Earnings releases and management commentary all had a similar tone this week. The general consensus amongst firms reporting earnings this week is that the global economy is entering a recession that will last most of 2009. Most companies began to see weakening on a global scale in September, with the weakest demand in automotive, housing, and durable goods markets. Operations across all industries are tightening and capital expenditures are slowing as companies shift into cash preservation and build mode.
Companies seem to be encouraged by the coordinated response by governments and central banks around the world. While most statements showed confidence that government actions will ultimately restore global liquidity, there is a great deal of uncertainty regarding the depth and duration of economic decline as well as the timing and strength of a recovery.
These are obviously challenging times, and they are challenging for companies across all industries. Management statements this week acknowledged the importance of taking advantage of growth opportunities when they present themselves and position themselves for the future.
The market is beginning to distinguish between companies that will see modest growth and those where growth is going to fall off a cliff. In many cases it is easy to pick out the relatively stable businesses from the unstable ones. The companies that are holding up are doing so because they are very high quality companies.
Click here to read a summary of various earnings reports from this week.
Peter Lazaroff, Junior Analyst
Friday, October 24, 2008
Daily Insight
U.S. stock activity exhibited another extremely volatile session on Thursday, but ended the day on the plus side as the broad-market rallied 5.5% in the final hour of trading. The Dow, which swung 555 points from the session’s peak to trough, jumped 5.2% in the final hour.
I was going to come in today and say it’s a good sign that we’re rallying at the end, but no one really knows in this market, the volatility is insane. Further, overseas markets were hammered last night, and into this morning for the European bourses. Stock-index futures are “limit down” – meaning trading curbs meant to keep things orderly have kicked in and prices cannot fall further prior to the bell. (Orderly, that would actually be nice) So, the fact that the market has rallied at the end of the prior two sessions is probably pretty meaningless right now.
Market Activity for October 23, 2008
We are fairly confident the market has poor earnings assumptions and a meaningful recession priced in at this point – although there are other factors that don’t exactly give the equity investors a great feeling, as touched on yesterday. (The government has pulled every trigger in its arsenal, except for its most powerful – a tax-rate response to this situation. This is beyond puzzling and proving to be a huge mistake)
The market is fundamentally oversold; everyone knows it, but it doesn’t matter right now as de-leveraging and fear continue to play out. We’re likely witnessing the most oversold market since October 1974, which proved to be the most awesome buying opportunity of all time – but just like that period 34 years ago to the month plenty of obstacles remain in the path of progress.
Even though fundamentals have been discarded, longer-term investors should not ignore the fact that multiples have compressed and the S&P 500 market cap-to-GDP ratio has dropped to a point that doesn’t properly reflect the actual size of the economy. To bring it back to a level that makes more sense, it is not unreasonable to expect that market cap to increase by $4-5 trillion, which would amount to a 50% jump in the index. Also, the broad market now trades at 2003 levels, yet after-tax corporate profits are higher by 115% since the S&P 500 last stood at this price.
Of course, if we get policy adjustments that fundamentally change our economy to one that involves more government action for the longer-term, then a jump of this magnitude will only be delayed.
On the economic front, the Labor Department reported jobless claims rose 15,000 to 478,000 in the week ended October 18 – this was double the expected increase, but remains below the peaks of the prior two job-market downturns.
The government stated that 12,000 of last week’s claims resulted from Hurricane Ike, which hit six weeks ago, as shutdowns from that weather-event continue to flow through to firings.
Nevertheless, we won’t be able to blame claims on that weather event from here and other areas of the report are showing weakness will continue – not that that’s a huge surprise based on what has developed over the past few weeks. The ratio of states reporting increased claims to those reporting a decrease is a meaningful sign of weakness – 39 states and territories reported an increase to 13 that reported a decrease. The credit-market freeze up of the past five weeks, and reactions to this occurrence such as an elevated level of caution and holding off, has damaged economic activity for at least the next two quarters.
The four-week average of jobless claims (chart below) fell 4,500 to 480,250. During the September employment survey this measure hit 445,750 – the October jobs report will be released on November 7 and this claims data suggests we’ll see another 100k-plus decline.
The economic deterioration from the credit-market event has occurred with amazing speed – it was just six weeks ago that economic data was suggesting the business side of the economy would offset weakness from consumer activity due to the housing and labor-market downturn. (Business spending on capital equipment was on the rebound, rising 7.0% at an annual rate April-August, but that trend will show a collapse when the September figure is released next week.)
Everything changed when Lehman went down on September 15 and the credit-market disturbance that resulted. Even firms that were not directly affected by this situation have become extremely cautious, which funnels down to job-market fundamentals.
In other economic news, the OFHEO Home Price index showed a decline of 0.6% for August – OFHEO stands for Office of Federal Housing Enterprise Oversight.
For the past 12 months, the index has home prices down 6.6%. As we explain each month, this is quite different from the S&P Case/Shiller Housing index (the index the press focuses on), which has prices down 16% over the past 12 months. This OFHEO index has its flaws, it does not include the high-end market, but it is much broader than the Case/Shiller reading, which includes only the 20 largest metro areas – several of which have endured the largest price declines due to heightened speculation during the boom.
Bottom line, weight Case/Shiller, OFHEO and the National Realtors Association existing home sales data equally and it suggests home prices are down 10% year-on–year. Probably very close to reality for the majority of U.S. regions.
A “Time for Choosing”
Over the past five weeks you all have certainly noticed the tone of the letter has grown negative – at least relative to my normal tone; the data along with thoughts of impending policy changes have that effect. Simply to provide a commentary on weak economic releases and market-specific data by definition leads to less-than-optimistic expression.
Taking a longer-term view though, the U.S. economy has so much going for it. Our entrepreneurial spirit, productive workforce, awesome ability to innovate, ability to attract capital, streamlined corporate structures, geographical breadth and track record of bouncing back from the most dangerous of scenarios are huge benefits that should not be forgotten.
However, we cannot have a Washington that stifles most of these benefits. To move to increased levels of regulation and onerous tax rates will smother our economic benefits like a python squeezing its prey (and I do have in mind Thomas Paine’s Rights of Man with this comment). The direction of policy over the next couple of years will shape whether we have the ability to continue along an economic trajectory that has raised living standards more in the past quarter century than possibly anytime in history or something more in line with Europe, a slow erosion that stifles the national spirit. We have indeed arrived at another “time for choosing.”
Have a great day!
Brent Vondera, Senior Analyst
I was going to come in today and say it’s a good sign that we’re rallying at the end, but no one really knows in this market, the volatility is insane. Further, overseas markets were hammered last night, and into this morning for the European bourses. Stock-index futures are “limit down” – meaning trading curbs meant to keep things orderly have kicked in and prices cannot fall further prior to the bell. (Orderly, that would actually be nice) So, the fact that the market has rallied at the end of the prior two sessions is probably pretty meaningless right now.
Market Activity for October 23, 2008
We are fairly confident the market has poor earnings assumptions and a meaningful recession priced in at this point – although there are other factors that don’t exactly give the equity investors a great feeling, as touched on yesterday. (The government has pulled every trigger in its arsenal, except for its most powerful – a tax-rate response to this situation. This is beyond puzzling and proving to be a huge mistake)The market is fundamentally oversold; everyone knows it, but it doesn’t matter right now as de-leveraging and fear continue to play out. We’re likely witnessing the most oversold market since October 1974, which proved to be the most awesome buying opportunity of all time – but just like that period 34 years ago to the month plenty of obstacles remain in the path of progress.
