Daily Insight

U.S. stocks wavered between gain and loss several times yesterday before rallying in the final minutes to close higher. The tug-and-war session began after the pre-market release for July personal income registered the largest decline in four years as a special addition to government transfer payments (part of the stimulus package) ran its course – this has been the only boost to incomes for several months as private-sector components have been falling. Stocks rallied, however, after the latest pending home sales report easily surpassed expectations, suggesting home-buying activity will rise for the next couple-to-three months.

Financial, industrial and consumer shares were the leaders yesterday. Certainly the housing number helped these groups, but it was rather surprising how consumer shares looked past the income figures. In the very short-term the “cash for clunkers” program will offer a boost to consumer activity but it is front-loading spending; personal consumption will fall off again when the program expires.

Utility shares led the declining sectors after East coast electric power company PPL Corp. reduced its 2010 forecast as they see power demand will continue to erode.

Market Activity for August 4, 2009
Personal Income and Spending

The Commerce Department reported that personal income fell 1.3% in June, the largest percentage decline in four years, pretty much erasing the May increase of 1.3% -- that number was revised lower, originally estimated as a 1.4% increase.

The June figure was pushed lower as government transfer payments fell 5.9% for the month. As we mentioned last month, government transfer payments made up 97% of the May income gain and one cannot view such realities as sustainable – it was illogical for the market to get excited about that increase. The area that really matters, private-sector incomes, fell again – rental incomes were the only segment to rise, up 1.0%.

Compensation, normally the largest part of personal income, fell another 0.3% in June, down 3.8% year-over-year. Wages and salaries fell 0.4%, down 4.7% from the year-ago period – the largest annual decline since these records began in 1960. Proprietor’s income slipped 0.1% in June, off by 8.3% year-over-year. Income from assets (a combination of interest and dividend income) fell 0.4% and is down 10.8% from June 2008. Farm income got hammered, down 3.2% in June and crushed over the last year, lower by 44.5%.

This didn’t stop spending from rising for the month though as personal outlays rose 0.4%, which was more than the 0.3% expected. This may marginally improve the Q2 GDP report when it is revised later this month. Spending on non-durable goods led the increase, up 1.65% for goods meant to last less than three years. Spending on durable goods fell 0.2%. On an inflation-adjusted basis personal spending was down 0.13% in June and is down 2.15% year-over-year.

As a result of the decline in incomes, while spending increased at the same time, the personal savings rate (what I refer to as cash savings) slipped to 4.6% from 6.2% in May. This reading will pull back a bit more over the next couple of months as the CARS program will boost spending for July and probably August. (The market may become very excited over these consumer readings, but will have the rug pulled out from under its euphoria as personal outlays will decline when Uncle Sugar…sorry, Sam, ends his cash handouts.

A few months out, we will then see this measure of savings resume its march to 8-10% as the job market remains fragile for sometime to come and stock and home values (the two largest savings vehicles) remain off of their peaks by 36% and 21%, respectively. Later, when interest rates being to move higher, this savings figure will pick up speed as there will be an additional incentive to hold cash.

Pending Home Sales

The National Association of Realtors reported that pending home sales jumped in June, marking the fifth-straight month of increase. Pending sales, which indicate actual sales will follow two months later, rose 3.6% for June after a 0.8% rise in May, a number that was revised up from 0.1%. So long as there aren’t too many loans that fall apart by the time of closing, we’re going to see a few months of sales advances – a very good sign for the supply figure, which has improved but remains elevated.

All four regions of the country reported an increase in contract signings. The South led the way with a 7.1% gain; the West saw pending sales rise 2.9%; pending sales in the Midwest rose 0.8%; the Northeast was the laggard, with pending home sales up just 0.4%.

As we’ve been talking about, a sustained recovery in home sales is unlikely as the tax-credit for first-time buyers expires by December and one cannot expect interest rates to remain this low for long. Still, this is great news for the housing market as it is beginning to find its legs, even if the rebound is due to the aforementioned stimulus. Let’s hope we’re not front-loading things (as we seem to be within other areas of the economy), as first-timers are rushing to get in by the November 30 cut off for that tax credit, only to see sales move meaningfully lower in 2010. (I don’t enjoy striking this pessimistic tone, but I also don’t want to look naïve when the inevitable occurs).


Have a great day!


Brent Vondera, Senior Analyst

PFG 2Q09 Earnings release

Principal Financial Groups (PFG) reported 2Q09 earnings result of $150.3 million net income available to common stockholders or $0.52 per diluted share, compare to 2Q08 number of $168.3 million or $0.64 per share. It missed analysts’ estimate by 20%. Reduced fees earned from asset valuations, a stock offering on May of 2009 that increased number of shares outstanding, and high pension costs due to negative market performance all contributed to the decline in the per share result.

Generally, their numbers were all lower compared to 2Q08 when the S&P 500 still was trading at upper 1200 level. However, over the three consecutive quarters, PFG has shown some improvements and their business has returned to more normal state. Total assets under management decreased to $257.7 billion from $308.0 billion year ago period, but increased 9% since the last quarter.

Net income available to common stockholders includes some realization of capital losses on their other than temporary impairment of fixed maturity securities, losses related to hedging activities, commercial mortgage loan losses, and etc.

Significant market losses coupled with rising unemployment level and reduced investment income is negatively affecting company’s earnings result for the quarter, but the company is also likely to benefit more upon improvement in unemployment level and interest rate increase. The market is already recovering, up 48% from the March low, which will make PFG’s comparable earnings look fabulous in the near future.

Patience has been proven to be a virtue with this company, marking remarkable 289% come back from March low. However, the stock is still 65% below its end-of-2007 price level and it will only be taking longer from here to recover, since the job market will not be able to turn around as quickly as the market did.

PFG is trading at 8.5 P/E, near half of their historical 14 average P/E level.

Whole Foods Market Inc. 3Q09 Earnings release

Whole Foods Market Inc. reported 3Q09 earnings of $0.25, beating 3Q08 earnings of $0.24 by 4% and surprising analysts’ estimate of $0.20 by 25%. Revenue increased 2% to $1.88 billion even as store sales decreased overall. It is especially remarkable, considering current economic situation, and compared to last quarter’s negative sales growth. Their Ccst conscious approach to expenses paid off, increasing their overall gross profit 33 basis points (excluding LIFO adjustment). WFMI increased fiscal year 2009 diluted EPS to $0.80-$0.82 from previous guidance of $0.65-$0.70.

WFMI closed at $24.82 pre-earnings, and earnings release after market boosted the company 13.5% in after market trading.

Haemonetics 1Q09 Earnings

Haemonetics (HAE) reported earnings for the first quarter of fiscal 2010 of $0.69 diluted earnings per share, a 17% increase from $0.59 1Q09 diluted earnings per share, and beating Bloomberg analysts’ estimate by 6%. HAE also pulled strong margin improvement, adding 370 basis points to operation income margin of 17.1%.

The largest component of Haemonetics business, plasma disposables, showed some nice growth for the quarter, marking a 26% increase in $154 million revenue, benefiting from long term contract implementations, global growth in plasma collections, and price increases. Platelet disposables revenue was $34 million for the quarter, down 4% and Red Cell Disposables revenue was $12 million, leveling with previous year over year.

The company reiterated its full year earnings per share guidance at $2.75 to $2.85.

With all this positive news on Haemonetics earnings, stock still closed 5.1% lower for the day.

Hologic, Inc. 3Q09 Earnings Release

Hologic, Inc. (HOLX) reported 3Q09 revenue of $403.1 million, a 6.1% decrease from $429.5 million in 3Q08. Diluted earnings per share excluding one time items came in at $0.29, a 12% decrease from 3Q08, beating Bloomberg analysts’ expectation by 12%.

The company blamed the current economic environment, the resulting delays and reductions in hospital spending and longer sales cycles for this decline. As evidenced by a reduction in Selenia System sales, and a decrease in company’s osteoporosis assessment, mini C-arm, MRI Product lines, and flat ThinPrep products, HOLX is having a difficult time selling their product to hospitals and upgrading current systems in the hospitals.

HOLX’s write-off of certain intangible assets continued for 3Q09, albeit at a much smaller pace of $4.1 million dollars, and the company also recognized net charges of $40.1 million on amortization of intangibles related to Cytyc merger and the Third Wave acquisition, and a full quarter of costs and expenses from Third Wave.

Considering the current market situation, where hospitals are just waiting on health reform to finalize before making any big purchases and trying to make their books strong to secure any financing needs, plus all their internal write down issues inherited from untimely acquisitions, are double whammy for the company. That is why the company with a 39 average P/E ratio for the past 5 years is currently trading at 12 P/E, and it seems all this bad news is already priced in. Frankly in my view, they rather seem to be weathering this storm quiet well.

A few positive notes include FDA Approval of Adiana Permanent Contraception System, which will start contributing in 4Q09, and expected continuing double digit growth on Diagnostics and GYN Surgical revenues. Diagnostics newly includes Third Wave product revenue of $10.3 million in 3Q09.

HOLX’s backlog stands at $333.6 million, which is within its historical range.

For the fiscal year 2009, the company now expects sales to come in between $1.625 billion and $1.65 billion, lowering the top estimate by $15 million.

Daily Insight

U.S. stocks rallied, sending the S&P 500 past 1,000 for the first time since November, as China’s factory sector recorded its fifth-straight month in expansion mode and U.S. manufacturing made nice progress toward expansion mode for July.

Commodities rallied on that news out of China, helped even more by a dollar that continues to get crushed, as basic material shares led the broad market higher. Energy shares also helped lead the rally as crude marched back to $71 per barrel.

The S&P 500 has now jumped 48% from the wicked March 9 low of 666. This is great news, it is certainly very nice for the American psyche, but I also find it difficult to get excited about the latest leg of this move – I’m talking about the 12% move in the last three weeks. (And just for the record, for those who may not remember, in the March 10 letter we stated it does feel like something powerful is about to occur as we were 515 days into the bear market and the S&P 500 was down 57% -- following the 1929 crash the broad market was down 42% 515 days in and this is no Great Depression. Others know that my view of fair value is 900 on the S&P 500, so I don’t want anyone to believe that my comments of concern means that the vast part of this rally is not justified; the vast majority of this rally is justified – particularly since health-care legislation and Cap&Trade have run into trouble).

But one understands, or should, that when things go up this fast, even if it is off of an unjustified low, the pullback is not far off. The degree of the pullback will depend upon the extent to which values run up beyond what is rational. The concern here is that when the inevitable move down of 15-20% does occur, investors will fear a replay of last March and exacerbate the retrenchment. I don’t think it is beyond reason to guard against this possibility. Don’t’ increase your equity exposure and chase this thing higher.

ISM Manufacturing (July)

The Institute for Supply Management’s manufacturing index rose to 48.9 for July, easily surpassing the 46.5 that was expected, up from 44.8 for June. While this latest reading shows factory activity contracted for an 18th straight month, a reading over 42 suggests the overall economy is growing (although as the ISM report states, “it would be difficult to convince many manufactures that we are on the brink of recovery”).

Most of the sub-indices of the report looked really good, with production hitting a pretty robust level of 57.9 (second month of expansion), new orders hitting 55.3 (second month in three above 50) and the backlog of orders posting 50.0 (first 50 print since the September debacle).

Export orders also moved into expansion mode, posting 50.5 and this is going to be a number that drives ISM, and helps the economy in general over the next few quarters.

Still, the inventory gauge remains deep in contraction mode, moving up to 33.5 from 30.8 but nevertheless really depressed as the chart below illustrates. I happen to look at this as not such a bad sign as it means the production needed to rebuild stockpiles is soon to come, but most economists view this low level as a possible sign that businesses are still very cautious and may not rebuild stockpiles to a meaningful degree.

This is a concern, and one I share but over a longer-term perspective. Whether it occurs in the third or fourth quarter (the boost to GDP from inventory rebuilding), it doesn’t really matter, it’s going to happen. But businesses know that tax rates are going higher and this adversely affects their expectations for growth. As a result, they’ll hold back over the next year more than would otherwise be the case. This is why I believe the government’s spending, while helping GDP in the short term, will come back to haunt thereafter as the capital sapped from the private sector will do damage.

Six of the 18 industries within the survey reported growth in July, matching the June report. Here is what ISM reported respondents as saying:

“There is concern about overall health of strategic suppliers – continue to see new suppliers filing Chapter 7 or 11, posting significant risks to supply chain.” (Machinery industry)

“We believe our inventories are now at the bottom of this cycle, driving stronger demand for raw materials.” (Paper Products)
My comment: This speaks well for the commodity trade.

“While our aftermarket business has improved slightly, we are still awaiting an increase in OEM demand.” (Transportation Equipment)
My comment: This will turn as auto plants kick start production, which should be soon as “cash for clunkers” will drive auto sales for a couple of months. Problem is it will be short-lived.

“Looking at another round of shutdowns to align supply with projected demand.” (Nonmetallic Mineral Products)

“No stimulus for manufacturing.” (Fabricated Metal Products)
My comment: this is one of the problems. These last two responses illustrate that economic activity remains very soft and outside of the areas that either the Fed or fiscal government stimulus specifically goose, things don’t look much like a recovery.

Construction Spending (June)

The Commerce Department reported that June construction spending rose for only the third month of the past 12 as residential building activity offset weakness on the private-sector commercial side of things.

Spending rose 0.3% in June to $965.7 billion at an annual rate, after a 0.8% decline in May, as both private and public sector residential activity increased. The big boost came from government outlays for both residential and commercial projects (up a large 4.6% for residential and 0.9% for commercial). Private-sector residential construction rose 0.5% and was down 0.5% on the commercial side.

As we’ve talked about for six months, the government construction spending will drive this overall reading higher and will be able to offset weakness within the private-sector commercial component, which I suspect will get pretty ugly over the next year (20% of hotel loans are expected to default through 2010 and warehouses, distribution centers and industrial buildings are having a rough go due to very weak activity).

While private-sector residential construction spending rose at a nice pace for June, I don’t think it will stage a sustained uptrend as sales will have too many issues weighing on home purchases. The tax credits for new home buyers will run out after this year and unless interest rates remain very low, the fragile job market will keep sales from rebounding outside of one-two month pops.

U.S. Vehicle Sales

The CARS (Car Allowance Rebate System) program – also known as “cash for clunkers” – helped to spark vehicle sales in July, pushing the figure above what the industry believes to be the breakeven point of 10 million units for the first time since December.

Total U.S. sales (both domestic and foreign) rose to 11.3 million units SAAR (seasonally-adjusted at an annual rate), up from 9.7 million in June. I don’t think there is any doubt the CARS program will be extended as the plan’s originally allotted $1 billion in funding has run out. The House passed legislation to add another $2 billion and we may find another couple of billion dollars added on top of that before it is all said and done.

This is one of the most economically stupid plans the government has ever come up with, and that’s saying something. Yes, there will be those that state it’s a huge success, and no doubt when people are going to be given money they’ll take advantage of it. But even if this plan were smart economics, all we’re doing is borrowing sales from the future and encouraging consumers to take on more debt as the unemployment rate has double-digits in its sights and incomes are stagnant-to-lower for most workers.

What’s more, as stated above, these sales should boost manufacturing activity as auto plants will ramp up production again, but this too will just front load things. What happens when the unemployment rate remains high, incomes flat and the consumer is saddled with a higher debt burden? It doesn’t take a genius to answer that one.

From an economic point of view, it makes zero sense to destroy vehicles that have a useful life. The familiar “cash for clunkers” nomenclature gives the impression that the trade-ins are all 1980 Chevy C-10s, but many of these vehicles are very likely 12-year old SUVs that have plenty of life in them – the dealership is required to destroy the motor before collecting their $3500-$4500.
Beyond that, one wonders if those at the lower rungs of the economic ladder are not hurt the most by this program. You can bet there will be less 10-15 year old cars on the market and that means higher prices for those who cannot get a loan to buy a newer car and have only enough cash to buy vehicles such as those now being destroyed. Like so many things that come from those who prop themselves up as the champion of the “little guy,” their incredibly stupid ideas hit those at the bottom the hardest.

Have a great day!

Brent Vondera

Fixed Income Recap

Positive news overnight from China’s manufacturing sector sent commodities skyrocketing and the dollar suffered as a result. Dollar weakness and a 1.5% rally in stocks lead to a broad selloff in Treasuries. The intermediate section of the curve suffered the worst, not surprising considering the news.

Inflation was the catalyst for yesterday’s move, shown by the outperformance in TIPS (10yr breakevens were wider by 10 bps). The curve steepened by 8 bps on Monday to +244 bps after flattening 32 bps last week.

CIT
CIT took another step toward avoiding bankruptcy yesterday by boosting the price they will pay in a tender offer for notes due August 17. The terms of the offer have changed a few times in the past few weeks, but in its most recent form CIT agreed to pay 77.5 cents on the dollar for the bonds. The offer was bumped to 87.5 yesterday, and the participation needed for the tender to be successful was lowered from 90% of bondholders to just 58%. CIT claims that 65% of bond holders have already agreed to tender their notes.

This is an important hurdle for CIT, but the fight is far from over. The notes being tendered are trading on the open market around 93, a large rally from the low 80’s just a day ago, but still a 28% annualized yield. CIT continues to face a steep uphill battle.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks ended mixed on Friday as the latest GDP report came in better-than-expected, yet the latest regional manufacturing report failed to impress investors. A number of times it looked like stocks would stage a rally as many saw that GDP report as a sign the economy has turned, but the figure was helped too much by the government side of things (this may have increased doubts about the sustainability of a recovery) and that manufacturing report (for the Chicago region) failed to make it to 45, which appeared to be the whisper number.

Material, financial, energy and industrial shares led the broad market to a fractional gain. (Commodity prices are on fire this morning on a another good factory number out of China, which we’ll touch on below, with Dr. Copper up 4.5% and crude back above $70 per barrel; this should keep the rally in basic materials and energy going).

The Dow Average added 17 points thanks to a big day from Chevron. The NASDAQ Composite slipped as the index was pressured by tech shares. Mid cap stocks registered a fractional gain, while small caps declined.

Second-quarter GDP (initial estimate)

The Commerce Department reported their initial estimate to Q2 GDP came in at a much-better-than-expected -1.0% at a real annual rate, yet the previous two reading (Q1 and Q4 2008) were revised lower. That doesn’t matter right now as the market looks forward but it’s a reminder, as if we needed one, of the severity of this downturn.

We’ve now contracted for four-straight quarters. Prior to this recession we have never seen more than two-consecutive quarters of decline in the post-WWII era and the previous two readings of -6.4% and -5.4% are far and away the most harsh two-quarter decline since the 1957-58 recession (-4.1% in Q4 1957 followed by -10.4% Q1 1958).

Economic activity was buoyed by a 5.6% jump in government consumption that added 1.12 percentage points to the figure – much more of this to come – and net exports, which added 1.38 percentage points to GDP. Exports actually fell 7.0%, but imports fell more, down 15.1%. (The decline in real exports of 7% was a vast improvement from the 29.9% plunge in the first quarter. Real imports fell 15.5% at an annual rate, big move down that speaks to the troubled in consumer land but much better than the slump of 36.4% in Q1)

And speaking of the consumer, the largest segment of GDP – personal consumption – fell for a third quarter in four (that’s never before occurred since records began in 1947), down 1.2% at an annual rate. This followed a 0.6% rise in Q1, a 3.1% slide in Q4 and a 3.5% slump in Q3. (That Q1 rise of 0.6% was revised down from 1.4%, which was revised down from the initial 2.2% estimate that had the press giddy that the consumer was back. Oh, I wish it were true.) Personal consumption subtracted 0.88 percentage-point from real GDP. Durable goods shipments got slammed by 8.1% last quarter, which is what led the segment lower. Non-durables fell 2.5%.

Business investment (structures, equipment and software) fell 8.9%, normally a large move but not compared to the record 39.2% collapse of the prior quarter. Non-residential structures decline 8.9%. Equipment and software fell 9.0% --this reading was down 36.4% in the first quarter.

One should expect a statistical bounce from business investment for the current quarter, as we discussed after that last durable goods report. Business investment subtracted 1.82 percentage-points from the GDP reading.

Inventories, which many expected to rebound, fell for the sixth quarter in seven, down $141 billion at an annual rate, which put the two-quarter reduction at $250 billion – by far a record decline. Again, we will se a statistical bounce in GDP as the inventory dynamic catalyzes growth – simply put, there must be some ramp up in production after a slashing of inventories such as this.

And this is where the meat is for the next two quarters. Massive inventory liquidation and the small reduction in real final sales of just 0.2% in Q2 – final sales is GDP less inventory change – sets up for that inventory dynamic to rush through the pipeline. (Although the timing of this statistical bounce is fairly uncertain by way of the Chicago manufacturing number discussed below, it may not occur in the third quarter as we currently expect; we’ll just have to see how things progress over the next two months)

A statistical rebound does not make for a sustained recovery, we must see final demand come back and businesses must begin to spend again. In addition, all of the government spending in the world cannot fully offset weak consumer and business consumption. It can foster a three-four quarter increase but not much beyond that.

Residential fixed investment (housing) subtracted from GDP for the 14th straight period, down 29.3% at an annual rate last quarter. The segment reduced GDP by 0.88 percentage point.

So, this latest report, and with the revisions to the prior quarters, shows the economy contracted at a 3.9% in real terms over the past year. This marks a new record since data began in 1947.

This downturn has been severe and the damage done to the consumer will take some time to work out, putting a drag on GDP in the coming quarters. Over the next two quarters, its appears the inventory dynamic and net exports will offer a boost to growth, followed by a reading that more closely resembles something more typical of expansion in the fourth (its four–six weeks to early to throw out an actually number.) Government spending will keep the “dream” alive for the first two quarters of 2010 (most of the stimulus spending will kick in next year) but after that the expansion will peter out as the pay back for the way we’ve attacked this contraction will come due.

The economic rebound needs to be put into perspective, even if we get one, maybe two, 4% readings (although unlikely with unemployment this high and tighter credit standards) these would still be weak numbers coming out a contraction such as this – normally you see a 6.5%-8.0% bounce after rough recessions.

The way I see it the recovery will be similar to the 1980 recovery in terms of its short duration. Notice how the bounce back in GDP is strong after a deep contraction (such as the 1961 recovery following the rough late 1950s contraction, the 1975 recovery following the harsh 1974 recession and the 1982 recovery). I have my doubts that this one will be followed by a strong 6.5%-8.0% quarter even with the huge stimulus money set to roll in 2010

Chicago Purchasing Managers Index

In the day’s other release the Chicago PMI showed manufacturing in the nation’s most significant region improved for a second-straight month. The index rose to 43.4 for July after a 39.9 print in June. While the gauge remains in contraction mode – a move above 50 marks expansion – it is being weighed down by the auto sector. As production come back in autos this reading should move above 50, call it September when it moves back to expansion is what I’m guessing.

Most sub-indices of the report suggest things continue to improve, however, the inventory reading is disturbing as it got slammed back to 25.4 – a record low.

The Rally Rolls

Stock-index futures are up big this morning on last night’s news that China’s manufacturing sector remained in expansion mode for the fifth-straight month. China’s PMI (equivalent to our ISM manufacturing report, which we’ll get this morning) came in at 53.3 for July (a number above 50 marks expansion). While the figure is not raging to robust levels, pretty much holding at this 53 level, the Chinese government is pushing banks to lend aggressively. I haven’t seen the latest number, but the previous reading on credit expansion showed lending tripled from the year-ago level. So long as this is the case, China’s PMI will continue to grow, even if it means big banking trouble down the road.

If U.S. manufacturing shows additional progress toward that 50 mark, we hit 44.8 in June after 42.8 for May, and hit or surpass the estimate of 46.5 when this morning’s figure is released, we should make a run today for 1000 on the S&P 500.
Have a great day!

Brent Vondera

Fixed Income Recap

Today the Treasury will announce the sizes for next week’s 3-, 10- and 30-year auctions and the market is expecting some big numbers. Last week was a rough week for supply, with bid/covers down pretty much across the board, but after everything was said and done, the long end of the curve was higher for the week and the short end was down only marginally.

Some are saying short term yields were up in anticipation of the Fed raising rates soon, but I just don’t how the market can be thinking that now. Bernanke’s favorite phrase continues to be “Economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” And in his last speech, William Dudley, President of the New York Fed, argued, “That it is still premature to talk about ‘when’ we are going to exit from this period of unusual policy accommodation.” How do those words coming from the two most influential monetary policy makers translate into higher short term rates in the near future? I’m confused.

