is for sure is the issue isn’t going away.

Retail Sales

On Friday, the Commerce Department reported that retail sales rose 0.5% (+0.3% was expected) in January. Ex-gasoline was up the same and core sales (ex gas, autos and building materials) came in at a hot 0.8% - this even as building materials got hammered, down 1.2% for the month; the figure is off by 9.9% over the past 12 months.

The furniture and aforementioned building materials segments were the only components of the report to post declines in January. Food & beverage was up 0.8%; gasoline stations up 0.4% (probably all price driven though); sporting goods sales advanced 1.0%; general merchandise was up 1.5% (after getting hit by 1.1% in December due to weather); non-store retailing jumped 1.6% after high-powered advances in December and November of 2.2% an 2.5%, respectively.

The non-store retailing results do make it difficult for one to argue that the December decline in overall retail sales was due to winter weather. The strong results show that online purchases picked up a lot of the slack. BTW, I forgot to mention above that the December decline was upwardly revised to show sales slipped 0.1%, not the 0.3% initially estimated. Notwithstanding that upward revision for December, the December-January combination is still weak from the perspective of the past several years.

This is a good report considering income growth has been flat-to-weak as the jobless rate sits at 9.8%. I do caution though that pretty decent spending over the past several months, really going back to May with a couple of weak numbers thrown in, has gotten ahead of household cashflows. The growth in government transfer payments, still hovering at the record percentage of total personal income, cannot continue. These payments are helping to drive consumer spending, but also driving deeper federal budget deficits.

We’ll see the savings rate dip in January from December’s 4.8% as result of this retail spending. Since this figure has to get to the long-term average of roughly 6.5% (this is a reality due to high joblessness and the evaporation of $12 trillion from household net worth) we’ll see weak personal consumption trends over the next year at least – but not without a big quarter here and there, remember those homebuyers tax credits will be going out over the next few months.

Consumer Confidence

The latest confidence reading came from the University of Michigan’s poll on the subject. The headline reading dipped to 73.7 from 74.4 in January – the long-term average is 88.0.
Consumers’ view of the current economic situation improved to 84.1 from 81.1, this is the highest reading since March 2008. However, the expectations reading (consumers’ take on things over the next six months) got crushed, falling to 66.9 from 70.1 – a reading of 66.9 is about the average of the past two recessions. (I’m talking about 1982 and 1991, the 2001 downturn was just that, it was not a technical recession in my view.)

The improvement in the current situation figure is probably due to the decline in the jobless rate last month. Consumers see this and believe the jobless rate will continue to decline, but it doesn’t exactly work this way, as we’ll see in the coming months.

Business Inventories

The Commerce Department reported that business stockpiles fell in December after the first back-to-back gains since July-August 2008. In fact, those increases in the previous two reporting months were the first positive readings at all since August 2008.

Business inventories fell 0.2% in December, but it did result from higher sales as they advanced a very nice 0.9%. One would like to see a little more confidence among business managers (but who can blame them) but this is better than inventories falling even as sales collapse, which is what occurred in the 10 months that ran November 2008-August 2009.

The inventories-to-sales ratio has nearly returned to the all-time low of 1.24 touched in January 2006, coming in at 1.26 months’ worth in December.

One can take both good and bad messages from this report.

The good is that the inventory-to-sales ratio is rock bottom. Firms have slashed stockpiles like never before, at least in the postwar era, and sales have begun to bounce. We’ll watch to see if this sales trend has the juice to keep going, but the combination of super-low stockpiles and increasing sales suggests the next two GDP quarters will be good, catalyzed by the inventory dynamic we been talking about for a long time now. (First-quarter GDP is shaping up to post another reading in the 5% handle.)

The bad is that even though inventories are near record lows it has not yet compelled firms to aggressively rebuild stockpiles; this is a result of high levels of uncertainty – doubts that consumer spending will continue to trend higher and worries of higher tax rates and an increased regulatory environment. If sales keep improving, then firms will be forced to rebuild inventories – that means more production. But if they don’t, then the catalyst the rebuilding process offers to economic growth will not fully take hold.

Have a great day!

Brent Vondera, Senior Analyst

Daily Insight

2010-02-12T07:45:00.001-06:00

Markets searched for direction in the early going, but stocks ultimately finished with solid gains.

A relatively pleasing weekly jobless claims report showed a larger-than-expected decline in initial jobless claims to 440,000 and a continuing claims tally of 4.54 million – a one-year low. Additionally, markets cheered consumer price data and a lending report out of China that lacked evidence of inflation, suggesting China can lay off tightening measures for the time being. (Of course, China raised the bank reserve requirement this morning in an attempt to slow credit expansion, so apparently yesterday’s excitement was unwarranted.)

Meanwhile, leaders from the European Union announced that financial assistance will be made available to Greece, but no specific details were provided. Markets continue to wonder how much money will be involved and whether aid will extend to other countries currently facing fiscal challenges. It does appear, however, that investors are growing more optimistic on the situation and are more confident that Greece’s credit crisis won’t have spillover effects in the U.S.

The materials sector and the energy sector led the way with gains of 1.58% and 1.57%, respectively. More impressive was that they outperformed the broader market for the entire session, even in the face of a firmer dollar during the early going. Financials lagged as a report from the Financial Times said leading economies are close to agreeing on a global bank tax.

Market Activity for February 11, 2010
Job picture improves slowly, but surely

Weekly initial jobless claims declined 43k to 440k, versus last week’s figure which was revised upward by 3k to 483k. The four-week moving average, which provides a smoother trend in claims, dipped by 1k to 468.5k, while continuing claims dropped to 79k to 4.54 million.

A Labor Department official said the results reflect the end of an “administrative backlog” that built up when state government offices were closed during the year-end holidays. Next week’s claims data will probably be affected this week by the snow storms on the east coast.

Today’s Wall Street Journal has a nice article today (Page A4) that examines a concern mentioned before in this letter, which is that many of the jobs eliminated by the recession are gone forever. Economic growth will eventually return as will job creation, but the types of work will be in different industries.

Using the example from the Wall Street Journal, an economy growing at 3% will add roughly 133k jobs a month. The problem is that about 100k jobs a month are needed just to soak up new entrants to the work force, which means the pace of job creation economists are anticipating will only slowly reduce the high unemployment rate.

On the bright side, we are seeing the classic cycle unfold where layoff announcements ease first, which is then followed by a surge in temporary hiring and eventually leads to more permanent hiring. It’s just that this time the era between job losses and meaningful job gains is likely to be longer than normal.

Coming out of past recessions, the expansion of debt-financed consumption on housing, autos, and other durables has been the strongest engine of job growth – clearly there are massive impediments to this scenario occurring this time around.

On tap today

Advanced retail sales were initially scheduled to be released yesterday, but were delayed until today due to the weather in Washington. We will see further evidence that consumer spending has returned, albeit at a much lower level than before the crisis as the focus remains on deleveraging.

Other releases today include the preliminary January reading of the University of Michigan Sentiment Index, expected to rise to 75.0 from 74.4, while business inventories are forecasted to rise 0.2% in December after posting a 0.4% increase in November.

Have a great weekend!

Peter Lazaroff, Investment Analyst

Daily Insight

2010-02-11T07:41:00.000-06:00

U.S. stocks closed lower on Wednesday after the latest mortgage applications report showed purchases fell 7% last week and a Bloomberg measure on global investor confidence pointed to a growing unease over government finances – nothing new there but it reinforced the concern.

Basic material, utility and energy shares led the broad market’s decline – so much for that commodity-related rally extending to a second session; I’m obviously referring to material and energy sectors, which led the market higher on Tuesday. Financials were the only of the 10 major sectors that closed higher for the day.

Volume remained weaker than weak with just 960 million shares traded on the NYSE Composite. Through hump day volume has averaged just 1.06 billion shares per day, 10% below even the low average of the past six months.

Market Activity for February 10, 2010
The Great Unwind; It’s Going to Be Slow and Extremely Telegraphed

Bernanke laid out the elements of his exit strategy in a text release yesterday and nothing was unexpected. They will continue to let some of the temporary lending programs expire -- the exit from these programs is substantially complete. They will also increase the discount rate, thus modestly widening the spread between the rate banks can borrow from the Fed (discount rate) and the rate banks borrow from one another overnight (fed funds). That spread was narrowed during the crisis.

The bond purchase program (quantitative easing) will end on March 31. Although, where the Fed leaves off Fannie and Freddie picks up as it has been reported the GSEs will increase purchases of delinquent loans beginning in March; expecting to purchase a significant portion of the seriously delinquent population within a few months, but I digress.

The Fed will also engage in reverse repos, which means they’ll sell Treasury and agency-debt securities to primary dealers thus taking money out of the system.

Bernanke & Co. will also engage in more unconventional measures, such as adjusting higher the interest paid to banks that keep excess reserves at the Fed and set up term deposits that hold these funds from the system for a specified period of time. This, they hope, will incentivize banks to keep more reserves in these accounts rather than lend them out – lending them out would expand the money multiplier thus boost inflationary ramifications. (This will be quite interesting to watch in the highly charged political environment. Politicians are trying to get banks to lend more and Congress will make it tough on Bernanke to engage in this policy, even if it is well in the future. The Fed is supposed to be independent of Congress, but we’ll see how that goes.