Even though fundamentals have been discarded, longer-term investors should not ignore the fact that multiples have compressed and the S&P 500 market cap-to-GDP ratio has dropped to a point that doesn’t properly reflect the actual size of the economy. To bring it back to a level that makes more sense, it is not unreasonable to expect that market cap to increase by $4-5 trillion, which would amount to a 50% jump in the index. Also, the broad market now trades at 2003 levels, yet after-tax corporate profits are higher by 115% since the S&P 500 last stood at this price.
Of course, if we get policy adjustments that fundamentally change our economy to one that involves more government action for the longer-term, then a jump of this magnitude will only be delayed.
On the economic front, the Labor Department reported jobless claims rose 15,000 to 478,000 in the week ended October 18 – this was double the expected increase, but remains below the peaks of the prior two job-market downturns.
The government stated that 12,000 of last week’s claims resulted from Hurricane Ike, which hit six weeks ago, as shutdowns from that weather-event continue to flow through to firings.
Nevertheless, we won’t be able to blame claims on that weather event from here and other areas of the report are showing weakness will continue – not that that’s a huge surprise based on what has developed over the past few weeks. The ratio of states reporting increased claims to those reporting a decrease is a meaningful sign of weakness – 39 states and territories reported an increase to 13 that reported a decrease. The credit-market freeze up of the past five weeks, and reactions to this occurrence such as an elevated level of caution and holding off, has damaged economic activity for at least the next two quarters.
The four-week average of jobless claims (chart below) fell 4,500 to 480,250. During the September employment survey this measure hit 445,750 – the October jobs report will be released on November 7 and this claims data suggests we’ll see another 100k-plus decline.
The economic deterioration from the credit-market event has occurred with amazing speed – it was just six weeks ago that economic data was suggesting the business side of the economy would offset weakness from consumer activity due to the housing and labor-market downturn. (Business spending on capital equipment was on the rebound, rising 7.0% at an annual rate April-August, but that trend will show a collapse when the September figure is released next week.)
Everything changed when Lehman went down on September 15 and the credit-market disturbance that resulted. Even firms that were not directly affected by this situation have become extremely cautious, which funnels down to job-market fundamentals.
In other economic news, the OFHEO Home Price index showed a decline of 0.6% for August – OFHEO stands for Office of Federal Housing Enterprise Oversight.
For the past 12 months, the index has home prices down 6.6%. As we explain each month, this is quite different from the S&P Case/Shiller Housing index (the index the press focuses on), which has prices down 16% over the past 12 months. This OFHEO index has its flaws, it does not include the high-end market, but it is much broader than the Case/Shiller reading, which includes only the 20 largest metro areas – several of which have endured the largest price declines due to heightened speculation during the boom.
Bottom line, weight Case/Shiller, OFHEO and the National Realtors Association existing home sales data equally and it suggests home prices are down 10% year-on–year. Probably very close to reality for the majority of U.S. regions.
A “Time for Choosing”
Over the past five weeks you all have certainly noticed the tone of the letter has grown negative – at least relative to my normal tone; the data along with thoughts of impending policy changes have that effect. Simply to provide a commentary on weak economic releases and market-specific data by definition leads to less-than-optimistic expression.
Taking a longer-term view though, the U.S. economy has so much going for it. Our entrepreneurial spirit, productive workforce, awesome ability to innovate, ability to attract capital, streamlined corporate structures, geographical breadth and track record of bouncing back from the most dangerous of scenarios are huge benefits that should not be forgotten.
However, we cannot have a Washington that stifles most of these benefits. To move to increased levels of regulation and onerous tax rates will smother our economic benefits like a python squeezing its prey (and I do have in mind Thomas Paine’s Rights of Man with this comment). The direction of policy over the next couple of years will shape whether we have the ability to continue along an economic trajectory that has raised living standards more in the past quarter century than possibly anytime in history or something more in line with Europe, a slow erosion that stifles the national spirit. We have indeed arrived at another “time for choosing.”
Have a great day!
Brent Vondera, Senior Analyst
Thursday, October 23, 2008
Daily Insight
Round-tripper
U. S. stocks were pounded again yesterday and frankly I’m not buying the claim that this is because of poor earnings assumptions. Stocks have priced in these earnings assumptions and a substantial recession at this point. Yes, there is uncertainty over how badly profit results will be affected by this mess a quarter or two out, but heavens the broad market is down 42% from the peak – it’s priced in at this point. At least some of this move is about the election.
Credit markets are in the process of thawing, so we don’t have that to blame right now, certainly not to the degree we could a week ago. Uncertainty, or rather near certainty that market-sensitive tax rates will erode after-tax return expectations, is causing additional damage as a de-leveraging event may still be playing out.
Certainly, the economic damage locked up credit markets have wrought continues to pressure stocks. For each 5% move lower – and that’s not a scientific trigger point, I’m just throwing a figure out there – hedge funds and mutual funds receive additional redemption calls, and must sell stocks as a result.
Yet, the bounce off of the lows of the session yesterday does not suggest the move was due solely to this phenomenon. When redemption calls drive these sell offs we see erosion increase to the close, that didn’t occur on Wednesday.
Market Activity for October 22, 2008
The S&P 500 is back to levels not seen since April 2003, and June 1997 when the broad market hit this level for the first time – a round-tripper.
However, we are holding above the 849 intra-day low in terms of the S&P 500 and 7890 for the Dow, which were hit on October 10. I’m not going to pretend to be a technician, but the longer we hold above those levels the better.
It isn’t fun going no where for a decade. But multiples continue to compress and history shows after round-trippers of this duration, the Great Depression being the exception, it isn’t long before a sustained rally takes hold. This multiple compression action is an important one.
When we hit this level for the first time back in 1997 the broad market traded at a P/E of 23 times earnings and after-tax profits were about to go flat (many don’t know this but after-tax corp. profits declined Q3 1997 to the end of the decade). When we touched this level again in 2003, the index was trading at 30 times, after-tax corporate profits were in the process of an extraordinary five year growth run. Currently, the S&P 500 trades at 18 times trailing profits. Based on profit expectations for the next four quarters, the index trades at just 11 times – assuming profit growth expectations are off the mark by a huge 50%, you still have a forward P/E of just 14.
Problem is we may have some policies that aren’t exactly market-friendly to deal with. Further, a President Obama will be tested by our enemies (which Senator Biden has now warned us of, was he privy to a recent intelligence report suggesting this?), which could delay that sustained rally we’re all hoping far. It’s unfortunate we must rely on hope, but when no one is going to step up with a sensible fiscal policy response, that’s all you’ve got.
This is where the current administration takes the blame. With all that has been said, what got us here is hardly Bush’s fault; plain and simple the origin of this situation is Federal Reserve monetary policy mistakes – keeping rates too low for too long. (What were they thinking as they continued to cut fed funds to 1.00% in June 2003 even as the economy began to come back in 2002 and was rolling by the spring of 2003?) In fact, the Bush tax cuts (on income, dividends, capital gains, repatriated income and business write-off allowances) helped us withstand a 178% jump in the price of oil (mid 2003-mid 2005) – even before the super-spike occurred two years later – and housing’s drag on the economy that has lasted for 2 ½ years now.
However, for the administration to ignore a tax-rate policy response to the current troubles is mind-boggling. We’ve thrown everything at this issue – and for sure much of this does not have an immediate effect, but will in time – yet to hold back on the most powerful policy tool there is strange. So President Bush fears he doens’t have the numbers to get it through Congress, what does it hurt to try your darnedest?
