DELL, SO, MON, PG

S&P 500: +12.31 (+1.36%)


Dell (DELL) +0.78%
Dell reported less revenues and profit than last year, but the company still managed to beat analyst’s earnings expectations for the first quarter thanks to cost reductions.

CFO Brian Gladden said sales fell because of less demand from business customers and Dell’s decision to avoid price cuts. Dell said signals about the demand environment are mixed, but the company is preparing for what it believes will be a “powerful replacement cycle,” due to new products from Microsoft (MSFT) and Intel (INTC).

The company did not provide a specific financial outlook, but did announce it would slash another $1 billion in costs. That added to the $3 billion it had already pledged to cut annually within two years. Gladden sees the biggest opportunity for saving money in the cost of goods sold, including expenses from manufacturing and supplies.


Southern Company (SO) +0.42%
Southern Company announced it will manage and operate the U.S. Department on Energy’s new National Carbon Capture Center, which will develop and test advanced technologies to capture carbon dioxide from coal-based power plants. Arch Coal (ACI) and Peabody Energy (BTU) are among other partners.


Monsanto (MON) +3.99%
Earlier this week, Monsanto said earnings this fiscal year will be at the low end of its previous forecast because of stronger-than expected competition in its Roundup herbicide business.

The company is sacrificing Roundup sales volume to maintain prices amid increased competition from cheaper generic glyphosate herbicide from China. CEO Hugh Grant was surprised at how quickly and how much Chinese generic versions recently reached global markets. The generic version retails for about $20 a gallon, compared with $30 for Monsanto’s Roundup Grand.

The company expects growth in seeds to offset any decline in Roundup sales.

Procter & Gamble (PG) -1.24%
Yesterday, P&G said fiscal 2010 profit may rise as much as 4 percent as it introduces new products and doubles its distribution capacity in emerging markets.

The company raised some prices in some markets to cover fluctuating exchange rates, although it had to cut prices in categories such as fabric care and tissues to maintain its share.

On the topic of the balance sheet, the company’s primary use for cash will be to maintain its credit rating (Aa3 at Moody’s and AA- at S&P), but will also be used to expand its manufacturing capacity and to maintain the dividend. P&G will stop share repurchase program until the economy improves.


Quick Hits

• New Model Army?
• The Fed’s Balance Sheet
  

Peter Lazaroff, Junior Analyst

Fixed Income Recap

Treasuries rallied for the second day in a row leaving most of the curve unchanged for the week. The two-year finished up 5/64, and the ten-year was higher by 1 7/32. The benchmark curve flattened by 11 basis points, to end the week at +253.5 bps, flatter than we began the week believe it or not. A basis point represents .01%.

Mortgage rates as measured by the Fannie Mae 60-day Commitment Rate spiked 48 basis points yesterday to 5.21%. I normally quote the Mortgage Bankers Association Survey, which is only updated weekly. The Fannie Mae Commitment Rate is a rate commonly used in the mortgage origination industry, and is updated daily. Although it is not reflected in the graph the rate pulled back to 5.11% today.

It was certainly a wild week in rates but we really didn’t get anywhere. Mortgage rates are likely to stay above 5% after this week’s volatility, while the market waits to see if the Fed makes a move. The graph below shows the ten-year Treasury yield starting the week at 3.45%, and ending at 3.456%. If you took the week off you didn’t miss anything.

Next week is without an auction or a Fed purchase in the Treasury market, leaving traders with a few less worries.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Daily Insight

U.S. stocks, after struggling to find their direction during the morning session rallied in the afternoon. Energy shares led the upswing as oil prices look ready to take on the $70 per barrel handle; crude closed at $65.08 yesterday and is above $66 this morning. Financials were the next best performing sector as the Treasury market rallied, easing Wednesday’s concern over higher borrowing costs.

The market is in a gray area here, a state of confusion you might say, as the S&P 500 has traded in a tight range of 880 as the support and 925 as the resistance, just ahead of the 930 wall, over the past 20 sessions. I’m thinking very near term economic data is going to push us below that 880 level but it’s pretty clear that those who have not participated in this rally from the March 9 flagitious low of 666 are holding things up as they want in on the action.

Word that the Fed will boost their purchases of Treasury securities encouraged buying within the market place, full blown monetization of government debt is very likely but that’s another story. A $26 billion seven-year auction also went swimmingly, helping the Treasury market to rally and financials went along for the ride as the worry over a spike in rates eased, for now. One could say this is also why energy stocks jumped, the Fed’s actions will drive the dollar lower over time and that means higher commodity prices.

Treasury auctions are going to be more important than ever due to both fiscal and monetary policy decisions. A big test for this market will be the 10 and 30-year auctions scheduled for June 11 and 12, assuming Monday’s personal spending figure doesn’t blow a hole in the floor.

The day’s economic data was certainly no help; as we touched on yesterday, the market is holding up remarkably well considering what we’re seeing – more on the data below. Beyond the strong session for energy and financials all major industry groups, save consumer discretionary, closed to the plus side.


Market Activity for May 28, 2009


Jobless Claims

The Labor Department stated initial jobless claims fell 13,000 to 623,000 for the week ended May 23, beating the expectation by a bit, which was for a move to 627,000.
The four-week average fell 3,000 to 626,800.

Continuing claims made the 17th straight record high in the latest week, jumping another 110,000 to 6.788 million.

The insured unemployment rate, the jobless rate for those eligible for benefits, rose another tick to 5.1% -- the highest level since December 1982 when the post-WWII record unemployment rate of 10.8% was hit . This rate closely tracks the direction of the overall unemployment rate and you can expect it to blow past 9% when the May jobs report is released in a week.

This real-time data is illustrating there’s very little improvement within the labor market. We should not see a number like the 740,000 in payroll losses posted in January but a range of 530,000-600,000 appears to be in the cards for a couple of months still.

This level of losses cannot go on for much longer, although the auto-industry woes may make it a reality for longer than one would think possible, but it appears it may be a while before we move back to 300,000 in monthly job losses, which was the peak range for the last two recessions and the 2001 downturn.

Durable Goods Orders

The Commerce Department released their latest durable goods report, which showed orders rose 1.9% in April after a huge downward revision to the March data. The 1.9% bounce follows a 2.1% decline in orders for March (previously reported as a 0.8% decline). Durables were driven by a 2.7% increase in the vehicle and auto parts component and machinery orders – problem is we’d like to see something other than autos driving the reading because we know it’s not going to be of help over the next couple of months as auto plants will be idled.

Durable goods have endured the worst contraction in orders since the late 1940s.

Excluding transportation, orders rose 0.8% after a 2.7% decline in March – this number was revised down big time too, initially reported as a 0.6% decline.

The non-defense capital goods ex-aircraft component (a proxy for business spending) registered another large monthly decline, down 1.5%. On a three-month annualized basis, the decline has improved nicely, down 28.6% compared to the -44.2% last month that was affected by the massive 12.3% plunge in business spending orders during January. Needless to say, this rate of decline, while improved, shows businesses are still in a mode of heavy caution.

On a year-over-year basis, business spending is down 26.4%. This is the number to watch as we desperately need the business side of the economy to pull us out of this situation since the consumer will need additional time to get their bearings again. Unfortunately, the government has inserted itself as the economic driver. The consequence of this decision will be a crowding out of private sector activity as capital will be sapped via higher tax rates and debt purchases as result of the outsized deficit spending.

New Home Sales

The Commerce Department released new home sales for April, showing activity rose 0.3% to 352,000 units at an annual rate – the expectation was for sales to hit 360,000. This follows a 3% decline for March. New home sales are down 34% from the year-ago period. The record low of 329,000 units was hit in January, which was 76% below the peak hit in July 2005.

The lowest mortgage rates in 60 years and tax credits to first-time buyers have helped sales stabilize, albeit at the lowest levels since 1982.

The median price of a new home actually rose 3.7% last month, coming in at 209,700 – the figure is down 14.9% over the past year.

The number of new homes available for sale remains below the long-term average. This signals that the inventory to sales ratio will plunge once sales rebound in a significant way. The issue in the near term is the labor market, as we discussed yesterday; home sales don’t have much of a chance until job losses ease. Beyond that, sales will still have to fight headwinds as current fiscal and monetary policy will eventually drive interest rates higher.

On that inventory/sales figure, the supply of new homes relative to the rate of sales, the trend is moving in the right direction at least.

Delinquencies

In a separate housing market report, the Mortgage Bankers Association stated delinquencies as a percentage of all mortgage loans jumped again in the first quarter to 9.12%. This reading includes loans that are at least 30 days late. The delinquency rate among prime loans hit 6.06%; for subprime loans the rate hit 24.95%.

The percentage of seriously delinquent loans, those 90 days late, hit 7.24%, which means the foreclosure rate will rise – as of the first quarter that foreclosures made up 3.85% of all mortgage loans..

Today’s Data

This morning all eyes will be on Chicago PMI, a measure of factory activity in that region. Yes, we’ll get the first revision to Q1 GDP, which will get attention, but that Chicago reading will be the big one. The number made really good progress last month from a very low reading of 31.4 in March. The market will need to see progress continue, making its way to the mid 40s – a reading below 50 marks contraction but a solid move into the 40 handle will be enough to excite people.


Have a great weekend!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries rallied today after a number of issues plagued the market on Wednesday. The two-year finished up 1/32, and the ten-year was higher by a point. The benchmark curve flattened by 10 basis points, and currently sits at +265 bps. A basis point represents .01%.

The Treasury auctioned $26 billion in seven-year notes at a yield of 3.3%,

The Federal Reserve, who still denies having a specific target for certain interest rates such as residential mortgages, is definitely being forced to make a decision with rates moving higher. Thirty-year mortgage rates have dropped from 5.98% in November 2008, before the Fed announced the initial $500 billion in agency MBS purchases, to its current level of 4.81%. These record low levels are likely to rise due to the recent run-up in Treasury yields, but if we begin to see mortgage rates creep in to the 5%-5.15% area will that force the Fed to take action? If yes, then how?

The Fed’s MBS purchase commitments currently stand at 150% of 2009 supply and 25% of the market as a whole, how much more can they really buy? The Fed runs the serious risk of just inflating the recession away, through huge amounts of quantitative easing, only to have to trounce the next economic rebound to avoid hyperinflation. TALF has already been expanded to the point where the Fed is beginning to take some really questionable assets, on to their balance sheet, (subprime credit card loans and commercial real estate for example). When the Fed becomes such a major market participant, risk can’t be accurately measured by the private sector. Also not favorable for the long term.

Monetary policy, including quantitative easing, has a lagging effect. There is no doubt that the Fed has created a simulative rate environment, so the best course of action in my view would be to give it a chance to work. Even if it means no more 4.75% mortgages.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Daily Insight

U.S. stocks gave back most of Tuesday’s gains on news that the number of banks on the FDIC’s “problem list” climbed to the highest level in 15 years, concerns over government debt and comments from JP Morgan that credit-card defaults will continue to climb.

Banks are finding it difficult to build reserves fast enough to keep the ratio of reserves to non-performing assets static and that causes concern about loan activity and the degree of economic recovery. Frankly, based on the numbers we’re seeing on the delinquency front across a broad base of loans the stock market is taking the news remarkably well.

This is something we’ve talked about for a while, credit-card default rates -- along with commercial real estate losses that may not yet be halfway through the cycle – are going to cause trouble for some time. The very positively sloped yield curve (banks borrow near zero and lend much higher) will keep interest-income margins elevated, but I don’t see how it offsets these other major challenges.

As credit-card lines continue to be cut (exacerbated by legislation capping late fees and interest rates) it will put additional pressure on consumer activity. Consumer spending as a percentage of GDP will work its way from 72% of GDP back to the historic average of 65%, which will mean slower growth rates. If government policy were focused on spurring the business side of the economy, we’d be able to offset this drag a bit, but policies are doing nothing but scaring business and keeping managers cautious – not helpful.

And speaking of that positively sloped yield curve the spread between Treasury two and 10-year notes widened to a record on concern massive government debt issuance will overwhelm those Fed efforts to keep borrowing costs low. The degree of the slope generally portends the magnitude of the economic rebound (the more positive the better), but these are not normal times and if long-end interest rates spike because traders are worried about enormous levels of debt issuance rather than because the prospects of recovery has increased, you can forget about a meaningful recovery. The Treasury auctioned $35 billion of five-year notes and traders sent long-end yields much higher as a result.

The latest home sales data failed to offer a counterbalance to the aforementioned weights. Existing home sales did rise, as we’ll discuss below, but only from very depressed levels – there’s a difference between stabilizing at very low levels and a pure rebound.

Housing needs economic growth to rebound, not the other way around. Economists continually state a necessary condition for economic recovery is a housing rebound. This is backwards; until the labor market improves substantially you can’t have a significant bounce in housing and until the economy recovers you can’t have labor market improvement. The Fed can work on pushing mortgage rates down all they want, and it will certainly help - although not without longer-term ramifications – but when the economy continues to shed 500k-600k payroll positions a month there’s not much anyone can do. It just takes time.

Market Activity for May 27, 2009


Crude Oil

The price of crude for July delivery rose to a six-month high yesterday, now nicely ensconced above $60, closing at $63.13 per barrel. Signs of increasing demand out of Asia (China’s stimulus is beginning to take root and they are also surely stockpiling commodities for fear of future price spikes), word OPEC will cut production and speculation that the weekly energy report will show a drawdown in gasoline inventories all helped push the price higher. (We now know this morning the worry of an OPEC production cut was not necessary as the cartel has decided to leave production unchanged; crude prices have barely budged though, don just a nickel this morning)

One wonders how the consumer will react to higher gasoline prices this summer. The plunge in pump prices from last summer’s spike definitely helped cushion the blow of reduced incomes. If the retail price of gasoline holds below $2.50 per gallon (roughly $2.00 wholesale) it shouldn’t present a problem. However, if we push to $3.00 at the pump…well, that’s just one more obstacle.

Mortgage Applications

The Mortgage Bankers Association reported its mortgage applications index fell 14.2% during the week ended May 22, which followed a 2.3% increase for the previous week.

Refinancing activity, which currently makes up 70% of the index, slid 18.9% last week after a 4.5% uptick in the prior period. Purchases managed a 1.0% gain after falling 4.4% in the previous week. It appears the refinancing wave that took place in March and April has pretty much run its course. Either that or those who have not yet refied, and have the equity to do so, are waiting for a 4.5% fixed 30-year mortgage rate before pulling the trigger – not sure they’re going to get that number, but one never knows; if the Fed increases its mortgage-backed securities purchases it could happen. As the market has recently overwhelmed the Fed’s work in driving rates lower one can bet Bernanke & Co. will be increasing their Treasury and mortgage-backed purchases.

As discussed above, it will take some meaningful improvement in the labor markets to get home buying fired up again. The affordability index is at an all-time high – meaning it has never been a better time based on the combination of prices and mortgage rates – but the labor market is the prevailing factor; if potential home buyers loss their job, or the probability of this occurring is elevated – and it clearly is – they’ll hold off. As we move closer to the summer months it is becoming increasingly evident there really is nothing the Fed can do to spark home sales.

In the meantime, let’s hope their attempt does not cause additional problems 18-24 months down the road that then results in an economic double-dip – the chances of this occurring, another recession after, say, four quarters of GDP growth, are definitely elevated.

Existing Home Sales

The National Association of Realtors reported that existing home sales rose 2.9% in April, beating the expectation, to an annual rate of 4.68 million units. The data was driven by a 6.4% pop in multi-family units (condos and co-ops). Single-family sales rose 2.5% after falling 3.3% in March.

The median price for total existing homes slid 15.4% from the year-ago period, it currently sits at $170,200; the price for single-family units alone is down 14.9% compared to April 2008, currently at $169,800 – the peak of $230,900 was hit in July 2006.

Distressed properties (much of which involves foreclosures) made up 45% of all sales last month – only the most intense bargain hunting is occurring. First-time buyers accounted for 40% of sales, driven by tax-credits.

It appears we’ve hit bottom in the housing market, but one can’t say much beyond that. Existing home sales remain below the February reading. I focus on the Feb. number because that month was surrounded by ultra-low record readings of 4.5 million units (again, at an annual rate) for January and March – this latest data only appears to be an improvement based on those extremely depressed levels. Same is true when looking at only the single-family units.

By region, the Northeast and West posted sales gains of 11.8% and 11.1%, respectively. Sales in the Midwest and South were flat.

The supply figures continue to show there are a lot of properties to work off still. The single-family homes available for sale jumped a bit last month, rising to 3.34 million units from 3.06 million.

When matching supply against the current sales rate the glut continues at there are still 9.6 months’ worth of single-family existing homes on the market. Same is true when we add in multi-family units, as the total existing home inventory/sales ratio moved back up to 10.2 months’ worth.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

The two-year finished down 1/64, and the ten-year was lower by 1 12/32. The benchmark curve steepened by 12 basis points, and currently sits at +275 bps. A basis point represents .01%.

The recent selloff in Treasurys has pushed the yield curve to its steepest point on record, 1 basis point higher than the previous record set on October 13th 2003. Yield curve shape is based on a variety of factors, including liquidity differences between different Treasury issues and expectations for interest rates in the future. I will touch more on the reasons for the spike in longer-term rates below.

Treasurys were lower again today after $35 billion in 5-year notes came to market. The bid/cover ratio, the ratio of bids submitted to bonds sold, was 2.32, a sign of good demand compared to a 2.19 average for the last four auctions. More supply comes tomorrow when the Treasury will auction $26 billion in seven-year notes.

The increased supply is certainly making its presence felt in the market but it doesn’t deserve all the credit for the recent selloff. With all the talk of a Q3-Q4 end to the recession many are starting to wonder what will come of all the excess liquidity in the market. If the Fed is unable to pull the liquidity from the market appropriately, then inflation, simply defined as too much money chasing too few goods, will result. A larger than expected rate of inflation spells danger for investors who aim to protect the purchasing power of their savings.

Today’s auction results seem to point more towards inflation concerns rather than supply. Today’s supply was no surprise. The market has known about the record Treasury issuance that will be coming this year for some time now. The strong demand is just coming at a higher price for the US Treasury as investors look to protect against inflation. TIPS outperformed comparable nominal Treasurys by 75 basis points today, showing investor’s preference for inflation-indexed bonds compared to nominal (non-adjusted) Treasurys.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Fixed Income Recap

The two-year finished down 3/64, and the ten-year was lower by 45/64. The benchmark curve steepened by 6 basis points, and currently sits at +256 bps. A basis point represents .01%.

With no economic data and a shortened trading session in bond land, the market turned its focus to next week’s supply. The Treasury will issue $100 billion in 2’s, 5’s and 7’s next week, and if the market told us anything the past two days, demand for government paper is not nearly what it was a few months ago.

The media has really beaten the “US Treasury to lose its AAA credit rating” story to death. Standard and Poor’s got the ball rolling yesterday when they put the UK’s AAA credit rating on negative watch. Meaning they are still AAA but the credit agency is just revisiting the analysis.

There’s no doubt that this administration is spending borrowed funds at a frightening pace, and unless the Fed ups its participation through additional quantitative easing we will definitely see higher rates on Treasury borrowing for the rest of the year. But to say that investors should begin to worry about the credit of the US Treasury is a little much.

A lot of global money flooded into Treasuries during the collapse of the credit markets driving yields to record lows and the dollar to multi-year highs. That trend is reversing now more because of an increase in inflation expectations than a broad based currency meltdown, sorry CNBC. When economic activity picks up, inflation will begin to show itself, but even higher than average inflation from these price levels is far from destabilizing. The exposure this is getting in the media is just way too much.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Fixed Income Recap

The two-year finished down 3/64, and the ten-year was lower by 1 & 33/64. The benchmark curve steepened by 15 basis points, and currently sits at +250 bps. A basis point represents .01%.

The Fed has purchased $123 billion in longer dated Treasuries since it began its current quantitative easing campaign on March 25. The target amount currently stands at $300 billion, but according to the minutes from the April FOMC meeting, some Fed officials are open to increasing that amount.

Primary dealers took those comments into consideration today when they submitted $45.7 billion in Treasuries to be purchased by the Fed, roughly 50% more than the average. Only $7.4 billion on the $45.7 billion were accepted by the Fed. The Ten-year sold off more than a point immediately after the results were announced.

Investors fearing rising rates are eager to dispose of Treasuries in favor of investments that will fare better in an inflationary environment. Dealers called the Fed’s bluff and today’s price action shows how that can backfire.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Fixed Income Recap

The two-year finished up 3/64, and the ten-year was lower by 7/64. The benchmark curve steepened by 4 basis points, and currently sits at +235.5 bps. A basis point represents .01%.

There were no Fed purchases or Treasury auctions today. The Fed will buy Treasury notes tomorrow and Thursday.

TALF
The $1 trillion Term Asset-Backed Securities Loan Facility was created by the Fed to aid the flow of credit to consumers by providing liquidity for securities backed by loans for credit cards, equipment dealer floor plans and small businesses. It was expanded May 1st to include newly issued Commercial Mortgage Backed Securities (CMBS) and previously eligible TALF loans maturing in 5 years, (the previous limit was 3).

The program was expanded again today to include already issued AAA rated CMBS to spur more participation in the program. The first TALF auction on May 2nd took in $10.5 billion in securities and the auction scheduled for June 2nd doesn’t look like it will be much bigger.

Today’s announcement greatly expands the universe for TALF eligible securities. According to Bloomberg, only $35 billion in TALF bonds have been created this year. In comparison, $12.2 billion in CMBS were created last year, down from the record $237 billion sold in 2007, and although many of them aren’t rated AAA, this gives many more opportunities for firms to participate. Whether it makes sense for the Fed to take all this extra risk onto their balance sheet is another story.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Fixed Income Recap

Investors fled the safety trade today as stocks rallied hard. The two-year finished down 7/64, and the ten-year was lower by 53/64. The benchmark curve steepened by 4 basis points, and currently sits at +232 bps. A basis point represents .01%.

The Fed purchased $3.18 billion in longer dated Treasuries with maturities from 8/15/19 to 2/15/26. Cumulative Fed purchases stand at $107.89 billion, still a ways from their target of $300 billion that is scheduled to finish in September.

TED Spread Continues to Fall

The spread between 3-month T-bills and 3-month Libor, dubbed the TED Spread, is widely used to measure credit market functionality. 3M Libor is the rate used by banks to lend each other money for a three month period, so unlike Treasuries, Libor lenders are exposed to default risk. When credit tightens and banks become less willing to take the risk involved in lending to each other, they move to T-bills to avoid the default risk and still maintain liquidity. As a result Libor rises and the yield on T-bills falls, widening the TED Spread. This is what happened in September and October of last year.

Three Month Libor has fallen every session since March 27th, including a 4.1 basis point decline today, bringing the TED Spread to its lowest level since August 2007.

However, on a relative basis, one would thing TED has a ways to go. For example, on August 8th 2007, the last time the TED Spread was this low, 3-month T-bills were at 4.95%. This indicates that although the TED Spread has come in from the extremely wide levels of last fall, it remains high on a relative basis. The current relative spread, which compares the nominal spread to the current rate environment, is still elevated at 389.2%, compared to just 8.7% in 2007.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Fixed Income Recap

Treasuries sold off on a very quiet day in the market. The two-year finished down 1/64, and the ten-year was lower by 23/64. The benchmark curve steepened by 3.5 basis points, and currently sits at +227.5 bps. A basis point represents .01%.

TIPS
CPI, the measure for inflation that is used for the principal adjustment of TIPS, was released this morning for the month of April. The headline number came in at unchanged from the previous month, in line with expectations. The core index (not including Food & Energy), increased .3% month-over-month, compared to the .1% that was expected.
TIPS outperformed nominal coupons today. The TIPS ETF (ticker TIP) was up .21% while the nominal Treasury ETF (ticker IEF) was down .25%. TIPS outperformance for the year is pretty impressive. The deflation scare of last fall has truly died.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Will Principal Financial Group reject TARP?

S&P 500: -10.19 (-1.14%)

Principal Financial Group (PFG) -1.48%
You may remember from my April 9 post that the Treasury Department ad decided to grant TARP funding to life insurers – Principal Financial Group gained over 21 percent that day.

Today, the Wall Street Journal reported that the Treasury was finally ready to cut checks to six insurers – including Hartford Financial Services Group, Allstate, Prudential Financial, Ameriprise Financial, Lincoln National, and Principal Financial Group – but several of the insurers are no longer in need of assistance.

Prudential Financial and Ameriprise Financial have already decided to decline TARP funds, while Allstate and Principal Financial are expected to forgo government funding as well. Principal raised $1 billion in a common stock offering earlier this week at a price of $19.75, and Allstate successfully offered $1 billion of debt this week.

As I said in the post linked above, the strength of Principal’s business is their 401(k) business, which is a dominating player in the small to medium-size business market.




Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks snapped back yesterday, looking past an increase in jobless claims and a large jump in continuing claims, to end a three-session losing streak – the longest such streak since the surge from the March 9 low.

At the beginning of the week we mentioned there will be a tendency among those who sold at the low and have missed out on this rally from those depths to look for any weakness as an opportunity to get back in, odds are this action had some affect on yesterday’s market activity.

Financials, technology and basic material shares led the rally. Advancing stocks beat decliners by a three-to-one margin on the NYSE. Some 1.4 billion shares traded on the Big Board, right in line with the three-month average.


Market Activity for May 14, 2009


One would think additional comments late yesterday to set up an exchange for over-the-counter derivatives market (focused at reducing risk in the financial system) was also helpful for stocks. As discussed in March, this has been on the table for a while now but it seems real progress is being made to that end. So long as this is done right, and not totally screwed up as it works its way through the various regulatory agencies, setting up a clearinghouse for the credit default swap (CDS) market in particular will prove hugely beneficial. The market is currently opaque and transparency is key to optimal pricing.

Pricing in the CDS market can get out of line due to the lack of transparency and this can exacerbate declines in stock prices as it affects the market’s perception of default risk.

Jobless Claims

The Labor Department reported initial jobless claims rose 32,000 to 637,000 for the week ended May 8 after two weeks of decline that had increased confidence the reading would continue to improve, this data batters than belief. A “good part,” according to the Labor Department, of this increase was due to the Chrysler layoffs. It’s pretty much a known that auto workers waste no time filing for jobless benefits, so job cuts in the industry show up via claims very quickly.

Looking through the individual state’s data on claims it does show job losses within the construction and services industries continues, so it can’t totally be blamed on the auto sector.

The four-week average rose 6,000 to 630,500.

The most disturbing aspect of this report remains the continuing claims data. It set a record for the 15th consecutive week and the increase (up 202,000) is the biggest jump we’ve seen during this 15-week run of new highs. This spells big trouble for the overall jobless rate.

And speaking of which, the insured unemployment rates (jobless rate among those who have filed for benefits at least two weeks ago) ticked up another 0.1% to 4.9% -- the highest level since December 1982 when the overall unemployment rate stood at the post-WWII high of 10.8%. We’ll be testing that level over the next year.


Producer Prices

The Labor Department also reported the producer price index (PPI) rose 0.3% in April (a rise of 0.2% was expected) after a 1.2% decline for March. Prices paid to farmers, factories and other producers had been declining – down 3.7% compared to the year-ago period – but have flattened out, on average, over the past four months.

Most of the recent inflation gauges have had energy as the main driver, but for this latest PPI reading food was the kicker, which jumped 1.5% last month.

The consumer goods segment rose 0.4% for the month, despite a large 6.2% decline in natural gas prices. A 1.3% rise in prescription drug prices and a 2.6% increase in gasoline more than offset the decline in nat. gas. We know gasoline prices continued to climb into this month and nat. gas has rebounded, so the consumer goods segment is likely to drive PPI higher again for May.

Producer prices generally are not a big concern, and especially so right now as they are just beginning to rebound from the plunge that occurred September-December. Even as PPI rises, strong productivity gains of the past couple of decades have allowed firms to absorb these costs, which means they do not entirely pass them along to the consumer. This will be an important thing to watch as PPI jumps several months out, productivity improvement will need to rising at a healthy clip.

The crude materials aspect of the PPI report (the headline PPI reading measures finished producer prices, crude materials are obviously those that go into making these finished goods) jumped 3.0% last month. Now, this is a huge monthly increase, but follows big time declines in crude-material prices so one can’t gather too much from this jump just yet. However, it will be important to keep an eye on the trend here for it may give us a good sign as to the timeline of when troubling inflationary levels begin to take effect. It’s early days for now though.


Have a great weekend!


Brent Vondera, Senior Analyst

WMT, JCI

S&P 500: +9.15 (+1.04%)

Wal-Mart Stores (WMT) -1.86%
Wal-Mart reported first-quarter earnings that were in line with analysts estimates. CEO Mike Duke said the company believes customers who shop at Wal-Mart today will stay with it when economic conditions improve because of the business improvements its making.

Johnson Controls (JCI) +5.48%
Johnson Controls gained after Wachovia Capital Markets upgraded the auto parts maker to outperform. The research note said “recent restructuring efforts should enhance operating leverage and boost earnings significantly in 2011 and 2012.”

The report also said it expects the company to reduce debt by the end of 2011 and suggested they have the financial flexibility to make an acquisition if the opportunity arises.


Quick Hits

• The Auto Industry: Why Seven Must Become Three
• Businesses Quit Slashing IT Budgets
  

Peter Lazaroff, Junior Analyst

Fixed Income Recap

Treasuries rallied again today on poor economic data. The two-year finished up 3/64, and the ten-year was higher by 9/32. The benchmark curve flattened by 1 basis point, and currently sits at +224 bps. A basis point represents .01%.

Fed Purchases
The Fed purchased $27.2 billion in agency MBS during the past week. The 30-year fixed mortgage rate sits at 4.76% and has held under 5% for 2 ½ months now, which has brought prepay activity higher. An interesting story on the current state of the refi market

The Fed bought $2.975 billion in Treasuries today with maturities ranging from 5/15/10 to 2/28/11. The total Treasury purchases currently stand at $104.7 billion.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Daily Insight

U.S. stocks came under pressure yesterday after the latest retail sales report showed the jobless rate will keep consumer activity subdued and foreclosures surged 32% in April (although it shouldn’t be much of a surprise as the moratorium the government placed on foreclosures has ended and the spring is uncoiling).

The data out of yesterday’s Energy Department report, namely the trend among refiners that suggests they don’t currently expect a bounce back in demand, didn’t help matters – we’ll touch on that below.

Financial, basic material and industrial shares took the brunt of the damage.

Mid and small cap stocks got hammered. The S&P 400, a measure a mid capitalization shares, took a 4.38% hit. The Russell 2000 and S&P 600, the main measures of small cap shares, lost 4.72% and 4.73%, respectively.

Market Activity for May 13, 2009


Crude

Crude oil for June delivery remained near the $60 level despite the negative news on the consumer. The weekly Energy Department report showed an unexpected decline of 4.63 million barrels in supplies – inventories were forecast to rise one million barrels. U.S. supplies remain above the five-year average but have come off of the 19-year high that had been hit over the past three weeks.

Domestic demand is not showing signs of a rebound, so the reduction in stockpiles wasn’t a demand-driven event. Rather, oil imports hit a 10-year low as refineries decided to draw down existing stockpiles – unusual activity for this time of year with the summer driving season just around the corner; it suggests refiners are not especially optimistic that gasoline demand is making a comeback anytime soon.

That said, one cannot ignore the fact that production in China has shown signs of life over the past two months and the market is surely focused on the dollar that is trending lower. Then when the economy gets a boost from the inventory dynamic and the fiscal stimulus that has yet to occur (even if the bounce will prove very short term in nature) we could see traders push energy prices higher on rising GDP forecasts. It will probably take some pretty bad news to drive crude below the $50 handle again. Certainly activity out of China, where their stimulus (worth 20% of their GDP) is just starting to kick in, is unlikely to wane.


Mortgage Applications

The National Association of Realtors reported their mortgage apps index fell 8.6% after a 2% rise in the previous week. An 11.2% decline in refinancing activity (it appears we’ve seen most of this activity run its course) pushed the index lower – refis currently make up 72% of the index. However, purchases managed a slight gain of 0.5% after the strong 5% rise in the previous week


Import Prices

The Labor Department reported that import prices for April rose for a second straight month, up a large 1.6% (three times the forecast) after the 0.2% gain for March. This increase was all due to petroleum prices as the oil component jumped 14.6% and petroleum products (lubricants, kerosene, diesel fuels, aviation fuels, etc.) raged higher by 15.4%. Petroleum and petro-related import prices are up 30% over the past three months as they rebound from the plunge of the previous six months.

On a year-over-year basis import prices remain down big at -16.3%. But as commodity prices continue to rise this reading will erase its YOY negative reading and may quite possibly show the extremely elevated readings of summer 2008 by this time next year.

Retail Sales

The Commerce Department reported retail sales declined 0.4% in April, following a downwardly revised 1.3% drop for March. As stated yesterday, I thought the reading would show an increase (the expectation was for no change) as the Easter holiday fell in April this year. This often boosts the number, and quite possibly the reading would have been even worse if not for this calendar event.

Excluding auto sales the figure showed a slightly larger decline, down 0.5%. Auto sales were one of the only bright spots in the report – this component rose 0.2% as dealers, via help from government financing, were able to offer very low rates again after a few months in which they had trouble accessing credit markets.

The sporting goods and books segment also posted an increase, up 0.3% for the month and health stores, which have registered only one monthly decline over the past seven months, saw sales rise 0.4%.

Outside of these areas the rest of the report was ugly, particularly after the previous month’s large declines. The segment weakness we found most interesting was in the grocery store and gas station components.

Gasoline prices were pretty much flat in April, so the significant 2.3% drop within the segment can’t be explained by falling prices. Grocery stores posted a large 1.1% decline in April – considering the Easter holiday had to help the reading somewhat that’s a big decline. Both of these numbers scream joblessness – less driving due to the loss of employment and consumers tightening their belts for even the primary necessity reading of the report, groceries.

(Digressing for a moment, policy makers may have been able to stem this surge in the jobless rate if they had aggressively cut tax rates on capital, labor income, corporate taxes and repatriated income when it became apparent the economic world had changed last fall. This would have boosted disposable incomes, created incentives for businesses to boost capital spending, eased job cuts to some extent, and offered a higher floor for stock prices. But the Bush administration chose to return to the rebate check strategy, which never works, and the Obama administration explains that they will raise tax rates and create entire new entitlement programs, thus boosting government spending and driving massive deficits for years to come. I’m not saying all would have been right with the world, there was a major credit event that took place, but the policy direction chosen is clearly not the correct prescription and lower tax rates would by definition have boosted after-tax incomes, profits and capital return expectations. It would also have been dollar supportive, which is not the case right now; when run for the safety of the Treasury market comes off, the dollar will be in big trouble because of higher tax rates on capital and the massive debt issuance that will result over the next few years)

Department and clothing store sales fell 0.5% and 0.2%, respectively. These declines are logical, if consumers are going to reduce groceries, they’re surely not buying that new spring line of clothing; especially since credit-card lines have been cut (and you can bet that legislation to restrict interest rate changes on credit-card balances will result in even less availability). Electronic store sales fell 2.8% after a large 7.8% decline in March – massive discounting is likely playing some role here, it’s not totally a volume thing.

Looking out over the next year, we’ll see months in which consumer activity pops, which is likely to occur to some extent for May after two months of decline. This may cause the so-called pundits to believe the consumer is back, again. However, the need to boost cash savings, as the two major savings vehicles (stocks and houses) have taken a pounding, will weigh on activity for an extended period of time – and if energy prices surge again, that will act as yet another drag on the retail figures.

The consumer makes up 70% of GDP (that number is clearly going back to 65% over the next year or two), so as this segment remains weak we will greatly depend on the business side to boost economic growth. Of course, government is moving in to take a much larger role, but it can provide only a short-term boost, and over the longer-term this government spending will depress growth as it saps capital from the private sector. Washington needs to be very careful in its vilification and crowding out of the private sector; policymakers must tread with caution with regard to higher tax rates and regulations. If they choose to progress down the current path, they’ll find the business side will remain very cautious and continue to reign in its capital spending projects.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Investors rushed toward the safety of Treasuries today on retail sales data that came in weaker than expected. The two-year finished up 1/32, and the ten-year was higher by 29/64. The benchmark curve flattened by 4 basis points, and currently sits at +224.5 bps. A basis point represents .01%.

Credit

While stocks have pulled back over the past few days, corporate bonds have been doing the opposite. Comparable Treasuries are up a little over the same period, but not nearly enough to justify how credit has outperformed stocks this week. The following graph compares the performance of CSJ (1-3 Year Credit ETF) and SHY (1-3 Year Treasury ETF) month to date.

And this graph shows CSJ and the S&P 500 over the same period.

Successful non-guaranteed bond offerings from Morgan Stanley and Bank of America and upcoming issues from American Express and J.P. Morgan are likely to blame for this outperformance. These companies have benefitted from the Temporary Liquidity Guarantee Program, which allows banks to issue corporate debt with a guarantee from the FDIC. In order to repay TARP, the Treasury is requiring banks to show the ability to issue debt without the guarantee, which has prompted several to do so.

Although debt costs will increase without a backstop from the FDIC, this new issuance shows that the credit markets have come a long way since last fall.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

No worries at Intel

S&P 500: -24.43 (-2.69%)

Intel (INTC) -0.53%
Nearly a full decade after Advanced Micro Devices’ first complaint about its larger competitor, EU regulators laid a record $1.45 billion fine on Intel for abuse of a dominant market position. This decision follows a 2005 ruling in Japan and another in Korea last year, both of which determined Intel was abusing its dominant market position.

But shareholders don’t care much for the opinion of government officials, and the share price of Intel barley moved today on the news. Investors are far more interested in Intel’s attempts to cut costs, improve margins, and control inventories – the main focus of its analyst day on Tuesday.

The ruling is more of a positive for AMD than a negative for Intel since any form of settlement would help AMD with its debt load. In terms of the market for microprocessors, however, little will change.

The practice in question is allegedly restrictions attached to volume rebates, not the principle of rebates themselves. Intel holds over 70 percent of the market for all microprocessors (the central engine of every computer) and benefits from a self-reinforcing scale advantage that allows them to outspend AMD on research and development by more than four to one.

In short, Intel’s fines are nothing to worry about.


Quick Hits

• Taylor Says Fed May Not Have Much Time Before Rate Rise Needed
• Putting GE Capital Through Its Stress-Test Paces

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks pared earlier session losses after former Federal Reserve Chairman Greenspan stated the housing market may be on the verge of recovery and financial markets should continue to improve. The comments, part of a speech to the National Association of Realtors, helped the broad market rally in the final hour of trading – although some weakness in the final minutes drove the S&P 500 and NASDAQ Composite back into the red. The Dow Industrials did, however, close to the plus side thanks to shares of Coca-Cola, Exxon, Chevron and IBM.

The Transportation Average, as we talked about yesterday is an important indicator to watch right here, slid for a second-straight session and has appeared exhausted over the past week. This is a reliable gauge for the entire market and may be suggesting the nine-week long rally is nearing an end. We may see a bit more upside as investors who have been on the sidelines and missed out on this surge from the wicked depths of 666 on the S&P 500 look for any pullback as a chance to get back in. Beyond that we’re probably very close to some degree of retracement after the 39.6% rally from the March 9 low, as of Friday. Whether this will be a 10%-15% pullback to be followed by another surge forward or a move back the middle of this trading range…we’ll just have to wait to find out.


Market Activity for May 12, 2009


A Tough Road for the Greenback

The dollar has had a rough run after hitting a multi-year high in early March. If the safety trade continues to recede the greenback will no longer benefit from the rush to own Treasury securities, but will be left to fundamentals -- and those fundamentals are ugly with a very easy Fed and massive levels of debt issuance coming down the pike. (There are only two ways to build a healthy and stable dollar value in a post gold standard world: there must be low tax rates on capital and monetary policy must be sound; the latter is not in play right now and the former will soon change for the worse)

As the greenie declines in value commodity prices will rise. As a result, the road to harmful levels of inflation may be shorter than most believe. Keeping an eye on the value of the dollar is essential and will prove to be one of the most accurate indicators of future inflation levels.

Trade Figures

The U.S. trade deficit widened a bit in March, but not because imports bounced back to positive territory (which would illustrate U.S. consumer and business spending have markedly improved); rather imports into the U.S. declined at a slower pace than U.S. exports declined during the month.

For the month, the deficit rose 5.5% but remains at a very low level, especially when one looks at the real (inflation-adjusted) figure excluding petroleum. (Funny how the same people who rail about trade deficits are many of the same who say we must continue to place restrictions on domestic energy production. If we didn’t need to import 70% of our petroleum-related energy needs, trade deficits would have been much narrower a few years back when the price of crude hit $145 – I’ve got a feeling we’ll have a date with déjà vu a year, 18 months outs; when economic activity bounces, the price of crude will push to $80, then $100)

U.S. exports fell 2.4% in March, following a 1.5% increase in February, and imports fell 1.0%, after a 5.1% decline in Feb.

While imports fell in March, the degree of decline was a huge improvement from the mid-to-high single digits of the previous five months. Nevertheless, a decline in imports, as mentioned above, means that consumers and businesses remained reluctant to spend in March – but no surprise there. The capital goods component of this data (business spending) fell another sharp 5.2% in March.

In terms of U.S. exports to regions and countries:

Export to Europe fell 17.8%, to Mexico down 14.5%, to Brazil down 18.4% and to the Pacific Rim down 25.4% -- China down 12.3%, Japan down 20.5% and Asia NICs (newly industrialized countries) down 34.5%. All of these numbers show trade activity remains very depressed, not the implosion of the previous several months but still extremely weak.

I put the China figure is bold because the rate of decline showed the largest improvement, coming off of 25% declines (again in terms of U.S. exports to the country) of the previous three months. China’s stimulus, virtually completely infrastructure-based in nature, will push commodity and overall U.S. exports to China higher over the next several months.

Budget Statement

The Treasury Department reported the first monthly budget deficit for April in 26 years, stating the shortfall came in at $20.9 billion, compared to a $159.3 billion surplus for the same month a year earlier – April, obviously, is usually a month in which the government books a surplus due to the jump in tax payments.

Fiscal-year-to-date (FYTD) the budget deficit sits at $802.3 billion, expected to hit $1.8 trillion, or 13% of GDP, when the fiscal year comes to a close in September – that will be more than double the previous post-WWII highs hit in 1983 and 1992. (The all-time high budget deficit-to-GDP ratio is 33.5%, which occurred in 1942 as we were financing the war)

Federal spending jumped 17.5% in April based on the year-ago period, while revenue (tax receipts) fell 34.1%. Corporate tax receipts, totaled $70.8 billion, a 58.6% decline from a year ago. Individual receipts came in at $566.4 billion, a decline of 24.2% from the April 2008.

I’m generally not a deficit hawk, simply because the budget shortfalls of the past 30-40 years have been completely manageable, averaging 2.4% of GDP – one only needs to look at average long-term interest rates during the last 40 years for evidence that our deficit spending has not been harmful. But when you get into the 10% deficit-to-GDP ratio range, harm will be done. These levels are not sustainable; they certainly are not conducive to a healthy dollar value.

And I don’t buy the argument that these deficits are short-term in nature, too much of the current stimulus spending will work its way into the budget baseline. In addition, there is an attempt to add a $1 trillion per year national health-care program – forget about the drug rationing and decision making by the government with regard to who gets care and when, we’re watching the Social Security and Medicare systems crumble right in front of our eyes, and still Washington wants to progress further along this entitlement road?

Eventually reality is going to confront Washington’s fantasy view of how the world works, particularly with regard to the affect massive increases in government spending has on the dollar, interest rates and economic growth. If we pass the next exit on this “Road to Serfdom,” it’s not going to be pretty.

Today’s Data

This morning we get mortgage applications for the week ended May 8, import prices and Retail Sales (both for April).

Retail sales will get the most attention as the market is intensely focused on consumer activity. The figure is expected to come in flat after a 1.2% decline in March. Watch for the number to beat estimates as Easter fell in April this year.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasurys were little changed today on mixed equity markets and Fed buying that went as expected. The two-year finished up 1/64 on the day, and the ten-year was lower by 2/32. The benchmark curve steepened by 2 basis points, and currently sits at +228.5 bps. A basis point represents .01%.

Fed purchased $6 billion in Treasuries maturing from 5/31/12 to 8/15/13. Cumulative purchases stand at $101.7 billion.

Inflation Expectations
Treasury Inflation Protected Securities (TIPS for short) are used by investors to hedge against the risk of inflation. They are backed by the full faith and credit of the US Government, just like regular (nominal) Treasurys, but instead TIPS pay a fixed real rate of interest on principal that is adjusted for inflation as defined by the Consumer Price Index (CPI). So when inflation increases so does the investor’s nominal return.
TIPS also play an important role in Inflation expectations. As investors become more concerned about inflation, the gap between the yields on TIPS and nominal Treasurys widens out. This gap is called the “Breakeven Rate”. The graph below shows the ten-year breakeven for the past 12 months.

The rate is forward looking, meaning that the 10-year breakeven is an estimate for average inflation over the next 10-years.

Notice that on 11/20/08 the 10-year breakeven actually went negative. Oil had dropped from $145 to below $50 a barrel, the credit markets had seized up following Lehman’s bankruptcy which halted production activity and the Fed had yet to begin its long-term securities purchases. As evidenced by the graph, deflationary concerns that were unreasonable even given the circumstances, have since been squashed.

I think TIPS remain a good buy. The quantitative easing efforts by the Fed have begun to work, but if we continue to be truly forward looking we can’t ignore the red flags. Congress would rather solve the problem by re-inflating the housing bubble instead of allowing the market to correct itself to a healthy sustainable level, and they appear to have the Fed’s services at their disposal in order to do so. Fed/Politician interconnectedness spells danger when it comes time to removing liquidity from the system and the result will likely be inflation.

I could definitely be wrong. If the Fed can return to a state of independence, and pull the extra liquidity from the market at the appropriate time, then above average inflation could not happen. I’m certainly not wishing for any monetary policy failure, but judging by what breakevens have done so far this year, I’m not the only one with these concerns.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst