Daily Insight

Markets ended the day lower on weaker economic news. For the day, the Dow Junes Industrial Average (DJIA) closed down 205.67 points to close at 11378.02, or 1.78 percent.

On the New York Stock Exchange (NYSE), there were 571 stocks advanced, 1,279 stocks declines and 23 stocks remained unchanged. There were also 33 new highs and 39 new lows.

Market Activity for July 31, 2008
As reported in yesterday’s Insights, the Gross Domestic Product (GDP) figures did not meet expectations for the second quarter and were reduced in the fourth quarter from expansion to contraction. The main contributors were personal consumption (added 1.08 percent), exports (added a huge 2.42 percent) and government consumption (added 0.67 percent). Housing continued to weigh on GDP with residential fixed investment subtracting 0.67 percent, but the big factor was the large subtraction from inventories that dragged down GDP by 1.92 percent.

Additionally, the Labor Department announced that the number of people seeking jobless benefits rose to the highest level in five years, although as Brent has established many times before, this weekly data is very volatile and is generally used as part of a four-week moving average instead of looking at each week independently.

In addition to the economic news, the market also responded to lower than expected earnings from ExxonMobil (ticker symbol: XOM). Although the company reported higher earnings in a single quarter in the history of corporations (a truly remarkable figure – nearly 11.7 billion of profit in a single quarter), it was less than Wall Street had expected (the thought almost 12.9 billion was on deck). The stock fell by 4.86 percent, leading the whole energy sector lower.

In addition to lower profits from XOM, crude oil fell by 2.19 percent or 2.77 per barrel to 124.09 per barrel in New York. This drop extended losses for oil to 11.4 percent for the month of July, making it the largest drop in percentage terms in the 25 year history of the New York Mercantile Exchange.

Wild-man Alan Greenspan hit the airwaves on CNBC just as the bell was about to ring. He told Maria Bartiromo that the U.S. is “nowhere near the bottom” of the housing slump. It’s funny because, two years ago I went to a conference in Washington D.C. where he was a speaker and at that time he told the audience that the worst was nearly over in housing. So much for the maestro –

Today we have what an old colleague of mine referred to as the “jobs jamboree.” The employment report is actually two separate reports that are taken from two separate surveys. The first report is the household survey looks at the employment data by reviewing 60,000 households.

The second part is the establishment survey looks at 375,000 businesses and looks at nonfarm payrolls, the average workweek and average hourly earnings. Generally the market focuses on the establishment survey given the relative size and data dependability.

The unemployment number came in a ticker higher than Wall Street estimates at 5.7%, but this is not terribly surprising after yesterday’s jobless claims number. Nonfarm payroll data came in slightly better than expected this morning and average hourly earnings matched the Street’s expectations, but average weekly hours fell slightly below expectations.

Additionally, we just got earnings from General Motors (ticker symbol: GM) and they are as disappointing as we expected – $15.5 billion second quarter loss. Don’t worry – we weren’t looking to buy – but we were looking at some GM bonds today for the fun of it. Right now issues maturing in 10 years or more are trading at 50 cents on the dollar, which would mean yields of 18 percent per year, assuming all of the payments are made along with getting your money back (obviously, a huge assumption!).

Last but not least, I saw this picture on Greg Mankiw’s blog. He is a professor at Harvard and keeps a timely blog. I thought the picture was great even though Pick n Pay’s are mostly in South Africa and New Zealand.



Have a great weekend!

Dave Ott, General Partner

Daily Insight

Please accept my apologies for the extremely late Daily Insights this morning. As Brent mentioned the other day, he is on vacation and I plum forgot until I walked in the door.

Market Activity for July 30, 2008

Markets were strong yesterday which was particularly refreshing because it built on the rally the previous day. The S&P 500, the broadest measure of large cap activity, gained 0.80 percent, adding to the 2.30 percent advance on Tuesday.