On to better thoughts -- The Greenback
Wow! The dollar continues to soar. Wonder if Giselle is ready to accept US dollars as compensation again?
Another Congressional Lashing
Ratings agency executives were on Capitol Hill attempting to defend yet another berating by those who hold themselves up to be as pure as the wind-driven snow yesterday.
Funny how regulators never come under attack. For instance when the SEC’s regulatory division head (Annette Nazareth) decided it was a good idea to switch from fixed capital ratio standards to “sophisticated” Basel II mathematical models in the middle of a housing boom it didn’t’ turn out to be an award-winning idea. But few are talking about that terrible mistake. Doing so when housing was on fire, thanks to Greenspan’s recklessly easy money policy – effectively subsidizing debt –, meant that highly rated mortgage–backed securities were treated as if they were nearly as safe as cash. This meant less capital was required – a major source of the current problem. I don’t recall those now pointing the finger at the private sector questioning this regulatory move back then.
No doubt the ratings agencies are guilty as charged, but it’s not like moronic regulatory decisions have not played a major role. The next time someone sells you on something because of its sophistication, run!
This morning we get back to data. It’s Thursday, so we’ll be watching the jobless claims release for the week ended October 18– it’s not likely to be pretty but will hold below the peaks of the past two labor-market downturns.
Have a great day!
Brent Vondera, Senior Analyst
U. S. stocks were pounded again yesterday and frankly I’m not buying the claim that this is because of poor earnings assumptions. Stocks have priced in these earnings assumptions and a substantial recession at this point. Yes, there is uncertainty over how badly profit results will be affected by this mess a quarter or two out, but heavens the broad market is down 42% from the peak – it’s priced in at this point. At least some of this move is about the election.
Credit markets are in the process of thawing, so we don’t have that to blame right now, certainly not to the degree we could a week ago. Uncertainty, or rather near certainty that market-sensitive tax rates will erode after-tax return expectations, is causing additional damage as a de-leveraging event may still be playing out.
Certainly, the economic damage locked up credit markets have wrought continues to pressure stocks. For each 5% move lower – and that’s not a scientific trigger point, I’m just throwing a figure out there – hedge funds and mutual funds receive additional redemption calls, and must sell stocks as a result.
Yet, the bounce off of the lows of the session yesterday does not suggest the move was due solely to this phenomenon. When redemption calls drive these sell offs we see erosion increase to the close, that didn’t occur on Wednesday.
Market Activity for October 22, 2008
The S&P 500 is back to levels not seen since April 2003, and June 1997 when the broad market hit this level for the first time – a round-tripper.
However, we are holding above the 849 intra-day low in terms of the S&P 500 and 7890 for the Dow, which were hit on October 10. I’m not going to pretend to be a technician, but the longer we hold above those levels the better.
It isn’t fun going no where for a decade. But multiples continue to compress and history shows after round-trippers of this duration, the Great Depression being the exception, it isn’t long before a sustained rally takes hold. This multiple compression action is an important one.
When we hit this level for the first time back in 1997 the broad market traded at a P/E of 23 times earnings and after-tax profits were about to go flat (many don’t know this but after-tax corp. profits declined Q3 1997 to the end of the decade). When we touched this level again in 2003, the index was trading at 30 times, after-tax corporate profits were in the process of an extraordinary five year growth run. Currently, the S&P 500 trades at 18 times trailing profits. Based on profit expectations for the next four quarters, the index trades at just 11 times – assuming profit growth expectations are off the mark by a huge 50%, you still have a forward P/E of just 14.
Problem is we may have some policies that aren’t exactly market-friendly to deal with. Further, a President Obama will be tested by our enemies (which Senator Biden has now warned us of, was he privy to a recent intelligence report suggesting this?), which could delay that sustained rally we’re all hoping far. It’s unfortunate we must rely on hope, but when no one is going to step up with a sensible fiscal policy response, that’s all you’ve got.
This is where the current administration takes the blame. With all that has been said, what got us here is hardly Bush’s fault; plain and simple the origin of this situation is Federal Reserve monetary policy mistakes – keeping rates too low for too long. (What were they thinking as they continued to cut fed funds to 1.00% in June 2003 even as the economy began to come back in 2002 and was rolling by the spring of 2003?) In fact, the Bush tax cuts (on income, dividends, capital gains, repatriated income and business write-off allowances) helped us withstand a 178% jump in the price of oil (mid 2003-mid 2005) – even before the super-spike occurred two years later – and housing’s drag on the economy that has lasted for 2 ½ years now.
However, for the administration to ignore a tax-rate policy response to the current troubles is mind-boggling. We’ve thrown everything at this issue – and for sure much of this does not have an immediate effect, but will in time – yet to hold back on the most powerful policy tool there is strange. So President Bush fears he doens’t have the numbers to get it through Congress, what does it hurt to try your darnedest?
On to better thoughts -- The Greenback
Wow! The dollar continues to soar. Wonder if Giselle is ready to accept US dollars as compensation again?
Another Congressional Lashing
Ratings agency executives were on Capitol Hill attempting to defend yet another berating by those who hold themselves up to be as pure as the wind-driven snow yesterday.
Funny how regulators never come under attack. For instance when the SEC’s regulatory division head (Annette Nazareth) decided it was a good idea to switch from fixed capital ratio standards to “sophisticated” Basel II mathematical models in the middle of a housing boom it didn’t’ turn out to be an award-winning idea. But few are talking about that terrible mistake. Doing so when housing was on fire, thanks to Greenspan’s recklessly easy money policy – effectively subsidizing debt –, meant that highly rated mortgage–backed securities were treated as if they were nearly as safe as cash. This meant less capital was required – a major source of the current problem. I don’t recall those now pointing the finger at the private sector questioning this regulatory move back then.
No doubt the ratings agencies are guilty as charged, but it’s not like moronic regulatory decisions have not played a major role. The next time someone sells you on something because of its sophistication, run!
This morning we get back to data. It’s Thursday, so we’ll be watching the jobless claims release for the week ended October 18– it’s not likely to be pretty but will hold below the peaks of the past two labor-market downturns.
Have a great day!
Brent Vondera, Senior Analyst
Wednesday, October 22, 2008
Afternoon Review
Following up on the dividend discussion from yesterday, this post on the WSJ.com blog MarketBeat commented on the S&P 500’s unusually high dividend yield and suggests that the yields is likely to come down.
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Earnings reports have been mixed the last few days, but almost all companies are projecting lower profits in the coming quarters. I will provide a summary of earnings in Friday's post.
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Standard and Poor’s, Fitch, and Moody’s Investors Service are under intense scrutiny for putting profit gain before accuracy. These articles (here and here) are must reads for insight into the underlying problems in these ratings agency.
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A study by Bernstein Research showed that U.S. sales of store-brand household and personal products rose 8.9 percent in the four weeks ended Oct. 4. By contrast, sales of similar products increased by 2.3 percent at Procter & Gamble (PG) and 1.3 percent at Colgate (CL). In the year-earlier period, sales of private-label products increased 2.4 percent, according to Bernstein.
- Private-label brands increased market share in 15 out of the top 20 household and personal-products categories, according to a study by Bernstein Research.
- Consumer-products makers increased prices by as much as 16 percent this year to cover higher expenses for oil used in plastic packaging and pulp used for toilet paper, tissues, and paper towels.
- Shoppers are more likely to “trade down” when it comes to diapers and anything made of paper. That disproportionately hurts Kimberly-Clark (KMB), which specializes in paper products.