CIT
Little has changed with CIT since they adjusted the terms of their tender offer for $1 billion in notes maturing on the 17th. Analysts are estimating that CIT will need 90% participation from bondholders to avoid bankruptcy, but even if that is successful they will need a few more pieces to fall into place in order to stave off Chapter 11. Debt for equity swaps will likely follow for large issues maturing after this month, and as always, are far from a sure thing. CIT’s “hail mary pass” in all of this continues to be their request to move assets from some of their lending units to their bank. The primary benefit to doing that is the FDIC guarantee on CIT Bank deposits, something that CIT corporate bonds were denied when they did not qualify for the TLGP program. Whether they will be able to move assets to CIT Bank in order to better fund them is in the hands of the regulators, and does not look very promising.


Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks rallied Thursday as stock–index futures reversed from being meaningfully lower early yesterday morning, shifting on a dime to up big after the jobless claims data was released at 7:30CDT and showed another decline in continuing claims. That momentum from pre-market trading flowed into the official trading session and held as the market looked favorably upon earnings reports that, I’m sorry, didn’t seem all that great to me. In fact, the earnings season has deteriorated substantially, now down 30.3% for second-quarter results with 65% of S&P 500 members in thus far.

Stocks were also helped as the nonsensical assumption that weighed on traders Wednesday, this irrational view that China would put the clamps on bank lending, subsided. (This is was really a moronic thought. China’s got uprisings to tamp down, among other things; there is no way they would do such of thing even if it were to their long-run benefit) As a result, the reflation/commodity trade made a comeback as the basic material sector led the broad-market’s rally.

On the earnings reports that got positive press, it appears people are stretching here. For instance, MasterCard processed more purchases in the second quarter even as consumer spending fell, because of the shift, a generational shift, from cash and checks to debit cards. (Debit-card activity rose to 48% of combined card use in 2008, up from 22% in 1999) I really hope people didn’t see the numbers as a sign consumer activity is on the rise (outside of the “cash for clunkers” stimulus, which we’ll touch on below) because that is not what the MC figures say.

There was also Dow Chemical’s results, which were celebrated even though earnings per share (EPS) was down 93% from the year-ago period.

International Paper’s results were also cited as a catalyst for stocks. While EPS massively beat expectations, results were down 64% from the year-ago and a big part of their number came from the alternative-fuel tax credits.

For those of you who remember my comments on these tax credits a few months ago, you know what I mean. For those who don’t, paper companies use a by-product of production (known as “black liquor”) to fuel their plants. The irony of these tax credits is that paper mills must actually use fossil fuels to gain the credits because the legislation states that alternative fuels (black liquor in this case) must be mixed with fossil fuels (because the assumption was that these traditional fuels were already the primary source) in order to receive it. So the industry is actually using more oil, nat. gas, coal etc. than they did before this legislation that was meant to curtail the use of these fuels. For those who may not understand my dismay with increased government involvement, maybe this helps illustrate the unintended consequences that always result. Sorry for getting off on that tangent.

Anyway, we should see a big bang in terms of profit growth two-three quarters out as firms have cut costs to the bone. However, I think too many presently expect this surge in earnings to occur in the current quarter and the final demand is not yet there to boost top-line results. For now, yes companies are beating earnings at an elevated rate but its whipped cream on… well you know, because profits are down big time. And when the earnings rebound does occur it will be short-lived, just as the recovery will be, because the way we’re going about this is not conducive for a sustained expansion.

Market Activity for July 30, 2009
The Money Runs Out

The “cash for clunkers” program (officially the Car Allowance Rebate System, or CARS) ran out of money yesterday, six days after it began. This puts dealerships in a bind as they must destroy the engine of the trade-in before receiving the government subsidy – one wonders how many have been destroyed just as news was coming that the funds ran out.

Nothing to fear though, you can bet Congress will boost funds to the program so it will continue to boost car sales for the next couple of months. But think about the larger issue, shouldn’t we have learned from borrowing from the future after all that has occurred? And that is exactly what is going on here. Oh, and this program adds debt to the consumer, I don’t think this is what we need right here with the unemployment rate pushing to 10% and incomes stagnant. This will undoubtedly reduce personal consumption in future quarters.

And what does this say about the economic state of things. All we hear about is how the economy is going to rebound, yet activity needs to be goosed to a huge degree. (For the record, we believe a statistical rebound is upon us – when Q3 GDP is released in October it will show the first positive GDP print in a year, as I’ve been stating in between a lot of negative comments for a couple of months now – but the recovery will be much much shorter than that with which we’ve grown accustomed)

So the government will expand the $1 billion CARS program to, who knows, another $2,3,5 billion in order to get it through to November, which was its original timeline. This will boost auto sales a bit for July and probably get us well over 10 million units at an annual rate for August. This, like a number of other things, will juice that euphoria we’ve been talking about for a while now, but then auto sales will slump again and people will look around and wonder, what now?

Initial Jobless Claims

The Labor Department reported initial jobless claims rose 25,000 to 584,000 for the week ended July 25, remaining below that 600K level but I’ve got a feeling we’ll see that mark eclipsed again. The four-week average fell for a third-straight week as the average does not involve a 600K initial claims figure for the first time since January.

Continuing claims fell 54,000 to 6.197 million in the week ended July 18 (one-week lag for this figure). While continuing claims remains far above anything we had seen during past recessions (since this data began in 1967), it has declined substantially over the past three readings.

If not for the average duration of unemployment that continues to hit new records, 24.5 weeks as of the latest monthly jobs report, I would see this move lower in continuing claim as a very welcome sign, very bullish in fact. But since this is not the case, one has to view the fall in continuing as either a function of seasonal-adjustment problems due to the timing of auto plant shutdowns (although the Labor Department stated that these distortions have “worked themselves out”) or the expiration of benefits. Of course, both issues may be playing havoc with the reading as the revisions may show.

We’ll find out if these assumptions are correct very shortly. The first sign will come on August 6 when the July employment report is released. It will show a substantive decline in the duration of unemployment if this drop in continuing claims is for real. (As mentioned a few times, I expect the pace of monthly job losses to ease substantially either in the July report or most likely by the August reading to 150K-250K in monthly losses from this very elevated level of 400k-500k Still, this does not help continuing claims as hiring remains nearly non-existent) After that Aug. 6 jobs report, we’ll see it in the claims data itself. If the labor market has truly improved, then continuing claims will not rise again even as the duration with which one can collect jobless benefits extends, read below.

For now stocks remain on their “sugar high,” getting a boost from another decline in continuing claims. But beware, states are in the process of extending benefits to 59 weeks from 26 weeks (that’s right, 59 weeks). These 33-week extensions were supposed to kick in for all states in July, but several states are having a problem identifying who is eligible so the extensions will not be fully implemented until sometime in August. If this claims data begins to move in the wrong direction again, and that Super Ring Blow Pop is sucked dry, the market may soon be crying itself to sleep.

Have a great weekend!


Brent Vondera, Senior Analyst

Notes from Cerner's earnings call

Cerner’s 2Q09 earnings were $43.7 million, up 23.8% from 2Q08, and diluted earnings per share of $0.52, up 23.8% from a year ago, however coming short of analysts’ estimate of $0.551. Bookings in the second quarter came in strong at $394.0 million, with a total revenue backlog of $3.7 billion, up 12% over the year-ago period. New bookings included 19 contracts over $5 million, 9 of which are worth over $10 million a project.

Cerner said that the market place is still very conservative. Companies are building up their cash balances to enhance their balance sheet so they can secure better financing options in the current market conditions. In addition, uncertainty in health care reform contributes to conservative spending.

System initiations are coming in at slower rate than they would have liked, and uncertainty surrounding the health care reform is preventing many hospitals and doctors offices from being proactive. Cerner remains very cautious still on 2009, yet at the same time they expect the second half of 2009 to show a clear picture of what the future holds for the healthcare system, and possibly some benefits realized in 2010.

Cerner will benefit from Stimulus money flowing into hospitals who then will use the money to buy Cerner’s products and services. The company also sees opportunities with their existing customers that have adopted only certain areas like electronic billings, but have yet to adopt electronic medical records or computerized order entry systems. It will largely depend on what “meaningful usage” will be defined by healthcare reform legislation. With breadth and depth of Cerner’s product line and its ability to work with client needs, Cerner will be a major beneficiary of stimulus money flowing through the industry.