Since the Fed’s been at zero for so long it means a massive excess of reserves are in place (makes cash very easy to procure), swamping the demand for those reserves – basically, it makes it very tough to manage the fed funds rate and I think this is where the term deposit strategy comes in, it immobilizes this money.

They also stated, if necessary, they can begin selling their holdings of Treasury and mortgage-backed securities to truly reduce the Fed’s balance sheet. That would jolt interest rates higher and it’s highly highly unlikely that they would do so.

Bernanke made a point of explaining that none of the most effective paths to unwind policy (drain liquidity) will take place for some time. He emphasized this point by throwing in the “exceptionally low” and “extended period” phrases with regard to fed funds.

Mortgage Applications

The Mortgage Bankers Association reported their applications index fell 1.2% for the week ended February 5, following the 21% bounce in the week prior. The index was dragged down by a 7% decline in purchases; refinancing activity rose 1.4%.

The rate on the 30-year mortgage fell below 5% for the first time since the week of December 18, averaging 4.94% last week. The decline in purchases even as the fixed rate on 30-year money is so cheap, along with other government incentives, shows the troubled nature of housing. It will ultimately take a significant improvement in the labor market to spark a durable rebound in the housing market.

Trade Figures

The U.S. trade deficit widened substantially more than expected in December, largely due to higher crude imports and the price we paid for those supplies. You know, as longer-term readers are familiar, I think it is quite ironic that many of the people who complain about the perils of our deficit in trade (importing more goods than we export) are many of the same people who work (or at least have no problem) to restrict domestic energy production. Our energy policy is a major reason for the degree of our deficit in trade, you take out energy and the trade deficit is just 40% of what it is in total including crude oil. I’m not saying we should attempt to produce all of our energy needs, we get 35% of our energy imports from Canada and Mexico. Partnering with our North American neighbors makes sense, particularly since many of their supplies are sources that are cheaply produced. But it makes no sense to restrict our own capabilities. It makes zero sense economically and is dangerous from a national security perspective.

Anyway, to the numbers. The trade deficit widened by 10.4% to $40.18 billion in December from $36.58 billion in November – economists had expected the figure to narrow to $35.8 billion. Exports rose 3.3% as imports increased 4.8%.

I’m not one to worry about deficits in trade, outside of the energy story, as higher imports do suggests at least some increase in domestic consumption is occurring – besides as long as we engage in the right economic and fiscal policy those dollars come back home in the form of investment. By way of how the numbers came in it suggests U.S. corporations spent some of the mounds of cash they currently sit on, which is needed to make up for the lack of consumer outlays. This is a function of the inventory rebuilding, even if it is scant compared to the normal expansion.

The increase in imports was boosted by not only a 16.9% month-over-month increase in crude oil but capital goods also looked good, up 4.7%. Telecom equipment, computer accessories the pushed the ex-aircraft capital goods reading higher. Consumer goods were unchanged.

Exports were also boosted by the capital goods component (up 5.2%), namely the 44% jump in civilian aircraft – that’s good to see. Industrial supply exports rose 6.1%, thanks to a 10.3% increase in exported automotive products. There is this sense of frustration among a certain segment of the U.S. population due to our appetite for foreign-owned (not produced, but owned) vehicles. But the rest of the world, specifically China, does buy a lot of cars from us and that shouldn’t go unnoticed.

The Greek Bailout

The European Union (EU) is expected to hold official discussions, the vaunted “summit,” today as they decide how to extend help to the Greek government to avoid a funding problem. A bailout raises the concern that the EU will cave to member countries that are the worst violators of budget deficit constraints. Will these countries pull down the Union over time? The EU was always walking a fine line, attempting to manage a one policy monetary system with various political budget policies. If they don’t get a handle on things it does raise the question: How long can the euro survive? This may sound like a ridiculous suggestion right now; it may not be so outrageous a couple of years out.

But the fact that they are going ahead with a bailout, which should have been expected all along, shows that they view a member defaulting on payment as a larger risk – even a small member such as Greece. But bailouts are only a short-term fix; the snowball continues to roll and get bigger.

The EU needs to understand that only growth and reduced spending will ultimately ease concerns over budget problems. That means a complete restructuring of their entitlement programs and tax structures. I’m not sure the EU citizenry has it in them to accomplish such action, they’ve been living the very comfortable life of European-style socialism for too long perhaps – but this system isn’t viable in the long-term, that’s the problem. The U.S. better heed the lessons coming from Europe right now, and fast, or we’ll have the same debt-funding troubles hit our shores.

Have a great day!

Brent Vondera, Senior Analyst

The Fed's Exit Plan

2010-02-10T15:32:00.001-06:00

Today, Fed Chairman Ben Bernanke released the central bank’s exit strategy. His statement didn’t shed much light on the timing of the exit, but it provided some more specific details on policy tools. It is clear, though, that meaningful tightening won’t be happening anytime soon as the Fed Chairman explained the economy still needs “highly accommodative policy.”

The Fed will “before long” modestly increase the discount rate – the rate at which the Fed charges banks for emergency loans – but explained that this “should not be interpreted as signaling any change” in monetary policy. As expected, Bernanke also discussed paying a higher interest rate on excess bank reserves and reverse purchase agreements as the first tools for tightening credit.

The media seemed to emphasize the Fed’s plan to pay interest on excess reserves, which provides banks with some incentives to not lend all of their capital. In addition, if a bank can earn a reasonable return from the Fed, which poses no credit risk, other banks loans will be priced higher and credit will contract. Until reserve levels are much lower – and they are at unusually high levels – this tool along with targets for reserve quantities may play a bigger role in the Fed’s exit strategy than the fed funds rate.

Bernanke also explained that the Fed could sell securities to drain reserves from the banking system, but he did not anticipate doing so in the near term. The Fed is allowing agencies and MBS to run off and would sell them only if “the economy is clearly in a sustainable recovery;” however, the Fed is still rolling over Treasuries into new securities.

The obvious risk to the Fed’s exit plan is the error in execution. The amount of credit expansion that could be caused by the enormous stockpile of reserves at the Fed is largely unknown, as is the rate at which banks will be content keeping these reserves with the Fed. The timing of the exit is also a very delicate balance that we can’t expect will be perfect.

Any progress towards an exit, however, should be viewed as a positive at this juncture since the “emergency” rates in place are simply unnecessary.

--

Peter J. Lazaroff, Investment Analyst

Daily Insight

2010-02-10T07:20:00.004-06:00

U.S. stocks began Tuesday’s session considerably higher on the heels of strong pre-market trading and gained momentum mid-morning on word that Greece will get European Union help with its budget. (It was always a fantasy that the EU would escape bailing out Greece, and unless things go very well they’ll be bailing other countries too as the Greek situation is the canary in the coal mine.)

Bailouts hardly suggest the damage will be mitigated outside of the short term, you pay for reckless behavior now or you pay a higher price later; the markets seem to like the later option, and it showed. The broad market did pare morning-session gains late in the day but closed nicely higher nonetheless.

If traders didn’t want to take a position in front of the Bernanke’s testimony on Monday, they sure didn’t have a problem with doing so yesterday. I think more people started to realize that Bernanke isn’t going to go and surprise the market right now – we’ll get more of the same: their exit strategy plan will involve reverse repos and interest payments on excess reserves as the primary ways the Fed will attempt to drain liquidity. I think he’ll make it very clear that this liquidity drain isn’t going to occur anytime soon. Mr. Bernanke was scheduled to testify today on the FOMC’s exit strategy, but due to the weather in Washington the Fed will only release the text version -- Big Ben is thanking the global cooling cycle, or is it just the seasonal change? I can’t keep track these days.

Shares of Caterpillar helped propel the Dow Industrials after Morgan Stanley upgraded the shares along with a few other industrials. CAT shares jumped 6% yesterday, following a 20% slide over the past month – the shares have been a spectacular performer since the March lows, jumping twice that of the broad market.

Basic material shares were the leading performing sector; the group has taken it on the chin over the last four weeks, down 14% until yesterday’s 2.5% pick up. Energy and industrials also outperformed the market. Health care and utility shares were the laggards but managed gains of 0.63% and 0.96% respectively.

Ex-financial profit results continue to hang in there, up 13% with 65% of S&P 500 companies in to this point. Revenues are up 3.8% -- 54% of companies have beat their revenues estimates, 39% have missed and 7% have matched.

Market Activity for February 9, 2010
NFIB Small Business Optimism Survey

The National Federation of Independent Business reported that their optimism survey rose to the highest level in 16 months for January. Seven of the 10 components of the survey rose last month, led by an increase in expectations for higher sales and a reduction in the number of companies planning to cut stockpiles. More businesses also planned to increase spending on new equipment.

The index rose to 89.3 in January from 88.0 the month prior. The cycle low of 81.0 was touched last April; the all-time low of 80.1 was hit in April 1980; the average reading since the NFIB began tracking small business trends in 1974 is 98.9.

As the chart above illustrates, the overall survey remains depressed, stuck below a reading of 90 for the longest stretch in the history of the survey.

The plans to increase new equipment spending reading, while the highest since November 2008, remains significantly below the low points of the previous two recessions (currently 20 vs. 25 in those prior downturns – the all-time low of 16 was hit in November 2009).

The hiring aspects of the report remain very weak – this along with the plans to increase equipment purchases are the two most important areas of the report to watch. The NFIB’s chief economist noted that there was no improvement in the job creation statistics for January. Just 9% of owners increased employment by an average of 3.0 workers per firm, but 19% reduced employment by 3.9 workers per firm.

Over the next three months plans to create jobs improved, but still more firms plan to cut than add. That’s not a particularly good sign, but since the plans to reduce fell more than the plans to increase jobs, the reading did improve.

The overall index was restrained by declines in the net number of firms saying it was a good time to expand and the reading anticipating better business conditions. The sales expectations reading, as mentioned above, improved but actual reported sales over the previous three months fell to -26 from -25 in December. We’re going to have to see actual sales improve for several months before small firms go on a hiring spree that would bring the unemployment rate meaningfully lower. The NFIB survey stated: “Owners complained that ‘poor sales’ was their top problem, and there is no need to hire with no new customers. It is hard for workers to ‘earn their pay’ in this environment, a necessity if a firm is to stay in business.” Wow, that’s a hard-hitting statement.

The survey went on to state: “Twenty-four months of recession have sapped the financial strength of many small firms that are too numerous now in the new spending/credit environment. Too many houses were built, too many strip malls opened, too many restaurants started, too many retail outlets were launched in the 2003-2007 period and all of them cannot be supported by a consumer that now chooses to save.”

These are very sobering comments. I think the official recession is not going to show it lasted two full years – and later commentary within the NFIB report did acknowledge the recession will likely be officially announced to have ended in the second half of 2009. It’s clear though that small firms still feel recession is upon us.

The inventory reading improved substantially, up 7 points to a -21 from December’s record liquidation reading.

The survey was based in 2,114 survey responses through January 31.

Wholesale Inventories

Distributors’ inventories fell in December even as sales rose for an eighth-straight month, coming off of the worst collapse in the postwar era as sales plunged 24% over an eight-month stretch.

So inventories fell 0.8% in December after a huge 1.6% November rise – the biggest since June 2004. This may have suggested distributors had trouble keeping up with demand after November’s big 3.6% jump in sales. Or maybe it’s because firms aren’t willing in this uncertain environment to add to stockpiles even as they are near record lows. The inventory-to-sales ratio came in at 1.12 months’ worth, the all-time low is 1.11.

We’ll need the following months to confirm whether or not firms are willing to stretch just a little bit and take on inventories that are meaningfully higher than the record low. In any event, very low stockpiles will continue to catalyze GDP growth for another quarter or two. Beyond that, we’ll need durable sales growth or it all just fizzles out.

Today’s Data

Today will be very light in terms of data releases as all we’ll get is mortgage applications and the December trade figures. The budget statement (federal budget deficit figure) was scheduled for release but has been postponed due to the weather. The January retail sales figure, which was scheduled to be release tomorrow, will also be postponed; the results are now planned to be announced on Friday.

I’ll be out of the office until Tuesday, either Dave or Pete will take over until then.

Have a great day!

Brent Vondera, Senior Analyst

Daily Insight

2010-02-09T07:10:00.002-06:00

U.S. stocks fell for the third day in four as it didn’t appear traders found reason to get in front of Bernanke’s testimony to Congress on Wednesday. The Fed Chairman will lay out the strategy for exiting the unprecedented level of monetary easing that is currently in place. To be sure, there are other concerns affecting the market right here but you never know what may be stated, or more importantly how the markets interpret Bernanke’s statements.

The broad market was actually holding in there pretty well -- up in the morning and hovering around the opening price level into the afternoon session – until sliding a bit in the final hour. For what it is worth, the Dow closed below the 10K mark for the first time since early February – it has crossed this mark 57 times now since 1999.

Some comments from former Fed Chairman Greenspan on Sunday morning’s Meet the Press may have also had an effect on trading. Greenspan stated that the economic recovery will be “slow and trudging.” He also explained that he’d be very concerned if stock prices continue to fall, more on that below.

Commodity prices rebounded a bit. It’s been a pretty good pullback, down 12% over the past month after hitting post-crisis highs. A move of 12% over this length of time isn’t saying a lot as these prices can swing violently, but it’s the most significant move since June and all about sovereign default concerns – European banks hold a lot of the public debt that’s in question and that gets the market concerned about future credit contraction.