- Interesting Bloomberg article on the subject.
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks gave some of the recent rally back yesterday as investors’ concern over the state of the global economy grows. The Dow, for instance, jumped 400 points last week and added another 413 on Monday as credit market indicators have improve, but yesterday the index gave back one-third of that bounce and if futures offer any guidance we may just give back another 200 points today.
Credit markets are thawing – the Ted spread has narrowed another 30 basis points this morning – but the market now seems to be focused on corporate-profit guidance and stocks are under some pressure again as a result. That said ex-financial S&P 500 profit numbers look quite good thus far, up 8.1% with 25% of members reporting to this point. But when we enter such a scenario, the market chooses to look at only the negatives, of which there are plenty – but that will change.
Market Activity for October 21, 2008
No matter what occurs over the near term valuations are very attractive here. I said that a couple of months ago, but it’s truer today. There are many really good companies trading at the cheapest multiples in a very long time, I heard someone state this morning that 40% of S&P 500 members are trading at 8 times earnings -- haven’t had time to look that up yet, seems a bit of an exaggeration, but for sure there’s an abundance of names trading at 10 times or lower and even if 2009 profit results come in 25% below expectations stocks will remain cheap. It’s just going to take patience, but when a sustained rally occurs, it will be powerful.
The Dollar and Commodity Prices
The U.S. dollar has bounced back strong and commodity prices have gotten clocked from the fed-induced peak in July.
A combination of the flight-to-safety trade and expectations of a series of ECB rates cuts has sent the dollar soaring from the low hit in April.
De-leveraging trades and concerns the credit-market freeze-up will damage global growth have combined to fully whack commodity prices.
Both of these develops are good for the consumer and they can be added to realities such as strong corporate balance sheets and low inventory levels to assist in a recovery once we progress from this current weakness. (We’ll note commodity prices are likely not down for the count. We will have an inflation issue to deal with over the next couple of years due to the massive liquidity the Fed has pumped into the system, but for now the objective is to deal with credit-market disturbances. Some will say we should just let things fall where they may, for it is the Fed’s easy money policy that got us into this situation to begin with, but that’s not going to happen, not the way the world works.)
And speaking of which, the Federal Reserve rolled out another lending facility, about the sixth if memory serves. This one will provide liquidity to the U.S. money markets – the program will be termed the Money Market Investor Funding Facility (MMIFF) and will purchase assets from money-market mutual funds to stave off any difficulties meeting redemptions. This program is authorized under section 13(3) of the Federal Reserve Act.
Under the MMIFF, the New York Fed will provide senior secured funding to facilitate an industry-supported private-sector initiative to finance the purchase of eligible assets from eligible investors. (Eligible assets will include certificates of deposits and commercial paper issued by highly rated financial institutions with maturities of 90 days or less.) JP Morgan will be one of the firms running the program.
This facility is an extension of the commercial paper (CP) program the Fed rolled out last week – some had commented that that CP facility was insufficient because it did not include CDs – a major source of funding for banks. This program is expected to ease strains in the bank funding market and assist in pushing LIBOR rates lower, which has occured.
Let’s hope the worst of the credit-market disturbance is behind us – developments of the past few days suggest this is the case. We’ll be keeping an eye on LIBOR, TED Spread and commercial paper spreads.
Moving On
The WSJ ran an article last night on how big bets in domestic currencies are hammering the emerging market economies, specifically the Latin American regions, but within Asia too. Many countries with which many investors believed offered nearly unstoppable growth prospects are showing trouble related to their own speculative bubbles – namely currency bubbles. As the U.S. dollar enjoys a powerful rally all of those betting against the greenback are paying dearly for that trade.
And there is no glee in these comments pointed at those who have believed in the decoupling theory – the view that emerging-market growth would not be affected by what occurs in the U.S. If the emerging markets are going to endure substantial weakness it makes it that much more difficult for global growth to withstand this period.
This is the time for the U.S. to take the lead – which has been our role no matter the situation for the past 70 years. Congress can call their plans to extend employment benefits and food stamps “stimulus” all they want but any serious person understands these programs are nothing but socialism in disguise. Broad-based tax cuts are needed here and will provide the correct prescription for pulling us out of the weakness clogged up credit markets has delivered. We itemized what needs to be done yesterday, so I won’t repeat the bullet points.
There are some that say you can’t get the bang for your buck in growth from cutting rates from current levels. Certainly when Reagan cut the top income tax rate from 70% a powerful incentive effect was delivered. But let’s not kid ourselves. We have a top income rate of 36%; a corporate tax rate of 35%; dividend and capital gains tax rates of 15% and a terribly onerous repatriated tax of 35%. We can still enjoy huge incentive effects by reducing from these levels and this will spark a stock market rally that gets optimism flowing again. From there, everything else will fall into place.
We’ll find which direction the country chooses in 13 days – a philosophy that believes public works programs will deliver the growth we need; or private-sector inspiring tax cuts that moves the government out of the way of American innovation and its natural entrepreneurial spirit.
Have a great day!
Brent Vondera, Senior Analyst
Credit markets are thawing – the Ted spread has narrowed another 30 basis points this morning – but the market now seems to be focused on corporate-profit guidance and stocks are under some pressure again as a result. That said ex-financial S&P 500 profit numbers look quite good thus far, up 8.1% with 25% of members reporting to this point. But when we enter such a scenario, the market chooses to look at only the negatives, of which there are plenty – but that will change.
Market Activity for October 21, 2008
No matter what occurs over the near term valuations are very attractive here. I said that a couple of months ago, but it’s truer today. There are many really good companies trading at the cheapest multiples in a very long time, I heard someone state this morning that 40% of S&P 500 members are trading at 8 times earnings -- haven’t had time to look that up yet, seems a bit of an exaggeration, but for sure there’s an abundance of names trading at 10 times or lower and even if 2009 profit results come in 25% below expectations stocks will remain cheap. It’s just going to take patience, but when a sustained rally occurs, it will be powerful.
The Dollar and Commodity Prices
The U.S. dollar has bounced back strong and commodity prices have gotten clocked from the fed-induced peak in July.
A combination of the flight-to-safety trade and expectations of a series of ECB rates cuts has sent the dollar soaring from the low hit in April.
De-leveraging trades and concerns the credit-market freeze-up will damage global growth have combined to fully whack commodity prices.
Both of these develops are good for the consumer and they can be added to realities such as strong corporate balance sheets and low inventory levels to assist in a recovery once we progress from this current weakness. (We’ll note commodity prices are likely not down for the count. We will have an inflation issue to deal with over the next couple of years due to the massive liquidity the Fed has pumped into the system, but for now the objective is to deal with credit-market disturbances. Some will say we should just let things fall where they may, for it is the Fed’s easy money policy that got us into this situation to begin with, but that’s not going to happen, not the way the world works.)
And speaking of which, the Federal Reserve rolled out another lending facility, about the sixth if memory serves. This one will provide liquidity to the U.S. money markets – the program will be termed the Money Market Investor Funding Facility (MMIFF) and will purchase assets from money-market mutual funds to stave off any difficulties meeting redemptions. This program is authorized under section 13(3) of the Federal Reserve Act.
Under the MMIFF, the New York Fed will provide senior secured funding to facilitate an industry-supported private-sector initiative to finance the purchase of eligible assets from eligible investors. (Eligible assets will include certificates of deposits and commercial paper issued by highly rated financial institutions with maturities of 90 days or less.) JP Morgan will be one of the firms running the program.
This facility is an extension of the commercial paper (CP) program the Fed rolled out last week – some had commented that that CP facility was insufficient because it did not include CDs – a major source of funding for banks. This program is expected to ease strains in the bank funding market and assist in pushing LIBOR rates lower, which has occured.
Let’s hope the worst of the credit-market disturbance is behind us – developments of the past few days suggest this is the case. We’ll be keeping an eye on LIBOR, TED Spread and commercial paper spreads.
Moving On
The WSJ ran an article last night on how big bets in domestic currencies are hammering the emerging market economies, specifically the Latin American regions, but within Asia too. Many countries with which many investors believed offered nearly unstoppable growth prospects are showing trouble related to their own speculative bubbles – namely currency bubbles. As the U.S. dollar enjoys a powerful rally all of those betting against the greenback are paying dearly for that trade.
And there is no glee in these comments pointed at those who have believed in the decoupling theory – the view that emerging-market growth would not be affected by what occurs in the U.S. If the emerging markets are going to endure substantial weakness it makes it that much more difficult for global growth to withstand this period.
This is the time for the U.S. to take the lead – which has been our role no matter the situation for the past 70 years. Congress can call their plans to extend employment benefits and food stamps “stimulus” all they want but any serious person understands these programs are nothing but socialism in disguise. Broad-based tax cuts are needed here and will provide the correct prescription for pulling us out of the weakness clogged up credit markets has delivered. We itemized what needs to be done yesterday, so I won’t repeat the bullet points.
There are some that say you can’t get the bang for your buck in growth from cutting rates from current levels. Certainly when Reagan cut the top income tax rate from 70% a powerful incentive effect was delivered. But let’s not kid ourselves. We have a top income rate of 36%; a corporate tax rate of 35%; dividend and capital gains tax rates of 15% and a terribly onerous repatriated tax of 35%. We can still enjoy huge incentive effects by reducing from these levels and this will spark a stock market rally that gets optimism flowing again. From there, everything else will fall into place.
We’ll find which direction the country chooses in 13 days – a philosophy that believes public works programs will deliver the growth we need; or private-sector inspiring tax cuts that moves the government out of the way of American innovation and its natural entrepreneurial spirit.
Have a great day!
Brent Vondera, Senior Analyst
Afternoon Review
The dividend yield on the S&P 500 is over 3 percent for the first time since 1992. However, Standard and Poor cut its estimate for 2008 dividend payments by the members of its S&P 500 index and project fourth-quarter dividends falling as much as 10 percent, which would be the worst quarterly drop in 50 years.
It is easy to get excited about the very high yields we are seeing today; however, there is a lot of pressure on balance sheets today and we could start to see many of these high dividends cut or suspended.
In spirit of this headline, this is a good opportunity to explain some basic ways to evaluate dividend payments. Our general stance is that there is no hurry to jump into a stock in fear that you are missing out on a high yield. Instead of jumping into a stock just because of a high dividend yield, investors should wait until it is more certain that the dividend payment is safe.
For example, if you were in a hurry to buy Bank of America soley for its 8 percent dividend earlier this year, then you were probably disappointed to see the dividend cut in half and the stock valuation decline.
With all of this in mind, here are a few ways to determine the health of a company's dividend.
Dividend Yield
- A company with a low dividend yield compared to the industry is either (1) a result of a high stock price that reflects the company’s impressive prospects and ability to make the dividend payment, or (2) the company cannot afford to pay a reasonable dividend because its business model is not as strong as its industry peers.
- At the same time, however, a high dividend yield can signal a sick company with a depressed share price (e.g. C, PFG, BAC, GE).
Dividend Growth
- Dividend growth is one of the simplest ways for companies to communicate the financial well-being and shareholder value. They send a clear, powerful message about future prospects and performance. Obviously double-digit dividend growth great, but something that at least surpasses inflation is nice to see.
- While a history of steady or increasing dividend is certainly reassuring, it is generally a bad practice for companies to rely on borrowings to finance those payments.
- Watch out for companies with debt-to-equity ratios greater than 60%. Higher debt levels often lead to pressure from Wall Street as well as debt-rating agencies. That, in turn, can hamper a company’s ability to pay its dividend.
Dividend Payout Ratio
- In general, the lower the payout ratio, the more secure the dividend because smaller dividends are easier to pay out.
- What is a high dividend payout ratio depends on the industry. Retail stocks tend to have ratios under 30 percent (retail is a terrible cash flow business); mature technology stocks (e.g. IBM) tend to be around 20 percent (they need cash for R&D); bank stocks are historically in the 30 to 45 percent range (the current payout ratios are not representative of historical ratios); consumer staples tend to be around 40 percent
- Anything above 45 percent or that is not the industry-norm means there may not be enough cash to weather hard times or raise the dividend.
Dividend Coverage Ratio
- This ratio is used to gauge whether earnings are sufficient to cover dividend obligations. The ratio is calculated by dividing EPS by the dividend per share.
- When coverage is getting thin, odds are that there will be a dividend cut, which usually hurts the stock price too.
- In general, a coverage ratio of 2 or 3 is considered safe. In practice, the coverage ratio becomes a pressing indicator when coverage slips below about 1.5, at which point prospects start to look risky. If the ratio is under 1, the company is using its retained earnings from last year to pay this year’s dividend.
- At the same time, if the payout gets very high, say above 5, investors should ask whether management is withholding excess earnings, not paying enough cash to shareholders. Companies that raise their dividends are telling investors that business over the coming 12 months or more will be stable.
There are obviously other variables that need to be considered, but this is a great starting point for evaluating dividends...Introduction to Dividends or Dividends 101, if you will.
Because there are so many earnings reports out this week, I will forgo earnings analysis until Friday.
Peter Lazaroff, Junior Analyst
Tuesday, October 21, 2008
Daily Insight
U.S. stocks rose as credit markets continue to thaw and earnings reports illustrate there will be some bright spots even if overall profit results are weighed down by the financial sector, for the fourth straight quarter. The Dow and S&P 500 both gained more than 4.5%; the NASDAQ Composite added 3.4%.
Energy shares led the gains, bouncing 11.15%, as measured by the S&P 500 Energy Index; these stocks have gotten crushed as oil prices have been cut in half from the fed-induced peak hit back in July and some bargain hunters are coming back in. Basic material and utility shares also enjoyed a huge day, jumping 8.15% and 8.06%, respectively.
The big news of the day is the continued thawing in the credit markets. It’s too early to get terribly excited, but the market has to feel much better as inter-bank lending becomes a bit more open (as illustrated by the decline in three-month LIBOR) and investors are not seeking out the ultra-safe investments to the extreme degree that was the case just a week back (as illustrated by three-month T-bills). The TED Spread shows the narrowing between these two rates – a very very good sign but it must continue.
Market Activity for October 20, 2008
Substantial economic damage has been done as the credit markets locked up for a full month, but stocks should get juiced if these spreads continue to narrow, as this is what will determine the extent and degree of the downturn. Sure there are other factors weighing on growth and investor expectations, but this is at the heart of the issue.
On the earnings front, things are looking pretty good, at this point. Thus far roughly 20% of S&P 500 members have reported and ex-financial profit results are up 8.8%. Financial profits are down 119% with 30% of the group reporting. (How can something fall more than 100%? It’s called profit losses.) But we do have four of the 10 major industry posting double-digit earnings growth (consumer discretionary, energy, tech and basic materials). Expect this ex-financial figure to ease as earnings season progresses, but for now things are looking pretty good.
On the economic front, the Conference Board’s Leading Economic Indicators (LEI) index rose 0.3% for September, marking the first increase since April. Nevertheless, this is not an accurate indicator – at least it hasn’t been over the past few years. We usual refrain from touching on this figure, but since it was yesterday’s only economic release, I thought it was worth mentioning.
The index got a boost from money supply growth (added 0.45%), interest rate spreads (slope of yield curve, up 0.19%) and consumer expectations (up 0.26%). The drag came from stock prices (down 0.20%), building permits (down 0.23%) and jobless claims (0.23%).
The index is designed to forecast the direction of the economy over the next six months, but that has not been the case. For instance, the LEI posted negative readings in half of the 36 months that ran January 2005 through December 2007. During that period GDP advanced at a real annual rate of 2.5% (and that’s with a major housing drag during half of that period), certainly better than the LEI was forecasting.
From here, the index will continue to get a boost from money supply growth (which will surge as the Fed pumps cash into the system to unfreeze credit markets), interest rate spreads (very positively sloped yield curve) and consumer expectations – not that consumer’s are going to be feeling great over the next couple of months, but from currently low levels, there’s really only one direction for this component to go.) The index will not take into account the harm credit-market disturbances have had on the economy over the past month, and sends the wrong signal as the short end of the curve is benefiting from the “safety” trade, making the yield curve more positively sloped than would otherwise be the case.
Moving On
I see Fed Chairman Bernanke is endorsing a second “stimulus” plan – oh, boy; here we go. Sure he states any stimulus package needs to “promote economic growth and job creation,” but in the current political environment – Bush hesitant to offer the right prescription, thus leaving it to Speaker Pelosi and Senate Majority Leader Reid to mold their variety of a “stimulant” – such words mean he is giving them the green light to say the Fed Chairman is behind their hand-out schemes.
That scheme, as I believe it is appropriate to term the proposal, involves increased unemployment benefits, food stamps and aid to cash-strapped states. (Cash-strapped stated, eh? They can’t reduce spending? It’s not like they haven’t received billions from the Federal government over the past few years. It’s not like revenue growth wasn’t huge during the previous three years. They should not be cash-strapped.) And someone please explain to me how increases in food stamps and unemployment benefits stimulate the broad economy?
Heck, the last “stimulus” plan sent checks out to most everyone ($168 billion worth) – unless of course you made “too much” as defined by those omniscient actors in Congress – and it did nothing. The personal consumption segment of the second-quarter GDP reading rose 1.2% at an annual rate – weak. You can expect a proposal that extends jobless benefits and food stamps to be even weaker, which means it adds nothing to growth but does substantial damage to the budget. This is pathetic.
When Washington wants to get serious, they can cut tax rates in a broad-based way – this actually has incentive effects and at the same time delivers increased tax receipts to the Treasury. Here’s what works:
Energy shares led the gains, bouncing 11.15%, as measured by the S&P 500 Energy Index; these stocks have gotten crushed as oil prices have been cut in half from the fed-induced peak hit back in July and some bargain hunters are coming back in. Basic material and utility shares also enjoyed a huge day, jumping 8.15% and 8.06%, respectively.
The big news of the day is the continued thawing in the credit markets. It’s too early to get terribly excited, but the market has to feel much better as inter-bank lending becomes a bit more open (as illustrated by the decline in three-month LIBOR) and investors are not seeking out the ultra-safe investments to the extreme degree that was the case just a week back (as illustrated by three-month T-bills). The TED Spread shows the narrowing between these two rates – a very very good sign but it must continue.
Market Activity for October 20, 2008
Substantial economic damage has been done as the credit markets locked up for a full month, but stocks should get juiced if these spreads continue to narrow, as this is what will determine the extent and degree of the downturn. Sure there are other factors weighing on growth and investor expectations, but this is at the heart of the issue.
On the earnings front, things are looking pretty good, at this point. Thus far roughly 20% of S&P 500 members have reported and ex-financial profit results are up 8.8%. Financial profits are down 119% with 30% of the group reporting. (How can something fall more than 100%? It’s called profit losses.) But we do have four of the 10 major industry posting double-digit earnings growth (consumer discretionary, energy, tech and basic materials). Expect this ex-financial figure to ease as earnings season progresses, but for now things are looking pretty good.
On the economic front, the Conference Board’s Leading Economic Indicators (LEI) index rose 0.3% for September, marking the first increase since April. Nevertheless, this is not an accurate indicator – at least it hasn’t been over the past few years. We usual refrain from touching on this figure, but since it was yesterday’s only economic release, I thought it was worth mentioning.
The index got a boost from money supply growth (added 0.45%), interest rate spreads (slope of yield curve, up 0.19%) and consumer expectations (up 0.26%). The drag came from stock prices (down 0.20%), building permits (down 0.23%) and jobless claims (0.23%).
The index is designed to forecast the direction of the economy over the next six months, but that has not been the case. For instance, the LEI posted negative readings in half of the 36 months that ran January 2005 through December 2007. During that period GDP advanced at a real annual rate of 2.5% (and that’s with a major housing drag during half of that period), certainly better than the LEI was forecasting.
From here, the index will continue to get a boost from money supply growth (which will surge as the Fed pumps cash into the system to unfreeze credit markets), interest rate spreads (very positively sloped yield curve) and consumer expectations – not that consumer’s are going to be feeling great over the next couple of months, but from currently low levels, there’s really only one direction for this component to go.) The index will not take into account the harm credit-market disturbances have had on the economy over the past month, and sends the wrong signal as the short end of the curve is benefiting from the “safety” trade, making the yield curve more positively sloped than would otherwise be the case.
Moving On
I see Fed Chairman Bernanke is endorsing a second “stimulus” plan – oh, boy; here we go. Sure he states any stimulus package needs to “promote economic growth and job creation,” but in the current political environment – Bush hesitant to offer the right prescription, thus leaving it to Speaker Pelosi and Senate Majority Leader Reid to mold their variety of a “stimulant” – such words mean he is giving them the green light to say the Fed Chairman is behind their hand-out schemes.
That scheme, as I believe it is appropriate to term the proposal, involves increased unemployment benefits, food stamps and aid to cash-strapped states. (Cash-strapped stated, eh? They can’t reduce spending? It’s not like they haven’t received billions from the Federal government over the past few years. It’s not like revenue growth wasn’t huge during the previous three years. They should not be cash-strapped.) And someone please explain to me how increases in food stamps and unemployment benefits stimulate the broad economy?
Heck, the last “stimulus” plan sent checks out to most everyone ($168 billion worth) – unless of course you made “too much” as defined by those omniscient actors in Congress – and it did nothing. The personal consumption segment of the second-quarter GDP reading rose 1.2% at an annual rate – weak. You can expect a proposal that extends jobless benefits and food stamps to be even weaker, which means it adds nothing to growth but does substantial damage to the budget. This is pathetic.
When Washington wants to get serious, they can cut tax rates in a broad-based way – this actually has incentive effects and at the same time delivers increased tax receipts to the Treasury. Here’s what works:
- Cut the top two income tax brackets (small business taxpayers) and make the current increased allowance for business spending write-offs permanent (as of now this expires in January 2009) -- you’ll get job creation.
- Cut the capital gains tax and watch the cost of capital fall, while the Treasury is inundated with tax receipts as investors unlocked old investments for new.
- Cut the dividend tax rate further and – in addition to the capital gains tax rate – the stock market will get on its horse.
- Cut the corporate tax rate and remove all doubt that the U.S. is the greatest place in the world to headquarter. You’ll get a two for one benefit as corporate profits rise and prices fall – corporate taxation is ultimately passed on to the consumer.
- Eliminate the dead-weight loss which is the repatriated tax and watch capital that is currently hiding overseas to escape this tax come home to provide billions in funds for R&D.
This is real stimulus. When Washington wants to get serious, you’ll know it. Right now, outside of some recent steps from Treasury that have reduced credit-market disturbances, everyone understands they are not.
Have a great day!
Brent Vondera, Senior Analyst
Monday, October 20, 2008
Afternoon Review
News pertaining to Acropolis securities was relatively light on Friday…
IBM confirmed 3Q EPS increased 22 percent to $2.05 per share, in line with last week’s pre-announcement, and the company said it sees “very strong opportunities” in developing markets over the next six months. It has had no problems issuing commercial paper, liquidity is very strong, and short-term signings picked up in September. Services and software were solid, but very weak hardware numbers show a clear industry slowdown. In this environment, I think it is safe to assume that no technology business segment is immune to macro pressures.
******
Russian stocks continued their steep slide (on Friday) as the Financial Times reported modest runs on medium-sized banks. The near collapse in commodity prices, including the more than 50 percent drop in oil in recent months, is also darkening the outlook. Central Europe and Russia Fund (CEE) is down 47.99 percent since 8/28/2008.
******
What happened today…
China’s economic growth (9.0 percent in 3Q) slowed more than expected. This data is likely to prompt Beijing to shift to looser monetary policy and step up fiscal spending (especially as inflation concerns cool). It is unclear to what extent Olympic-related factory closures and transport disruptions affected GDP, but it is no surprise that export growth took a hit considering the state of other developed economies. All in all, China’s economy is in a good place compared to the U.S. and Europe. There is confidence in their financial system, no liquidity problems or risk of bank insolvency, low levels of external debt and very minor exposure to foreign mortgage-related investments.
******
Energy related stocks rallied on the earnings release from Halliburton (HAL) who said that unconventional activity throughout the U.S. and Canada accelerated. HAL said a worldwide recession would have negative short-term implications for demand, but current prices still support most projects under way. International business has not yet been impacted by economic troubles and the drop in commodity prices, the CEO said.
******
One of the biggest news stories today may be Fed Chief Ben Bernanke’s support for a second fiscal stimulus package. Bernanke said that because the economy is “likely to be weak for several quarters,” including the risk of a “protracted slowdown,” a fiscal stimulus package seems appropriate. Bernanke would not provide a specific dollar amount but said any potential package should be “significant.” However, he did suggest that fiscal package should include “measures to help improve access to credit by consumers, homebuyers, businesses, and other borrowers.”
Commentary as well as video of Bernanke’s address to the House Budget Committee can be accessed by clicking here.
******
The upcoming election has highlighted some major obstacles for U.S. coal stocks. Coal powers half of the U.S. electricity supply, but also is the country’s largest source of carbon dioxide emissions. This article on WSJ.com examines how politicians are responding to the coal industries concerns.
******
At this point, it’s hard to put any credence into analyst estimates on housing prices (look where that got us today). That being said, Fitch Ratings projected prices will start to stabilize after falling 10 percent more.
“Fitch’s analysis shows that the 29 percent rise in prices realized between 2004 and 2006, representing one of the largest price growth periods ever recorded, has been reversed. With prices returning to early 2004 levels, Fitch believes that most of the additional 10 percent decline, which will bring prices back to levels seen in 2003, will occur over the next eighteen months. Fitch then expects declines thereafter to moderate.”
In case you missed it, WSJ.com posted a great interactive graph that shows the housing pains in the U.S.
******
139 of the S&P 500 companies are reporting earnings this week, so we should get a pretty good idea of which sectors are best suited to weather the storm. Companies reporting tomorrow that are of interest to Acropolis clients: Lockheed Martin (LMT), Pfizer (PFE), 3M (MMM), Quest Diagnostics (DGX), DuPont (DD), Caterpillar (CAT), Cerner (CERN), Raymond James Financial (RJF), and First Cash Financial (FCFS).
Prepared by:
Peter Lazaroff, Junior Analyst
Stock Market Volatility
You don’t need us to tell you that the market has been volatile, but I thought these statistics were interesting at the very least:
Year to date through Sept. 15, the average daily change in the Dow Jones Industrial Average (DJIA) was 122 points. Since that time, the average daily change is 348 points per day.
Prior to Sept 15, there were no moves greater than 500 points, but since then we have had six days where the DJIA moved in excess of 500 points. We have also had 10 trading days with intra-day movements of more than 750 points.
This graphic from NYTimes.com last week gives some perspective on the scale of stock market volatility.
Year to date through Sept. 15, the average daily change in the Dow Jones Industrial Average (DJIA) was 122 points. Since that time, the average daily change is 348 points per day.
Prior to Sept 15, there were no moves greater than 500 points, but since then we have had six days where the DJIA moved in excess of 500 points. We have also had 10 trading days with intra-day movements of more than 750 points.
This graphic from NYTimes.com last week gives some perspective on the scale of stock market volatility.
October 2008 Portfolio Insights
.cropped)
The highly anticipated October 2008 edition of Portfolio Insights has arrived!This expanded edition focuses on:
- The History of Past Down Markets
- Are Your Investments Safe?
- Fixed Income Strategy
- Equity Markets Activity
- Inside the Economy
- Ask Acropolis
Click here or on the cartoon to view the issue.
3Q 2008 Participant Insights
Another fantastic issue of Participant Insights is available for your viewing. In this issue of our 401(k) participant newsletter, Mona Gooden reviews some key rules for 401(k) investing and Debra Moran provides some commentary on how to view the market's recent volatility in regards to your retirement savings accounts.
Click here to view 3Q 2008 Participant Insights.
Click here to view 3Q 2008 Participant Insights.
Daily Insight
U.S. stocks engaged in another day of wild fluctuations on Friday as the broad market was higher by 4% just after lunch, but we lost it all in the final two hours of trading to close in negative territory. Nevertheless, it was a good week, the first in four, as the benchmark indices closed higher by nearly 5%.
The Dow Jones Industrial Average gained 4.75% over the past five sessions, following the worst week in the index’s history – down 18.15%. Despite the 400-point rebound last week, the Dow remains 2,570 points lower since Lehman Brothers went down on September 15. That marked the point the credit markets became disturbed, to put it lightly.
Market Activity for October 17, 2008
As of the past few days though, the credit markets do appear to be thawing – hopefully the trend continues, but one should not expect to accurately extrapolate based on the trend of the past week – the ride lower will probably not be straight down.
Below are two key indicators the market has been watching, and we’ve spent much time mentioning.
The first is three-month LIBOR, which shows the inter-bank lending rate for the specified period. While it shows banks remain unwilling to lend to one another, or charge a high rate to do so, it’s come down nicely over the past three sessions.
The next is the TED Spread, which illustrates the level of risk aversion in the marketplace. This spread is the difference between the rate on three-month LIBOR and three-month T-bills. The spread shows people continue to run to the safety of the Treasury market. That is, short-term Treasury yields remain very low due to huge demand for these securities. Once this fear wanes, rising T-bill rates will combine with falling LIBOR and this will, obviously, cause the spread to narrow – a clear sign things are normalizing.
Rates for one-month commercial paper also fell to a three-week low.
Friday’s Economic Releases
On the economic front, U.S. housing starts fell more than expected in September as construction of single-family homes plunged to the lowest level in more than 25 years, indicating the slump intensified and will be a larger drag on GDP – residential investment has weighed on economic growth for 10 quarters now; that drag eased in the second quarter, but will get worse again with regard to the final two GDP reports of this year due to the chaotic state of the credit markets.
The only time in the history of this data, which goes back to 1959, single-family starts were this low was in the middle of the 1981-1982 recession.
While this development hurts for now, it is a necessary condition for bringing the housing market back. Inventory levels as a percentage of sales remain at an extreme elevation and a serious reduction in supply is needed. That said, the homes available for sale data (not adjusted for the current sales pace) has plunged. So, when the sales numbers do begin to pick up again, the inventory-to-sales ratio (the supply figure that remains elevated) will come down fast.
It will take some time still, especially as the labor market has deteriorated. Further, demand will not improve substantially until the perception that prices have bottomed takes hold. And obviously, tighter credit conditions – rather, all but frozen credit markets – delay the rebound as well. We do believe though that the next chart illustrates some very important work has been accomplished.
We will have to see the permits reading bounce before housing begins to flatten out.
Digressing
Capitalism is certainly under assault after what’s occurred over the past month – referring to the plunge in stock prices --, but we should be very careful not to throw the baby out with the bathwater. Capitalism, for all of its flaws, remains the best of all of man’s inventions with which to allocate scarce capital, goods and services in order to fulfill unlimited wants. Period. Choose something else and you get lower growth, less prosperity and less choice – such as in Europe for instance. From the perspective of an individual country, tax capital more and it will simply go elsewhere as it seeks out the places where it is most welcome and best treated – to paraphrase the words of the late Walter Wriston.
Policy proposals to raise taxes are harmful. The claim that such an endeavor is necessary to punish the rich is perverse. While it may punish some in the upper class, it truly punishes those attempting to climb the economic ladder. The rich and well-off can shelter their income from onerous tax rates. What it does to other achievers is close the door to wealth – making it more difficult to walk through that door. We should not forget also that the majority of those that make up the top tax brackets are small businesses – the most prolific job creators in our economy.
It is no coincidence why rich Europeans are those that have been wealthy for generations. Conversely, in the U.S. you can run into a multi-millionaire today who didn’t have anything but good ideas and a strong work-ethic 10 years back. This is the key difference between the U.S. and Europe (this is just not a cultural difference but one of tax rates) and those that have the desire to move to the European model are actually punishing those they claim to help far more than those they claim to punish.
And on this claim that de-regulation is what brought us to this point, a topic we spent some time dispelling last week explaining that Congress has net increased regulations over the past several years coming out of the tech bubble and bust, there were two excellent Op/Eds in the WSJ on Saturday. One – the first link below -- explains the regulatory changes that helped deliver us down this path. The other – an interview with the brilliant Anna Schwartz – explains was put us on this path. For those with WSJ subscriptions, these are worth the read.
http://online.wsj.com/article/SB122428201410246019.html?mod=todays_us_opinion
http://online.wsj.com/article/SB122428279231046053.html?mod=todays_us_opinion
Have a great day!
The Dow Jones Industrial Average gained 4.75% over the past five sessions, following the worst week in the index’s history – down 18.15%. Despite the 400-point rebound last week, the Dow remains 2,570 points lower since Lehman Brothers went down on September 15. That marked the point the credit markets became disturbed, to put it lightly.
Market Activity for October 17, 2008
As of the past few days though, the credit markets do appear to be thawing – hopefully the trend continues, but one should not expect to accurately extrapolate based on the trend of the past week – the ride lower will probably not be straight down.Below are two key indicators the market has been watching, and we’ve spent much time mentioning.
The first is three-month LIBOR, which shows the inter-bank lending rate for the specified period. While it shows banks remain unwilling to lend to one another, or charge a high rate to do so, it’s come down nicely over the past three sessions.
The next is the TED Spread, which illustrates the level of risk aversion in the marketplace. This spread is the difference between the rate on three-month LIBOR and three-month T-bills. The spread shows people continue to run to the safety of the Treasury market. That is, short-term Treasury yields remain very low due to huge demand for these securities. Once this fear wanes, rising T-bill rates will combine with falling LIBOR and this will, obviously, cause the spread to narrow – a clear sign things are normalizing.
Rates for one-month commercial paper also fell to a three-week low.
Friday’s Economic Releases
On the economic front, U.S. housing starts fell more than expected in September as construction of single-family homes plunged to the lowest level in more than 25 years, indicating the slump intensified and will be a larger drag on GDP – residential investment has weighed on economic growth for 10 quarters now; that drag eased in the second quarter, but will get worse again with regard to the final two GDP reports of this year due to the chaotic state of the credit markets.
The only time in the history of this data, which goes back to 1959, single-family starts were this low was in the middle of the 1981-1982 recession.
While this development hurts for now, it is a necessary condition for bringing the housing market back. Inventory levels as a percentage of sales remain at an extreme elevation and a serious reduction in supply is needed. That said, the homes available for sale data (not adjusted for the current sales pace) has plunged. So, when the sales numbers do begin to pick up again, the inventory-to-sales ratio (the supply figure that remains elevated) will come down fast.
It will take some time still, especially as the labor market has deteriorated. Further, demand will not improve substantially until the perception that prices have bottomed takes hold. And obviously, tighter credit conditions – rather, all but frozen credit markets – delay the rebound as well. We do believe though that the next chart illustrates some very important work has been accomplished.
We will have to see the permits reading bounce before housing begins to flatten out.
Digressing
Capitalism is certainly under assault after what’s occurred over the past month – referring to the plunge in stock prices --, but we should be very careful not to throw the baby out with the bathwater. Capitalism, for all of its flaws, remains the best of all of man’s inventions with which to allocate scarce capital, goods and services in order to fulfill unlimited wants. Period. Choose something else and you get lower growth, less prosperity and less choice – such as in Europe for instance. From the perspective of an individual country, tax capital more and it will simply go elsewhere as it seeks out the places where it is most welcome and best treated – to paraphrase the words of the late Walter Wriston.
Policy proposals to raise taxes are harmful. The claim that such an endeavor is necessary to punish the rich is perverse. While it may punish some in the upper class, it truly punishes those attempting to climb the economic ladder. The rich and well-off can shelter their income from onerous tax rates. What it does to other achievers is close the door to wealth – making it more difficult to walk through that door. We should not forget also that the majority of those that make up the top tax brackets are small businesses – the most prolific job creators in our economy.
It is no coincidence why rich Europeans are those that have been wealthy for generations. Conversely, in the U.S. you can run into a multi-millionaire today who didn’t have anything but good ideas and a strong work-ethic 10 years back. This is the key difference between the U.S. and Europe (this is just not a cultural difference but one of tax rates) and those that have the desire to move to the European model are actually punishing those they claim to help far more than those they claim to punish.
And on this claim that de-regulation is what brought us to this point, a topic we spent some time dispelling last week explaining that Congress has net increased regulations over the past several years coming out of the tech bubble and bust, there were two excellent Op/Eds in the WSJ on Saturday. One – the first link below -- explains the regulatory changes that helped deliver us down this path. The other – an interview with the brilliant Anna Schwartz – explains was put us on this path. For those with WSJ subscriptions, these are worth the read.
http://online.wsj.com/article/SB122428201410246019.html?mod=todays_us_opinion
http://online.wsj.com/article/SB122428279231046053.html?mod=todays_us_opinion
Have a great day!
Brent Vondera, Senior Analyst
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