Cerner certainly is putting a lot of hope into future earnings. The company anticipates second half earnings to compensate for rather weak first half earnings due to the “spend it or lose it” nature of hospital budget spending. They also expect a clearer picture of the reform will boost demand for their product. Even though it sounds like they keep pushing their promises to a later date every quarter, it is reasonable. It is hard not to think that this is the path we are going to, validating hope with some reason.

Cerner lowered their full 2009 revenue outlook to $1.7 to $1.75 billion from $1.75 to $1.8 billion, but kept their diluted earnings per share before stock options unchanged at $2.40 to $2.50.

CERN is currently changing hands at $64.86, coming in at flat from yesterday’s closing price, erasing most of after market loss after the earnings announcement.

Daily Insight

U.S. stocks closed lower for a second-straight session but once again pared earlier losses in the waning minutes of trading. The broad market recouped 70% of the day’s decline in the final hour.

This market has some things tugging at it up here at the top-end of the range – the earnings season is showing some deterioration as we get more reports, data continues to show the labor market remains unusually fragile, there’s early concern Treasury auctions may put pressure on rates and overall conditions, while better, now match the worst we see during the normal recession – yet it remains resilient. This is probably a sign we’re going higher after some consolidation, but it’s a precarious economic situation and all it takes is one major report to come in worse than expected and we go meaningfully lower.

El-Erian of PIMCO says stocks are on a “sugar high.” Some find it tough to argue with this statement. Just like kids on a candy binge, one minute they are running wild, the next they’re crying themselves to sleep.

A 5% decline in the Shanghai Composite (our Tuesday night) is what led to the pressure stocks had to deal with yesterday. Speculation the Chinese government will put the clamps on bank credit – that’s laughable – led to concerns China’s growth will ease. This was most evident here at home by way of the commodity trade – copper down 2.27%, crude off by 6.40% and aluminum down 3.5% -- as traders feared Asian commodity purchases will slow.

Telecom, consumer staple and health-care shares were the winners yesterday. The other seven of the 10 major industry groups closed lower, with energy and basic material shares as the worst performers.

Market Activity for July 29, 2009

Mortgage Applications

The Mortgage Bankers Association reported their index of mortgage applications fell 6.3% in the week ended July 24 as refinancing activity fell 10.9% with no help from the purchases side, which came in unchanged last week. On a year-over-year basis, the overall mortgage index is up 16.1%; purchases are down 15.1% and refinancings have jumped 73.3%.

The 30-year fixed-rate mortgage rose to 5.36% from 5.31% in the week prior.

Durable Goods Orders (June)

The Commerce Department reported that durable goods orders fell 2.5% ( a decline of 0.6% was expected) after the first back-to-back monthly increases in a year – the May figure was downwardly revised to show a 1.3% increase (initially reported as a 1.8% increase) and orders were up 1.4% in April.

On the bright side, orders for machinery and primary metals jumped 4.4% and 8.9%, respectively (and that machinery figure was up from a strong 7.3% rise in May). What dragged the figure lower was a huge 38.5% plunge in commercial aircraft orders (but this is a highly volatile figure so you don’t put much emphasis on moves in these orders, they rose 60% in May), a 2.5% decline in computers/electronics and a 1.0% decline in vehicle and parts.

The ex-transportation reading rose for a second-straight month, up a really nice 1.1% ( this reading beat the expectation of no change) -- and this is the number you want to focus on especially for months in which commercial aircraft records such large moves, either up or down. This increase followed a 0.8% increase in May – it’s down 22.2% year-over-year.

The best news out of the report was the rise in non-defense capital goods ex-aircraft orders (the proxy for business spending), up 1.4% in June following a 4.3% rebound in May, which was off of a tough couple of months in April and March. This segment is down 21.1% year-over-year, a collapse but up from the post-WWII record low of -27.1% in April. The three-month annualized figure is showing real improvement – up 0.4% (actually positive) in June after registering -15.5% in May and -30.6% in April.

We’ll have to wait to see, which is the appropriate approach with all of the data as some of these better numbers bounce off of deep lows, whether its for real or not. Even if it is only a bounce and not something longer lasting, it should provide that statistical bounce to GDP we’ve been waiting for by the third quarter.

The shipments figures have yet to respond, and this is what funnels into the GDP results. Durable goods (ex-transportation) shipments were down 0.5% last month, which followed a 1.4% decline in May. This should pick up on the heels of the May and June rise in orders, offering a boost to that Q3 GDP reading.


Fed’ Beige Book

The Federal Reserve released its report on economic conditions within each of its 12 districts – this survey covers the past six weeks leading up to July 20. I generally don’t spend much time on this as we go over these things on a daily basis, but here were some of their comments:

The survey showed that labor and real estate market conditions remained weak and credit conditions tight, but did involve some better news than the previous survey as most regions saw signs of the recession easing.

Most districts indicated that “the pace of decline has moderated since the last report or that activity has stabilized, albeit at a low level.”

Most districts also reported “sluggish retail activity” with Cleveland, Minneapolis and Richmond reporting deterioration in sales.
(I was going to make a comment on the Cleveland home-price data via Tuesday’s CasShiller Home Price Index reading. Cleveland showed the largest monthly increase (up 4.1%) of all of the cities covered, according to that report. I found this odd as we know that that region has been hit especially hard by weak manufacturing activity, particularly among auto and auto parts production. I refrained from stating this yesterday as my overall comments have been negative enough over the past few months, but with this statement out of the Beige Book thought it was worthwhile mentioning it today. I think what you take from this is the high probability that the recent home-price increases are short-lived, they’ll go down again before the eventual sustained move higher)

New York, Cleveland, Richmond, St. Louis, KC and San Fran reported weaker demand for some categories of loans. (This is something we’ve discussed on several occasions. A lot of people are watching the very positively sloped yield curve as a sign economic activity will erupt – normally a very good indicator. While banks’ ability to borrow low and lend higher will over time offer great incentives to boost the supply of loans, it does nothing for the demand side. If businesses and consumers do not have the desire, or ability, to borrow, this indicator is much less reliable in predicting the future path of growth)

Most regions indicated that labor markets remain very fragile as most regions either reducing positions or holding steady. Aggregate employment continues to decline. The report showed a preference among firms for part-time workers rather than full-time. (This means that the U6 unemployment rate is going higher, currently at 16.5% – U6 is the official unemployment rate, plus discouraged workers, plus those working part-time because they cannot find full-time work)

There were pockets of better conditions in the labor market, specifically in the health-care (only component not to show a cut in payrolls during this recession), tech and defense-driven aerospace.

The most downbeat aspect of the report covered the state of the commercial real estate market, as the weakness in this area worsened in eight of the 12 districts.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Tuesday’s 2-year auction was less than stellar, but the general market attitude remained optimistic going into the second half of this week’s supply. Bonds opened strong on Wednesday, catching a bid on weakness in stocks overseas and it seemed as if supply concerns were fading by midmorning. In the hour or so before the auction yields started to creep up and were blown wide open when the results of this year’s worst Treasury auction were released.

I didn’t see it coming, and neither did the majority of the market as the weakly bid auction priced at 2.689%, 5 basis points higher than the market at 1 pm, with a 1.92 bids for every dollar of bonds sold, a weak number compared to the recent average of 2.26 for 5-year auctions.

Indirect bidders took 36.7% of the auction, a lower percentage than expected. The Wall Street Journal has an article sighting some interviews with major traders who are speculating that foreign buyers of Treasuries, who are historically large buyers of short-term US debt, are becoming increasingly concerned with higher rates and as a result have moved even further down the curve. In addition to the $115 billion in coupon Treasuries, over $100 billion in bills are being auctioned this week. Foreign central banks concentrating more on bill auctions instead of the 2- and 5-year auctions could explain some of what’s going on.


Cliff J. Reynolds Jr., Investment Analyst

Quick Hits

• China Sparks Drop in Emerging-Market Stocks
• GE Says Forced Finance Break ‘Increasingly Unlikely’
• Bernanke May Have to Sacrifice Lending Powers or Independence
• In a Savings Shocker, the Government Discovers That Paper Has Two Sides

Norfolk misses the mark

Norfolk Southern (NSC) said second-quarter profit dropped 45%, missing analysts' estimates, as lower revenue couldn’t offset the company’s cost cutting. Revenue plunged 33% on a 26% drop in volume and much lower fuel surcharges during the quarter.

Volume declined more than 20% across all segments, except in agriculture which declined 14%. Automotive volume was the worst performing segment, down 48% versus the prior-year period. Volume in Norfolk’s coal segment – which accounts for 29% of revenue and is the company’s largest segment – dropped 26% due to lower electricity demand, high inventories at utilities, competition from cheap natural gas, and low global steel production. Both automotive and coal volumes stand to improve in the coming quarters.

Fuel expense decreased 69% due to 26% fewer gallons consumer and sharply lower prices for diesel - $1.55 per gallon versus $3.58 per gallon last year. Still, Norfolk’s gross profit margin shrank 370 basis points to 74.8%. More concerning was Norfolk’s significantly lower first-half free cash flow of $104 million, or 2.7% of sales, compared to last year’s solid $448 million, or 8.5% of sales.

NSC shares finished the day -1.90%

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Peter J. Lazaroff, Investment Analyst

General Dynamics reports strong Q2 results

General Dynamics (GD) reported strong second-quarter results as revenue climbed 10.9% to $8.1 billion and the company raised its full-year earnings guidance.

GD also excited investors by reporting better-than-expected margin performance, particularly in business jets, expanded its operating margins 70 basis points sequentially to 11.7%. Equally impressive, the company’s total backlog is 22% higher than it was a year ago, standing at $66 billion.

The combat systems segment, which supplies tanks and machine guns, had a quarterly revenue increase of 19%. Meanwhile, the marine systems and information systems divisions posted revenue increase of 17% and 4%, respectively.

The Gulfstream business jet division continues to be an area of weakness, with profits falling 10% despite revenues growing 6.5%. The recession has eroded business demand for expensive planes and created a large glut of used jets that are for sale. What’s encouraging is that management said they see signs that the business jet market is stabilizing. Management said these signs include increased flying hours at the Gulfstream jet division, a drop in customer defaults, and increased new-order interest.

GD shares finished the day +1.51%

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Peter J. Lazaroff, Investment Analyst

WellPoint (WLP) profit slumps on weak economy and investment losses

Rising unemployment and higher investment losses led WellPoint’s (WLP) second-quarter profit to fall 7.6%. The company lowered its full-year 2009 earnings forecast to reflect first-half investment losses and cut its membership projections to reflect layoffs among its corporate clients.

More importantly the medical-loss ratio – the percentage of premium revenue used to pay patient bills – was higher than expected at 82.9%. Analysts consider the ratio a predictor of a health plan’s profitability.

Management noted medical expense growth would be at the higher end of the guidance range for the year due to slight increases in member use of medical services, unit-cost increases, and higher-than-usual flu activity. The company now expects a higher full-year medical cost ratio than it previously predicted.

WLP shares finished the day -5.70%

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Peter J. Lazaroff, Investment Analyst

Fixed Income Recap

Yesterday’s auction results were surprisingly bad. $42 billion in 2-year notes were sold at a yield of 1.08%, 2 basis points higher than the market. Anytime an auction for a short duration note is off the market by that much it’s a sign the market is caught off guard. The bid/cover was 2.75, lower than the 6 month average of 2.82 and well under the previous auction’s bid/cover of 3.19. Indirect bidders took just 33% of the bonds sold, well under what most of the market, including me, were expecting and the main reason why the auction results were so poor.

The results were less than desirable, but I don’t feel this is any sort of “beginning of the end” type situation for the Treasury. Although you might read other blogs and articles that paint a much dire picture, I don’t think yesterday’s results were all that terrible. The long end of the curve rallied which would not have happened if the less than stellar auction was the result of some large underlying problem. And even the bonds that will be auctioned today and tomorrow hung in there. The 5-year was down but outperformed the lagging 2-year and the 7-year finished higher for the day – a good sign despite the sloppy auction.

S&P cut its rating on Ambac from BBB to CC, just two notches above default status. Moody’s dropped its rating on Ambac to junk status in April, so this is no monumental development but it could have an effect on the market. S&P was the last ratings agency to maintain an investment grade rating on Ambac insurance, and now that it’s gone it could force some selling in Ambac insured issues. Municipal bonds are largely owned by retail investors with money managers that have strict guidelines on owning only investment grade issues. Many smaller municipal issuers aren’t rated themselves, so they rely entirely on the rating of the insurance. There are still a few bond insurers that remain AAA, and some issuers have already chosen to repurchase insurance for their outstanding debt. I expect more to do the same with this recent downgrade.


Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks fell for the first day in four as consumer confidence fell for a second-straight month. Worse-than-expected same-store sales results from Coach Inc. and Office Deport only increased concerns regarding the consumer.

Still, the market nearly shook off the weakness late in the afternoon session, the S&P 500 was down as much as 1.4% just before lunch, closing lower by just 0.25%. This is pretty remarkable considering what the readings on the consumer are showing. The labor market is going to keep the largest part of the economy fairly inactive and people will continue to focus on building cash savings. There seemed to be some illusions that personal consumption would make a comeback sooner than what is realistically likely, I think those illusions will dissipate as we get results for the back-to-school season.

While it is true the gridlock in Washington right now is a huge help in buoying the broad market as it appears the worst we’ve feared on the policy front will not come to fruition. Better-than-expected profit and housing-market results are major contributors as well. However, we’ve rallied 47% from the March 9 low and we still have another wave of housing issues to deal with -- I fear, a commercial real estate turndown that may only be in its mid-innings, consumer defaults on the rise, and a number of actions from Fed programs to administered loan modifications to government transfer payments to artificially low interest rates to cash-for-clunkers (which will offer a one-two month boost to auto sales but nothing more) that will be taken away. The market knows these are not sustainable or longer-lasting policies yet stocks continue to hold the high ground. The resilience is a good sign, but you’ve got to be prepared for a meaningful pullback, don’t get too excited and chase this thing – hold steady

American Express and Exxon led the Dow Average lower – AMEX because the stock has gotten ahead of itself at 26 times earnings and CC defaults in record territory and Exxon pulled back with the entire energy sector after British Petroleum’s CEO stated there is little evidence of a recovery in energy demand.

Utility, energy and basic material shares led the decliners. Technology, telecom, health-care and consumer discretionary (strangely) led the advancers. Roughly 1.1 billion shares traded on the NYSE Composite, about 12% below the three-month average.

Market Activity for July 28, 2009
S&P/CaseShiller Home Price Index

The S&P CaseShiller index showed that home prices fell 17.06% on a year-over-year basis in May for the 20 major metro areas the composite tracks – economists were expecting a 17.9% decline.

While still harsh, this reading marks the second month of improvement for year-over-year results. The improvement is most evident by way of the three-month annualized change, coming in at -8.81% in May after an 18.11% decline for April and a 25.26% plunge in March.

On a monthly basis, CaseShiller showed the first increase in nearly three years, up 0.45% as 14 of the 20 cities tracked registered a gain in prices – this is non seasonally-adjusted (NSA); S&P does release a seasonally-adjusted figure after the official release, which showed prices declined 0.16% June to July.

Certain cities in the West -- LA, Seattle, Phoenix and Vegas -- and the two from Florida – Tampa and Miami – continue to show price declines even on a monthly basis. These are the areas that have witnessed the highest levels of foreclosures. These six cities also make up roughly a third of the total index, which is why we’ve explained that the heavy weight to these foreclosure-laden cities causes this index to exacerbate the decline in home prices.

The other housing-market gauges also showed that prices rose in May, but the market will continued to be challenged by rising foreclosure filings and a lack of demand due to the fragile labor market. I wouldn’t expect a string of increases, but it is pretty clear that we’ve moved beyond the extremely depressed nature of housing to an environment that remains considerably less bad, yet still uncertain.

Consumer Confidence

The Conference Board’s Consumer Confidence reading fell for a second-straight month in July as worries over the nature of the job market worsened enough that the rally in stock prices were unable to offset. The headline survey hit 46.6 this month, which puts the index at the low points of the past four recessions – 1974, 1980, 1981-82 and 1990-91 (FYI, I don’t term the 2001 downturn a recession because it never recorded back-to-back declines in GDP).

The most important reading within the survey, especially with the jobless rate pushing to double-digits and the duration of unemployment at an all-time high (going back to 1947), is the net jobs “plentiful” jobs “hard to get” figure; the reading hit a 26-year low of -44.5 (lower segment of chart below). Those citing jobs as “plentiful” fell to 3.6% of respondents, down from 4.5% in June. Those stating jobs as “hard to get” jumped to 48.1% from 44.8% in the prior reading.

We have cautioned against the tendency to get excited as the confidence readings rose from the deep lows hit in February and March as the stock market rose from its lows. Some seemed to assume the bounce off of these levels was a sign further improvement in sentiment would ensue. Unfortunately, we’re now seeing the troubled state of the job market (and the decline in wealth even if the stock market has rallied hard off of its lows) is keeping consumers’ outlook in the tank and this does not bode well for a sustained housing rebound and certainly does not indicate that consumer activity in general is poised to make a steady comeback.

Economically speaking, we will very likely see GDP post its first positive print in a full year when the third-quarter figure comes out in October, but this will be a statistical recovery off of very low levels. The consumer needs time to get things right again, and businesses will take their time before they increase payrolls. As a result, the largest segment of the economy will continue to pressure on growth. We’ll see how the bulk of the stimulus spending (flowing through in 2010) counters this decline in personal consumption.

Richmond Fed

On a brighter note, the Richmond Fed reported that their index of factory activity remained in expansion mode for a third-straight month, jumping to 14 in July from 6 in June.

All sub-indices of the survey either rose or remained in expansion mode with the exception of employment. New order volume jumped to 24 from 16 in June, shipments rallied to 16 from 2 and capacity utilization doubled to 14 from 7. These are great moves, now if we can get the various other regional manufacturing reports to show the same degree of improvement, and the national factory survey (ISM) to move closer to expansion mode, it will help confirm the third-quarter of 2009 will post the first positive print on GDP in four quarters.


Have a great day!


Brent Vondera, Senior Analyst

Quick Hits

• Fed’s Yellen Sees First ‘Solid’ Signs of End to Slump
• Bashing Goldman Sachs Is Simply a Game for Fools
• Skeptics Continue to Abound

TEVA has a stellar second quarter

Teva Pharmaceutical Industries Ltd (TEVA) had a stellar second-quarter, with profits rising 25% on revenue from Copaxone and greater-than-expected savings from the acquisition of Barr Pharmaceuticals.

Sales climbed 20% to $3.4 billion, with currency negatively impacting sales by 9 percentage points. Revenue in the U.S., which accounts for 63% of Teva’s sales, jumped 36% driven in part by the new generic version of the hyperactivity drug Adderall XR.

After purchasing Barr Pharmaceuticals last year for $7.4 billion, Teva said they are ready for another major acquisition and could look beyond generic drugs to areas such as specialty or biotechnology. Such an acquisition could decrease the ratio of generic sales, which currently stands at 70%.

Fueling enthusiasm for the company today was that Teva projected 2010 earnings to be 30% to 35% higher than the 2009 results.

TEVA shares finished the day +4.21%
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Peter J. Lazaroff, Investment Analyst

JEC down 7% on bad earnings report

Jacobs Engineering Group (JEC), the second-largest publicly traded U.S. engineering company, reported a 13% decline in earnings as the global recession weighed on demand. Jacob’s also lowered the top end of 2009 earnings guidance, which was already reduced just three months ago.

Revenue declined 7.3% to $2.7 billion and operating margins declined 40 basis points from a year ago. Weaker margins reflect the current weaker pricing environment for engineering and construction services, especially relative to the very robust spending environment one year ago.

Jacob’s backlog finished the quarter at $15.8 billion, a 5% decline. The bulk of the $665 million removed from the company’s backlog was due to an upstream project cancellation. With 75% of sales in North America, Jacob’s results will continue to be pressured by weaker engineering and construction spending, particularly in the oil and gas industries.

JEC shares finished the day -7.21%
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Peter J. Lazaroff, Investment Analyst

Amgen (AMGN) profit rises 40%

Amgen (AMGN) had a fantastic quarter, beating both top and bottom line projections by cutting R&D expense and increasing sales of its arthritis drug Enbrel. The company upped full-year guidance in anticipation of continued strength in the second half of 2009.

The world’s largest biotechnology company recorded $3.7 billion in revenue, which is 1% less than a year ago, but represents a 12% increase from the first quarter 2009. Weighing on the revenue number was a 16% drop in sales of Aranesp, a treatment for anemia that was once Amgen’s top-selling drug, and unfavorable foreign currency exchange.

More importantly, Amgen continues to generate impressive levels of free cash flow, reaching $1.54 billion in the second quarter, or 41% of sales.

In addition to a strong quarter, Amgen announced an ex-U.S. denosumab partnership with GlaxoSmithKline (GSK). The deal is receiving praise from many analysts since GSK has great experience and the terms of the deal were favorable.

Going forward, investors will be eyeing the FDA advisory committee meeting for denosumab in August, and expectations are very high. Also of note, new data for Vectibix could bring big upside for the stock if the drug yields strong data in the first and second-line colorectal cancer.

AMGN shares finished the day +2.72%
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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks spent nearly the entire session lower on Monday as disappointing earnings results from Verizon, and to a lesser extent Aetna, appeared to offset the biggest jump in new home sales in eight years. But it’s tough to keep a good market down, the major indices rallied in the final minutes of trading to close higher.

Verizon’s results received a lot of attention yesterday and seemed to be the main reason stocks spent much of the day below the cut line. Between the company’s enterprise business (illustrating the business community remains in caution mode) and phone line (showing the troubled nature of both households and business) segments, the results weren’t helpful for the more optimistic of economic outlooks.

Financials, industrials, material and energy stocks led the way – material stocks got a boost from another big day for Dr. Copper; the metal continues to suggest reflation is in the works; energy caught a bid as oil extended its winning streak to nine sessions. Our dear dollar, down again.

Information technology, utility and consumer staple shares struggled. These areas weren’t down by much but were the only three of the major industry groups that failed to show green.


Market Activity for July 27, 2009
Shrinking Loan Activity

An analysis by the Wall Street Journal shows that total loans at the top 15 U.S. banks (which account for 47% of federally insured deposits) fell 2.8% in the second quarter. More than half of the loan volume came from refinancing activity and renewing existing credit lines, not new loans.
This is why we caution taking too much from indicators such as a very steep yield curve – under normal circumstances such a large difference between the rate at which banks borrow and the level at which they loan money would make for a green light in terms of economic activity, but this is not a normal contraction. Another factor leading to lower loan activity is the fact that the demand for loans is also down. Commercial and industrial (C&I) loans are off 14% at an annual rate year-to-date, as measured by the St. Louis Federal Reserve Bank.

Loan activity will eventually rebound of course, but it will take time and in the meantime will put pressure on economic growth.

New Home Sales

The Commerce Department reported that new home sales jumped 11% in June to 384,000 at an annual pace, blowing by the estimate for just 352,000 (although the 36,000 new homes that were sold in the entire country last month was less than the 45,000 foreclosure filings in California alone during June).

This marks the third-straight month of increase, just as existing home sales have recorded, yet the three-month average of 356,000 remains below the December reading of 374,000. (That December reading is a number we’re watching as a level to gauge future sales activity against as the actual low put in on new home sales that occurred in January was due to harsh weather conditions, and the weak results in April and May were likely affected by two months of very rainy conditions, so I view the December figure as the weather-adjusted low).

Sales of new homes are down 21% from the year-ago period, but falling prices (down a huge 5.8% in June) and near record low mortgage rates are now helping to offset high levels of joblessness.

In terms of region, new home sales jumped 43% in the Midwest, 29% in the Northeast (although not much of a player in the new home market) and 23% in the West (the combination of plunging prices and California’s additional $10K tax credit for new home purchases is driving sales in this region). Sales declined 5% in the South, the largest market for new homes.

The median price of a new home fell 12% to $206,200 from $234,300 in June 2008.

The inventory-to-sales ratio remains elevated, but the three-month rally in sales and a huge decline in construction have made very nice progress in pushing this number lower. The inventory-to sales ratio for new homes declined to 8.8 months’ worth, down from 10.2 in May. Let’s hope the labor market has made a significant turn for the better several months out because the housing market will need it when the tax credits expire and very low interest rates are no longer with us.

The new-home sales report kicked off a big week of data.

Today
Case/Shiller Home Price Index (May) – it’s so outdated but gets a lot of attention; C/S should show another month of mild improvement but its heavy exposure to foreclosure-riddled areas will keep it depressed relative to other housing indicators
Conference Board’s Consumer Confidence Survey (July) – expect it to fall after the big June job losses, although rising stock prices should offer some support

Wednesday
Mortgage Applications (w/e July 24)
Durable Goods (June) – expect it to fall after two months of gain, businesses are not yet close to spending and consumer-appliance sales will remain subdued

Thursday
Initial Jobless Claims (w/e July 25) – watch it move higher as firms continue to shed jobs; it will be interesting to see how continuing claims react after two weeks of big declines, a function of benefits expiring?

Friday
GDP (initial estimate for Q2) – expect a decline of 1.5%-2.0%, marking the fourth-straight quarter of decline; prior to this contraction we have not had more than two-straight negative quarters going back to WWII
Chicago Purchasing Managers Index (July) – it should move mildly higher but remain in contraction mode with auto production weak

In addition to this data we’ll get a number of Treasury auctions totaling $200 billion in debt issuance – these auctions are typically non-events but are closely watched now with massive government borrowing and the heavy debt issuance that results. The day that one of these auctions “fail,” people say no to a sub-4% 10-year note, will mark another trouble spot for the equity markets.



Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries sold off yesterday on a stock market that strengthened as the day wore on in addition to some selling in the market on continuing supply concerns. The curve continued its week long steepening trend to +268 bps as stronger demand for shorter term notes continues to buoy that portion of the curve. Foreign central banks are a major buyer of the short end right now, and with 2-, 5- and 7-year notes coming to market over the next three trading sessions the market is just rallying into the auctions. In early Tuesday trading the ten-year has already rallied back to where it was before yesterday’s selloff, the two year has made back half of its 4 basis point skid.

The $6 billion TIPS auction was bid fairly well. The auction was a reopening of the existing 20-year and came in about 5/64 cheaper than where the market was trading at the time. The yield came in at 2.387%, and the bid/cover for the auction was 2.27, higher than the last 20-year TIPS auction in January. Breakevens were mostly unchanged, wider by just 4 bps in afternoon trading.

$42 billion in 2-year notes will be auctioned today, $2 billion more than the last four 2-year auctions. Look for the indirect bid, the group of bidders that includes foreign central banks, to again dominate. Last month’s 2-year auction sent 68.7% of the bonds to indirect bidders – I wouldn’t be surprised if that number is even higher for today’s auction.


Cliff J. Reynolds Jr., Investment Analyst

Quick Hits

• Make Money, Whatever Happens to the Economy
• Real Yields Highest Since 1994 as Treasury Sells Record $115 Billion Bonds
• Fear, Falling Demand Keep Loans Shrinking

Daily Insight

U.S. stocks gained ground again on Friday, pushing the broad market higher by 4.13% for the week. Better-than-expected economic and earnings reports -- existing home sales rose for a third-straight month, the Leading Economic Indicators (LEI) index posted another increase and earnings results show the decline in Q2 profits will decline at a 25%-30% rather than the 35% fall off that was expected – pushed stocks higher for a second week.

We were backing off of the high end of this trading range prior to this latest rally as the broad market fell for four straight weeks, but the 11% surge in the last 10 sessions has put in a new upper level as we are just 2.5% from the Election Day mark of 1005.

The only interruption to last week’s rally was a fractional decline on Wednesday and it doesn’t look like much will get in the way of investors’ desire to push this market higher, we’ve got people worried about missing out and that means new money is likely to keep moving in for a while still. We’ve got a big week ahead of us though and with $200 billion in Treasury issuance – who would have thought we’d be talking about such numbers in one week’s worth of auctions just a year ago? – and these events will be met with heightened anxiety; all it takes is one auction to go bad.

Health-care and utility shares led Friday’s advance – strange for these two areas of safety to lead the way when the bulls are running, maybe the wall the two consequential pieces of legislation ran into last week (health-care and cap & trade) played a role. It may have also been the move lower in the latest consumer sentiment reading that caused a move back to safety – one never knows on a day-to-day basis. Tech shares were the worst performing sector, which pushed the NSADAQ Composite to its first loss in 12 sessions.

Market Activity for July 24, 2009

And speaking of which, on Friday we talked about how the gridlock over the health-care legislation is the best news we’ve seen in a long time. Yes, the leading indicators index is pointing up, 77% of earnings results have beat estimates and home sales and housing starts are on three month upswing.

But hang on, these positives data readings could end up fooling people into a false euphoria – and recall we’ve talked about being aware of a euphoric trend as we begin to see things improve. The problem is we’re very likely headed for a statistical recovery rather than something more sustaining. The leading indicators are being led by interest rate spreads, but this misses the low demand for loans, and housing starts, which one cannot expect to last due to the supply glut, so I would be cautious of this LEI index.

Additionally, the better earnings results (another factor in LEI) are based upon very low-bar hurdles – profits are down 25% from a year ago and revenues have been hammered, which shows the lack of final demand. Let’s not get ahead of ourselves here, stocks are up 47% from their 12-year nadir hit on March 9 and the troubles in consumer-land will pressure growth.

We also have actual home sales looking better over the last three months and it certainly looks like housing has stabilized. But can we count on continued gains with the consumer de-leveraging process far from done and higher tax rates (expectations that after-tax incomes will fall) and a poor job market will not help this situation. Until this works its course, it’s tough to see a sustained housing comeback, just yet.

(We received the latest consumer sentiment reading on Friday, which declined for the first time in four months. The University if Michigan’s Consumer Sentiment survey showed that consumers believe the economic freefall is over but are now focused intensely on a weak job market and the unlikely prospect of income growth. The percentage of respondents reporting income gains was the fewest in the survey’s history, which goes back to 1966. Plans to buy homes, autos and durable goods declined as well. The consumer remains the big issue. Businesses are holding back, delaying spending plans too, but personal consumption makes up 70% of GDP. Until the labor market improves this will be a significant drag on growth. We should see a couple of quarters of good growth in 2010 as nearly a trillion dollars in government spending kicks in. This will likely be able to offset the weak consumer activity but only for a short while.)

But the rebuff on the Obama (actually the Pelosi bill as she’s been more instrumental in writing it) health-care plan is a really good sign and it also looks like gridlock is helping on the other destructive agenda – cap and trade. Now let’s hope the administration doesn’t shift its focus to pushing through another one of their stimulus plans – this will not help the corporate outlook. Businesses know that the more the government spends, especially with regard to the current degree of outlays, that this will have a crowding out effect as capital is sapped from the private sector – the true area of growth.

It appears we may not get the worst some (including myself) had worried about in terms of policy, but even if national health care and C&T are dead we’ll still get massive deficits and debt issuance, higher tax rates across the board, and a regulatory regime not seen since the 1970s. We’re now back to 16 times earnings on the market now – valuations are reflecting that the worst by way of policy may not occur. But from here the market will need real structural economic performance and we are quite a way from there at this point. So my message, as has been the theme since returning to 900 on the S&P 500 on May 4, is to continue to be careful here, don’t increase risk by chasing this rally.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasury supply will weigh on the minds of traders this week. The Treasury plans to auction $115 billion in notes over the next four days, the second time in the last three weeks the Treasury has held four days of auctions in the same week. Including bills, this week’s supply is over $200 billion. The $115 billion number includes a $6 billion 20-year TIPS auction today. The level of success in this week’s auctions will be the primary dictator of rate movement this week.

On Friday, CIT altered its offer to purchase its outstanding floating rate debt due on August 17. Those who agree to tender their bonds before the end of July will still receive the original 82.5 dollar price, but those who sign up after that will only receive 77.5 cents on the dollar. This move may get more bondholders to respond sooner, but in doing so CIT runs the risk of deterring investors from participating altogether. The tender offer is very important to the survival of CIT because they are not allowed to use any of the $3 billion raised last week to pay off the $1 billion in debt that matures in August. If the tender fails to attract enough interest CIT will likely be forced into chapter 11, instead of trying to manage a restructuring outside of bankruptcy court. The bonds were trading in the low $80’s last week, a good sign considering the $82.5 tender price.


Cliff J. Reynolds Jr., Investment Analyst