Financials led the broad market lower, followed by basic material and industrial shares. All major industry groups closed lower.

Market Activity for February 8, 2010

Central Bankers and the Risk Trade

Central bankers are keeping a close eye on stock prices, as Greenspan signaled this weekend and we’ve talked about several times now. A key objective of the ZIRP (zero interest rate policy, for new readers) was to get traders and investors back into risky assets – they were running from anything other than cash and Treasury securities early in 2009. When you completely erase returns on cash holdings, as the Fed has done, you will get people hunting, desperately in some cases, for yield and returns – that means a rush of money into stocks, and higher-yielding corporate bonds.

Boosting stock prices is really the only quick way with which the Fed could begin to repair household balance sheets; they can’t do it from the perspective of income as that takes job growth, which takes a considerable amount of time. They have certainly accomplished this goal to some degree as household net worth has bounced $5 trillion since last March. The crushing 57% plunge in stock prices (from the Oct. 9, 2007 high to the 13-year low on Mar. 9, 2009) and the roughly 30% decline in home prices (from the July 2006 peak to the cycle low hit in Jan. 2009) stole more than $17 trillion from household net worth. It hit $66 trillion in 2007 and currently sits at $53.4 trillion.

But the perils behind this strategy are not fully being considering in my view, or maybe they have been recently. When your strategy is to push people into riskier assets, traders push aside their consideration of risk as they myopically hone in on the yield – it’s like throwing chum to sharks, a frenzy results. What these yield/return seekers have forgotten, is that there is another side to this trade – prices can move lower. It is utterly amazing to me how so many have forgotten this just 10 months removed from largest collapse in riskier-assets since the 1930s, but that’s what ZIRP does. We’ve recouped a lot by way of stock prices, half of the losses before this 8% pull back. Yet one gets this sense that too many people expected this substantial rally to continue without abatement. We simply face too many headwinds, and it takes time to forge through these challenges.

Anyway, Greenspan made it clear and for sure Bernanke is keeping a close watch on stock prices in particular. If the market endures a decent sized correction here -- which I think is likely as the market begins to consider weaker prospects for growth in the back half of 2010 and into 2011, the cost of very deep deficit spending, the sovereign debt realities that ensue, and a housing market that very likely has to get past another round of downside – we may not yet fully appreciate the extent to which both Congress and the Fed will accelerate easing strategies over the coming months. That means a return to quantitative easing from the Fed and additional spending from Congress, both of which will cause market distortions and new problems that will have to be worked off over the next couple of years.

I do not wish for this to occur, which is why this letter keeps harping on the need for the Fed to gently raise rates and Congress to slash tax rates across the board. Even mild rate hikes will cause problems for this economy, but the slashing of tax rates will offset that pressure – I can’t emphasize this enough. At some point, you’ve got to rein in some of the things we’ve done and force the market to stand on its own. If we don’t, I’m sure additional problems will arise – at which point the Fed won’t have to worry about a short-term correction to this rally from the March lows, but a mired stock market for a longer period of time.

Coming Data

We were without an economic release yesterday but get back to it today with the NFIB Small Business Optimism Index and wholesale inventories (December).

On Wednesday, we receive Mortgage Applications (week ended February 5), the trade balance (December) and the monthly budget statement (size of the budget deficit during January)

On Thursday, and I’ll be out off the office the final two days of the week, we get retail sales (January) and jobless claims.

The retail sales and jobless claims figures will get most of the attention, but NFIB and mortgage apps will be important to watch as well.

Next week things get very interesting with the following releases:
Housing starts, industrial production, Philly Fed and CPI. The market will want to see some bounce back in housing starts after December’s 16% plunge (we’ll see how weather-related that drop was) and industrial production will need to post a good reading (December’s results were all on cold weather as the utility component accounted for the entire increase).

Have a great day!

Brent Vondera, Senior Analyst

Daily Insight

2010-02-08T08:50:00.006-06:00

U.S. stocks spent most of the session in negative territory, hitting the day’s nadir shortly after lunch (Dow at 9834 and 1044 on the S&P 500), but turned higher about an hour before the closing bell. The Federal Reserve’s latest report on consumer credit provided the impetus for the market’s turnaround as it showed the smallest drop since the record consecutive months of decline began in February.