Instead of a single factor, there were several issues driving the market higher. First, the ADP Employer Services report showed that payrolls had grown by 9,000 jobs this month, while most economists were expecting a loss of 60,000 jobs. This survey isn’t the most important jobs picture, but any good news on employment is greeted positively these days.

Second, the Federal Reserve announced that it would maintain the emergency borrowing plan extended to Wall Street firms through January. 30 of next year. The program was established in March during the most acute phase of the credit crisis when Bear Stearns collapsed and was scheduled to end in mid-September. Other programs were also extended through January that should encourage lending between investment banks.

Third, energy shares were helped by rising oil prices, but those prices didn’t extend to losses on other stocks. Oil gained 4.58 a barrel to 126.77, or 3.75 percent. Large integrated oil companies like ExxonMobil and Chevron gained 4.30 percent 5.34 percent respectively.

Finally, financial shares continued their rally with Bank of America gaining 4.31 percent on top of the 14.83 percent gain on Tuesday. Financial stocks have had an amazing rally since July 15th. Bank of America, for example, has gained more than 80 percent since the low only 15 days ago. This is remarkable rally for a two week period. Obviously, the stock is still well blow prices from even at the beginning of the year, but it does seem to suggest that there is a bottom for financial companies. For the year the stock remains down 15 percent including dividends through yesterday.

Of course, all of this is yesterday’s news. Today, the focus is entirely on the GDP report that shows that the economy grew at an annualized rate of 1.90 percent in the second quarter. While that may seem like good news, it was less than the forecasted growth rate of 2.30 percent and the gains can largely be attributed to the one-time federal stimulus check sent out during the quarter. Housing continues to take its toll on the overall economy.

Whenever a new GDP figure is released, the government also puts out revisions to the previous two quarters. Markets right now are focusing on the revision from the fourth quarter of last year that was revised from a positive figure to a negative number. The first quarter still shows a gain of 0.90 percent, though it is subject to one more revision.

Classical definitions of recession are based on two consecutive quarters of contraction in GDP. However, the organization that now calls recessions, the National Bureau of Economic Research (NBER), now defines a recession this way:

The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. For more information, see the latest announcement on how the NBER's Business Cycle Dating Committee chooses turning points in the Economy and its latest memo, dated 07/17/03. (Source: http://www.nber.org/)

Therefore, although we haven’t yet experienced two consecutive quarters of recession, the NBER may still call one in the coming months. Generally, the NBER makes their official announcement well into or even after the recession itself.

Stocks opened lower on the news but are now heading back to neutral. If there is anything to be learned by the volatility we have seen this year, though, intra-day movements can be all over the board.

I promise to get Daily Insights out much earlier tomorrow. Also, we now publish Insights along with other articles on our blog, http://www.acropoblog.com/.

Best,


David Ott, General Partner

Daily Insight

U.S. stocks rallied yesterday, more than erasing Monday’s declines, as the market continues to be whipsawed. A nice move by the dollar, which helped to push oil prices lower, combined with what may have been a favorable view of Merrill Lynch’s decision to unload mortgage-related securities at a fire-sale price sparked the rally. More on that Merrill news below.

The price of crude for August delivery moved to its lowest level since May, which sent consumer discretionary shares higher – this is the theme these days. When the market rallies, financials and consumer discretionary shares generally lead the way.

Information technology and industrial shares enjoyed a nice day too as better-than-expected earnings results sent the sectors higher.

Market Activity for July 28, 2008

Information technology profits are up 21% with 60% of those names reporting. The capital goods segment of the industrial sector looks good too and may just return to double-digit growth if the business spending trends of the past couple of months continues.

Profit results for eight of the 10 major industry groups remain in positive territory – three have recorded double-digit growth, two have posted 9% or better and another three have recorded earnings growth in a range of 4%-7%. The weakness has occurred in financials and consumer discretionary, down 86.8% (no that’s not a typo) and 21.7%, respectively.

The dollar gained good ground yesterday after the latest home price index showed price declines eased and the July consumer confidence reading improved slightly. Neither report was good, but both were better-than-expected. The dollar’s gain likely was due more to the home price data, which we’ll get to below, than the confidence number, which has proved to be a worthless indicator of future spending for a long time, but I mention it nonetheless.


Oil prices dropped 2.04%, or $2.54 per barrel, to $122.19. With the exception of constructive action out of Congress regarding the self-imposed barriers to production, we need the dollar to rally in order for crude to fall back to desired levels. Fed and tax policy can go a long way in pushing the dollar higher, but this looks quite unlikely for now. So we just have economic data that will drive the $ and oil in the meantime – Thursday’s GDP number will beat current estimates, and the dollar should rally. However, we get non-farm payrolls (NFP) on Friday, which may put pressure on the greenback. So we may be looking at offsetting effects. This increases the importance of the August 5 FOMC meeting; the Fed has a major opportunity to put a dazed oil trade on the mat.


In other news, Merrill Lynch announced they’ll take another $5.7 billion in write-downs in the third quarter – largely from selling $30.6 billion of bonds at a fifth of their face value. This follows $9 billion in write-downs just three weeks ago when they reported second-quarter results. (Merrill had previously valued the $30.6 billion (face value) in bonds at $11 billion. This sale brings the value down to roughly $6.8 billion.)

While these are huge numbers, and carry tremendous costs to existing shareholders, this is a good sign. Merrill is taking their medicine and getting this stuff behind them. One shouldn’t miss that for every loser, there is a winner -- the buyers of these mortgage-related bonds should make out big over time, picking these positions up at 22 cents on the dollar. Absent these fire-sale prices, the losses would have only dragged on.

On the economic front, we received the latest figure from the S&P Case/Shiller Home Price Index for May, which showed a year-over-year decline of 15.78%. On a monthly basis, the index showed prices fell 0.86% (that’s for May from the April reading) and 15.91% at an annualized rate for the three months ended in May.

While these are large declines, the index did offer evidence the degree of price declines may be decelerating. For instance, the three-month annualized figure has eased from down 25% in March and the month-over-month decline has eased from -2.63% in February.

Further, keep in mind that this Case/Shiller index only captures activity among the largest 20 U.S. cities. The largest price declines have taken place in what we’re referring to as speculative areas -- San Diego, LA, Phoenix, Las Vegas and Miami. Detroit has been another major decliner, but this is due to other factors such as auto-sector woes and higher tax rates that have pushed businesses out of Michigan.

Seven of the 20 cities actually showed home price rose in May – Boston, Dallas, Charlotte, Denver, Atlanta, Minneapolis and Portland. So, there was some good news, but the overall point is that Case/Shiller is not a broad index. It does a good job of showing the direction of home prices, but exacerbates the degree to which prices have moved.

The broadest home price index is the OFHEO (Office of Federal Housing Enterprise Oversight) index, which shows home prices are down 6% over the past year. This index has its limitations too, as it captures only conforming loans, leaving out the upper-end of the housing market.

So we must factor in all of the data, it is a mistake to look at just one indicator. For a longer-term perspective I’ll leave you with charts of new and existing home prices. Notice that prices remain nicely positive going back to 1999. It’s tough to read on this graph, but existing home prices are 51.82% higher and existing home prices are up 46.7% from the summer of 1999. (I could only go back to 1999 as the existing median home price index began in that year.) Existing home prices are down 6.41% from the peak and new home sales are down 12.12% from the all-time high.



I’ll be on vacation through August 11 so David Ott, among others, will be filling in until then.

On economic watch over the next week will be the first look at Q2 GDP tomorrow and the July jobs report on Friday. Monday, personal income and spending for June will receive focus and then the FOMC meeting on August 5. For new readers, the FOMC stands for Federal Open Market Committee – the group that sets the Fed’s key interest rate.

We have seen some dissent within the FOMC of late. That is, more members have expressed the need to raise fed funds, gently for now – 20% year-over-year increases in import prices, a 10% jump in producer prices and 5% CPI will have that effect. Anyway, with oil $24 off its record high the Fed may have been lulled into a false sense of security regarding price stability and their comments on August 5 may turn dovish. If so, I believe they’ll be making a huge mistake and oil may rise again. (There are several other factors that determine the price of oil, but one thing at a time for now.)

However, if they show they’re serious about price stability – even with the credit-market challenges that confront the group – we may just see crude forced closer to the $110 level. This presents an awesome opportunity for the Fed and could bring with it a stock market rally, increased consumer consumption numbers and one serious risk removed from the market. It will be interesting to watch this play out.

Have a great day!

Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks began Monday’s session lower but looked to reverse course as the indices quickly popped to positive territory in the first 30 minutes of trading; that was until a dire IMF (International Monetary Fund) statement was released about 9:30CT. That release stated there was no end in sight to the housing woes and warned deteriorating credit conditions for consumers and banks may prolong a period of slow growth. (Interesting how they are now reframing their negative predictions as “slow growth” rather than “recession.”)

On this point for a moment, there is no doubt the credit markets are going through a period of trouble, but let’s not act as though things are worse than they actually are. I’ll point out that commercial and industrials loans have risen 18% over the past year and at a 9% annual rate over the past six months. The pace has slowed, but comments that credit has slowed to a halt are removed from reality. Below is a chart of C&I loans.


Losses among the benchmark indices increased in the afternoon after Treasury Secretary Paulson held a press conference that failed to address the market’s chief concerns – we’ll touch on this below.

Market Activity for July 28, 2008
To no surprise, financials and consumer discretionary shares led the market lower – these are the pressure points on days of weakness as concerns over housing, tax rates, price stability and the job market effect these sectors more than any other.

The good news that people should have been focused on yesterday was exactly that IMF report, as this organization’s predictions are rarely accurate. While we expect housing to remain weak for some time still, likely another year due the elevated nature of home supply and higher foreclosure rates, the fact that the IMF has predicted no end in sight may be the best indication the worst is over.

While financials and consumer disc. shares led the indices lower, nothing really helped as all 10 major industry groups were down yesterday. Industrial and information technology shares got wacked with the rest of the market. Utility, energy and basic material shares were the relative winners down 0.19%, 0.46% and 0.58%, respectively.


On the earnings front, outside of the financial sector, things continue to look quite good. Ex-financial profits are up 12% with 55% of S&P 500 members reporting thus far. Seventy-percent of those reporting have beat expectations. Still no one cares right now.

Take Verizon’s results as an example. The phone giant reported Q2 operating profit rose 15.5% as their wireless business was strong. Yet, all people could focus on was their weaker-than-expected landline business. Now, which segment is the growth story? Bad news would have been weak wireless activity, not the case though. So you have a stock that offers a 5.12% dividend yield and is delivering high single-digit profit growth trading at 12.8 times 2008 earnings. And this isn’t even one of the more compelling buys out there. The problem is investors may have to wait a while for attractive returns to materialize, but when they do, it will be big.

For now there are plenty of uncertainties in front of us. The shame of it is policy makers have created most of these uncertainties. A Fed that left rates too low for too long into 2004 and 2005 encouraged the mortgage mess we find ourselves in. The economy was rolling along at a very nice pace, yet they waited until June 2005 to get fed funds above 3.00%. Heck, they were still easing in the back-half of 2003, cutting fed funds to 1.00% in June of that year even as the stock market was signaling a boom and their own June 11 Beige Book report showed things were turning. Now, the same reckless easing policy is on again. Yes they must ensure liquidity and they are doing that via their lending facilities, but to jack their benchmark rate down 325 basis points in nine months (225 of that in six months) is reckless.

And then there is the Treasury Secretary.

Paulson Tries Again

Treasury Secretary Hank Paulson held a press conference yesterday afternoon -- in an attempt to reassure the markets I presume – explaining the virtue of “covered bonds” and the beneficial affect such debt instruments would have on the credit markets. However, while this may be the direction the industry goes over the next several years, it doesn’t do much for now because banks are still set up under the securitization framework – hence, many times they do not hold the assets that back these debt instruments on the balance sheet.

(The way I understand it: Covered bonds are securities issued by a bank and backed by a dedicated group of loans – a “covered pool.” If the issuing bank becomes insolvent, the assets in the covered pool are separated from the issuer’s other assets solely for the benefit of the covered bondholder. This is the major difference between covered bonds and asset-backed securities. Loans backing a covered bond remain on the balance sheet and should the originating bank fail to make payments, interest payments from the underlying mortgages would go to investors.)

Anyway, Paulson’s attempt whiffed, reminiscent of a Dave Kingman strikeout – for you 1970s and 1980s baseball fans, because this is not that which market participants are currently concerned – at least regarding the here and now.

At risk of sounding repetitious, it is the uncertainty over the housing market and its effect on consumer behavior, questions over tax rates, and the possibility/likelihood that the Fed is ignoring price stability.

The housing market will simply take time to correct; after several years of outsized gains, there is nothing Congress or anything other than time can do to fix it. The Fed will do what they are going to do; this is not Paulson’s turf, so nothing he can really do there either. But this is the Treasury Secretary we are talking about, the appropriate person (after the President) to offer tax rate proposals.

What he should be doing is demanding that Congress make the tax rates on capital, dividends and income permanent – as permanent as Washington gets anyway. Follow that up with a proposal to cut the corporate income tax -- which has become one of the highest rates in the world as virtually every other serious country has cut this rate -- and vastly reduce the tax on repatriated income. (This income earned overseas will stay there so long as it is taxed at a 35% rate) You want to bring it home, cut this rate down to single digits; it will come home in droves.

This would combine beautifully with the increased current-year business equipment write-off allowance and bonus depreciation that was delivered in May, and by the way has kicked started business spending as we discussed yesterday. This combination would be a big job and productivity producer, but Paulson doesn’t get it, and thus the market will continue to send the message that he is not delivering what it wants.

Look, these are times the equity investor must deal with on occasion. But this economy is fundamentally sound; allow the housing correction to run its course, get monetary policy back in order and simply do not damage after-tax return expectations by driving tax rates higher and the market will get back on its horse We only need a little tweaking, U.S. businesses are more streamlined than anytime in history, able to compete and dominate on a global scale, but bad policy should not get in the way. Raise tax rates in this environment of intense global competition and you get your hat handed to you.

As of the latest count, there was $3.5 trillion sitting in money-market funds – plenty of capital out there. Give it a reason to come out of hiding and you’re looking at a powerful market run – long-lasting. That said, the equity investor will need patience here, but when things turn, it will make it all worth it.

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks gained ground on Friday after better-than-expected economic reports showed a bounce in business spending will help catalyze growth and new home sales rose in two of the four regions. The gains helped the major indices pare weekly losses on the Dow and S&P 500, while the strong 1.33% rise on the NASDAQ Composite moved the tech-laden index to a gain for the week.

The Commerce Department reported durable goods whipped the consensus estimate, with the business spending component jumping 10.4% at an annual rate since March. This number will push the second-quarter GDP figure to a level that easily surpasses the current estimate. The new homes sales number, while weak, didn’t hurt either. The supply of new homes fell, but remains extremely elevated.

Market Activity for July 25, 2008

Information technology shares led the advance, which was nice. Earnings growth has outpaced the rise in share prices for several years with regard to the overall market, but increasing so for the tech sector. Energy and material stocks also helped the benchmark indices bounce back from Thursday’s pummeling after a multi-session pull-back for these shares. Industrials and health-care stocks also rebounded.

On the earnings front, S&P 500 profits remain in negative territory for the second quarter and nothing is going to help this figure move to the positive side with the financial sector weighing so heavily. Financial-sector profits are down 94% for the three months ended June 30 – that’s from the year-ago period. Yet, ex-financial earnings remain in double-digit territory – up 12.1% thus far; roughly 40% of S&P 500 members have reported.

Five of the 10 major industry groups have recorded 10%-plus growth – consumer discretionary (+20.1%), consumer staples (+10.5%), energy (+27.0%), health-care(+10.1%) and information technology (+20.9%). The industrial, basic material, telecom and utility sectors have posted results in a range of 2%-6.8%. Financials is the only sector that’s negative.

In economic news, the Commerce Department reported new home sales dropped at half the expected rate in June and the supply fell for the second month in three. We’ll note that sales have declined 33.2% over the past 12 month, but have increased 13.9% at an annual rate over the past three months.

That last comment is encouraging, but the report does not account for cancellations of previously signed contracts, so the new home sales data is not the most reliable. (Existing home sales, although working with a bigger lag that new homes is probably a better indicator as sales are not counted until the closing, rather than when signed like new homes sales.)

Too, this figure is quite volatile and the next couple months of data can pull the rug from any optimistic thoughts – just something to keep in mind. If this trend of the past quarter continues, however, it may signal the housing sector is beginning to stabilize, but it will take more data to make this conclusion realistic. That said, I think the non-speculative regions of the market – those excluding California, Arizona, Nevada and Florida – may be showing a bottom in prices. Those four states are big ones though, five of the biggest 20 cities reside in California and Florida alone, which will weigh on the overall figure.

In terms of region, the Northeast saw new home sales increase 5.3% in June; sales rose 2.5% in the Midwest. The South and West regions showed declines of 2% and 0.9%, respectively.

In a separate report, Commerce showed durable goods orders for June easily surpassed the consensus estimate, rising 0.8% overall and the ex-transportation number, which has posted a gain in three of the past four months, jumped 2.0%. The estimate was for a 0.3% decline on the overall reading and a 0.2% decline in the ex-trans number.

Total durable goods orders have fallen 0.3% at an annual pace since March. Excluding transportation – which takes out the extremely volatile commercial aircraft orders and a beleaguered auto sector – orders have jumped 13.5%.

As mentioned in Friday’s letter, we were focused on the business spending figure and it didn’t disappoint -- up1.4% in June and 10.4% at an annual rate for the last three months. The shipments of this segment – technically known as non-defense capital goods ex-aircraft – increased 5.9% at an annual rate during the second quarter. This number feeds right into the GDP figure and we’ve got a great shot at seeing a 3.0% real rate of growth for Q2. This would be huge considering housing continues to subtract a full percentage point from the figure.

Big gains in electrical equipment and machinery orders were the catalyst for the capital goods segment. Industrial machinery orders were up 13.8% annualized past three months and 11.8% over the past year. Electrical equipment more than doubled, up 150% over the past three months – again that’s annualized – and 8.4% past 12 months.


In other news, the Senate passed the housing bill, which the President Bush will sign this morning I suppose. The bill involves the Fannie Mae and Freddie Mac provisions that would allow the Treasury Department to increase its credit line to the two GSEs, Treasury to take an equity stake if needed, and raise the size of loans eligible for purchase to $625,000 – that ceiling will depend on the region.

The centerpiece of the legislation is the program of $300 billion of FHA-insured mortgages to help refinance loans for those who cannot afford their current situation. The way I understand it, lenders would have to get a new appraisal on the property and then write it down by 15% from there for the homeowner to qualify. In return, the homeowner will have to share, equally, future price appreciation with the FHA. And if home values go down before they go back up, and the borrower goes under, then of course the taxpayer is on the hook.

Also, in the legislation is up to a $7500 tax credit for first-time homebuyers. They would have to buy between April 2008 and June 2009. That’s a big credit and may just kick sale up a bit; we shall see.

Have a great day!

Brent Vondera, Senior Analyst