There was also talk that the market was helped by speculation the EU would come up with a plan for Greece’s budget this weekend at the G7, this should be interesting. But it seemed to be more on the consumer credit news as the market’s about face occurred directly after that release. Now that the meeting has come and gone, we see it was more talk than anything else, as is usual. The sovereign debt story is not over; there will be a default or two and plenty of close calls. This is the nature of things coming out of such a deep global contraction, government spends like mad to combat the problem and that combines with a slide in tax revenues to widen budget gaps to levels that cause additional problems.

Total consumer credit fell just $1.7 billion in December after a record $21.8 billion decline in November – records go back to 1943. Revolving credit (credit card accounts) continued to decline, extending the record streak to 15 months – this is likely to continue for a while as credit lines run off of delinquency models. What helped the figure was the non-revolving segment, basically car loans. With loan terms averaging 3.26% during the month and maturity at 64 months…and loan-to-value at 92% -- giddy up!

Commodity prices continue to get hit pretty hard. Oil got slammed down to $70/barrel before recovering to $71.19 on Friday, down 8% in three sessions; gold was back to $1,052/oz. before jumping this morning; copper is down 7.5% since Wednesday and 18% from its recent high.

As the flight to safety has returned, the dollar is the beneficiary – up above 80 on the Dollar Index (DXY) for the first time since July as it was coming off of its crisis high of 89 on the DXY. Treasury securities are back in vogue as well. Man, anyone who went short Treasuries thinking it was a no-brainer has gotten crushed thus for in 2010.

Market Activity for February 5, 2010
January Jobs Report

The January jobs report printed numbers that set up an environment for very contentious analysis. Those who believe this recovery is normal in nature viewed the report with an optimistic hue, while those who understand that recoveries following credit/balance sheet-driven recessions are not at all normal viewed the report with skepticism.

For me, and I’m undoubtedly in the latter camp, I don’t look askance at the report, but would rather wait and see the subsequent months confirm what I think is going on – a large divergence between the household and payroll surveys due at least partially to a lot of people who were working in the construction sector now venturing out on their own, adding to the roles of the self-employed. Many of the nearly two million jobs that have been lost in that sector are not coming back, not anytime soon – for all intent and purpose they have been structurally eliminated and those formerly in the sector are beginning to realize this. The household survey picks up these self-employed, the payroll survey does not.

So let’s get to the specifics, and we’ll begin with what is more familiar to most people: the payroll survey. The Labor Department reported that 20,000 payroll positions were cut in January (economists had expected a 15K increase). Whether, 20K up or down, it doesn’t matter because this is a statistically insignificant level. What is statistically relevant is the downward revision to the December reading, which showed 150K jobs were lost; it was initially reported as decline of 85K last month.

In fact, February brings with it annual labor market revisions and those new readings showed that 8.4 million payroll jobs were slashed offer the past two years, it was previously believed that 7.2 million payrolls were lost. BTW, the Bureau of Labor Statistics “birth/death” model estimated that more businesses open than closed in 2009 for a net 1.79 million jobs. I’ve never questioned this B/D model, but it is a little hard to believe that the worst recession in the postwar era saw more businesses open than close, so it’s not out of the question to wonder if well more jobs were lost than even 8.4 million. I’ll leave it at that.

These numbers are obviously backward looking, they are in the past, so one shouldn’t dwell on them. What it does inform us of is that the repair that’s needed within the job market will take even longer to accomplish than previously expected. If a meaningful degree of repair in going to occur within the next two years then we are going to have to see even stronger monthly job growth and GDP figures than it normally takes. Normally, it takes at least 120K in monthly job gains to keep the jobless rates steady and something closer to 200K/month over a period of time to bring it lower. Those number may have to be greater now, possibly 150k/month to keep it from rising and 300K/month to get the jobless rate back down to 8% in 18 months time.

Anyway, back to the monthly numbers. In terms of industry, goods-producing industries shed 60,000 payrolls last month. Manufacturing actually added 11,000 jobs (first time in more than two years and much better than the three-month average of -23K). Construction cut 75,000 jobs (considerably worse than the three-month average of
-47K). I don’t believe one can blame this on the weather as was the valid case in December. It is more a function of the accelerating pace of commercial construction deterioration. But, we’ll see over the next couple of months which view is correct– if it was the weather, construction employment should bounce with vigor in the coming months and vice a versa.

The service-providing industries added 48,000 jobs in January after a downwardly revised -69k in December, which was initially reported as a 4K decline. Business services added 44,000 jobs (in line with the three-month average of +45K). Retail trade added 42,000 jobs (much improved from the -8K on the three-month average). Trade and transport added 15,000 (nice improvement as the three-month average is -18K). The financial sector cut 16,000 jobs (about in line with the -10K monthly average over the past three months).

Temporary positions rose 52,000, probably mostly within the business services sector, and are up 247,000 since September. This is good news as it usually indicates more permanent employment is on the horizon. This is the expectation, but the looming question remains to be seen; Will the gains be strong enough and durable enough to bring the jobless rate lower in a reasonable amount of time? Further, as I’ve suggested on more than one occasion, the reliability of indicators that have proven accurate in the past may not be so true this time. Temp. employment has risen very nicely, but in this environment one has to be cautious of firms’ willingness to turn these workers into permanent employees (and thus take on the benefit expenses that accompany a permanent worker) like has occurred in the past.

The government cut 8,000 jobs. The Federal government added 33K, but states and local cuts offset this increase.

So now we get to the household survey. This is the survey that is used to calculate the unemployment rates. For newer readers, the payroll survey (which calculates the number of payroll jobs gained or lost) is the monthly jobs number you read in the headlines. The household survey is used to calculate the unemployment rate and it captures the self-employed.

The unemployment rate fell to 9.7% from 10% in December. Economists had expected the rate to hit 10.1%.

The household survey showed a gain of 541,000 jobs last month, after the December decline in 589,000. This is a volatile measure (as the prior sentence illustrates) and has bounced all over the map over the past few months. This pick up for January is why the unemployment rate fell to 9.7% from 10% even as 111,000 people came back into the labor force – meaning they had looked for work in the four weeks that this monthly survey captures.

There is no way of knowing just yet whether this bounce in household employment is the beginning of something. I’ll repeat, it will take several months of a trend to be established to confirm whether we’ll muddle around at low levels of jobs growth or something more substantial will take place. I think what occurred via the large pick up in household employment is that enough of those out of work in the construction sector decided to become self-employed – one man shops of carpenter, electricians, etc. Thus, as they stated via the survey that they were out of work in December, they now stated they were working in January. Again, we’ll need some consistency in the readings over the next few months to confirm what is going on.

The U6 unemployment rate, which captures the officially unemployed plus “discouraged” workers (those that didn’t look for a job during the survey period because they believed their chances of finding one was low) and those working part-time because they couldn’t find full-time work, fell for just the second time in two years. U6 came in at 16.5%, meaningfully lower than the 17.3% in December as those who want full time work but are working part-time for economic reasons fell to 8.3 million from 9.2 million in December.

Unfortunately, the long-term jobless rose to a new record as the percentage of those unemployed for at least 27 weeks rose to 41.2% from 39.8% in December. More than four out of 10 unemployed persons out of work for more than 27 weeks.

In addition, the average duration of unemployment extended to a new record of 30.2 weeks from 29.1 weeks in December.

The average hours of production per week ticked up to 33.3 in January from 33.2 after hitting the all-time low of 33.0 in October. This number will have to rise to 33.8-34.0 before any meaningful hiring takes place. The 10-year average is 33.7.

So again, this report is quite conflicting. There were positives, such as the unemployment rate decline even as the participation rate rose, the rise in temporary employment, the continued easing in payroll losses (three-month avg. is just -35K/month, that was -220K/month just three months back) and the tick higher in hours of production.

Yet, we’ll need to see the jump in household employment be confirmed in the coming months, large questions remain as to whether this economic environment can produce the job growth needed to repair a meaningful portion of the 8.5 million payroll jobs lost over the past two years, and the long-term unemployment situation continues to deteriorate.

I think this report leaves more questions than anything and it doesn’t tell us much in terms of new information. Remember that we’ll have 700,000 2010 census workers (a two-month gig) being hired by early summer. This is going to cause distortions and make analyzing the data even more contentious among economists.

Have a great day!

Brent Vondera, Senior Analyst

Fixed Income Weekly

2010-02-05T15:51:00.003-06:00

Sovereign Debt
Concerns over government debt levels are building across the globe, and the effects have been felt beyond the sovereign debt universe. Stocks, commodities and foreign currencies all suffered in the back half of the week, as risky assets were shed in favor of US Treasury and Agency bonds. It was nice to see Dollar hold up in the face of all this, considering the budget and debt issues we face domestically. The dollar index rose 1.68% during the last 3 days of the week, and gold fell 4.62% over the same period.

Several dealers sighted heavy buying on the longer end, an obvious safety trade, while yields on bills were actually higher for the week, as investors sought duration to gain from the rally in bonds.

To try and put the sovereign credit issues into perspective I built this table comparing CDS of some major countries with some more familiar US companies. There are some large discrepancies between credit ratings and CDS cost (BB- Venezuela at 1,055 basis points vs. BB- Turkey at 214 bps.). This should explain pretty clearly how little credit ratings are worth these days.

Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst