Afternoon Review

Intel (INTC) +5.28%
Intel is not immune to the effects of an economic recession, which now appears to be dragging down microprocessor and PC demand. However, the magnitude of the change in Intel’s forecast seemed to catch the market by surprise. In fact, semiconductors have been among the more pessimistic over the last 30 days, lowering 2009 earnings estimates with an assertiveness that has not been matched by other parts of the market.

While some believe that companies have been too optimistic in earnings forecasts, this cannot be said of chip makers. A report from Citigroup notes that chip companies’ estimates reflect a decline in 2009 earnings of 20 percent or more, “significantly more conservative than other areas of technology or the broader S&P.” In addition, more than 90 percent of the earnings revisions are negative, which suggests “capitulation” among these companies. With those aspects in mind, this sector appears to be attractive.

Today, Nancy Pelosi said the U.S. House is likely to act next month on an economic-stimulus measure that would increase computer expenditures. This certainly will benefit Intel who absolutely dominates the computer processor market with over 80 percent of the market share. (Computer processors are like the brain or nervous system of a computer.)


First Cash Financial Services (FCFS) +6.47%
First Cash announced the acquisition of Presta Max, a privately-held chain of 16 pawn stores located in southern Mexico. The company believes the transaction will be accretive to its earnings in 2009.

CEO Rick Wessel stated, “The 16 Presta Max Stores will further expand our significant Mexican pawnshop operations. These new stores are profitable, provide us a valuable entry point into markets within Mexico and fit well into our long-term strategy for growth.”

First Cash also sold the operations of its Auto Master unit earlier this week, which the company had planned to exit since September. The cash flow and related tax benefits resulting from this transaction will support the continued expansion of First Cash’s pawn operation in Mexico and the U.S. as well as allow the company to reduce outstanding debt.


Harsco (HSC) +4.84%
Harsco said 2008 profit will be lower than it previously projected, but reiterated its 2009 profit forecast. Turmoil and uncertainty has led to Harsco aggressively reducing costs and exiting some underperforming contracts.

The company statement said the 2009 forecast “is based on the assumption that there will begin to be some relief from the current volatility and the beginning of a return of economic confidence by the second half of 2009.


Quick Hits

• Bailout Scorecard (the list keeps getting longer)
  
  

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Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks, after spending most of the session in an usually tight range, slid in the final hour. Traders shook off a really weak jobless claims reading that points to another month of big payroll losses when the December jobs data is released.

We were pretty amazed activity hovered around the flat line for most of the day, particularly on that claims report, obviously it eventually hit sentiment.

Until the final-hour sell-off gains in energy, basic material and industrial stocks were offsetting financial-sector weakness; however, nothing save health insurers and a couple of energy names held up in the end.


Uncertainty over whether the government assistance to the Detroit Three will have the votes to pass the Senate may have also weighed on stocks today, largely because of the additional pressure a GM and Chrysler collapse would put on the labor market – Ford is in a better position; they’ve got liquidity to get them past the next six months at least. What strength.

I’m guessing fears that the government won’t provide some funding are likely overblown. Once January 20 rolls around checks to Detroit will rip off like there’s no tomorrow.

Market Activity for December 11, 2008

Economic Data

The Labor Department reported initial jobless claims jumped to the highest level since November1982, ending a two-week decline. We’ll continue to match 1982 levels as it will take a reading above 700k to make a new high. Claims jumped 58,000 to 573,000 in the week ended December 6.

The four-week moving average, a less volatile measure, rose 14,250 to 540,500, as the chart below shows.


The insured unemployment rate, the jobless rate for those eligible for benefits, rose to 0.1% to 3.2%, the highest since August 1992 – this figure tends to track the overall unemployment rate.

Continuing claims, those taking benefits for longer than one week, jumped 338,000 to 4.429 million – certainly some of this is due to the government extending the period of time one can continue to take benefits, although most is simply due to deteriorating labor market conditions.


It doesn’t take an expert to understand what all this says, the payroll survey is going to register its fourth-straight month of large declines when the December reading is released, possibly a reading over 500k as we saw in the November data.

The unemployment rate will probably hit 7%, unless the number of discouraged workers rises and keeps the figure artificially low. This is why the unemployment rate is a lagging indicator and generally does not peak until 6-12 month after a recession has ended. It takes these discouraged workers to feel better about the environment again before they re-enter the workforce by actually looking for a jobs. (The definition of a discouraged worker is one out of work and has not looked for employment in the past four weeks.)

This labor market data along with what we know about the overall economy means we need to pull the trigger and go with big bang tax rate cuts – across the board, slash rates on income, capital, corporate profits and repatriated income. Anything less signals a failure to understand what gets things going and does so with staying power.

Of course, the Fed must be reigned in too so they are not allowed to make terrible mistakes like the 2003-2005 decisions to keep rates too low for too long. Real interest rates were negative (fed funds lower than the rate of inflation) which means the Fed subsidized debt. When you do this you get more debt, and this is what led to the housing bubble that caused much of the current harm when it popped. It also encouraged the over-leverages stance of institutions that smashed the financial sector and later everything else.

We understand the likelihood of a tax-rate response is highly unlikely with the administration and Congress that is coming in January 20, but it doesn’t mean to forget the government policy that has the most power. Maybe when we get the next payroll report it will begin to wake people up. It’s a real shame the current administration has not even offered such a move, even if the votes do not appear to be there.

Then again, maybe I’m off base; possibly we’ll be able to spend out way out of this situation. If we do, it will be the first.

In another report the Labor Department reported import prices fell hard again in November, plunging 6.7% on a 26% tumble in petroleum prices. On a year-over-year basis import prices have declined 4.4%, what a round-tripper this has made.


Excluding petroleum, import prices fell 1.8% last month and are up 2.6% year-over-year.


While you can see most of the decline was due to the precipitous drop in energy prices, whether including or excluding energy prices fell faster than anticipated. This is going to augment the deflation argument. However, with monetary conditions as they are – the massive easing and liquidity pumped into the system – it makes a sustained deflationary event highly unlikely.

This is certainly a minority view right now, but we believe prices will begin to rise again 6-8 months in a way that will get everyone’s attention. The dollar will have a rough time advancing from here since what we’re getting as stimulus are plans to throw money at the problem – which will push import price alone higher. A more appropriate response would be to provide incentives to produce that would bring more goods to market that absorb these massive money injections. We shall see how it turns out.

Finally, the Commerce Department reported the trade deficit widened to $57.2 billion in October, which was a surprise – a narrowing was expected as import declines were estimated to be larger than the drop in exports. Imports ended up falling 1.3%, while exports fell 2.2%

The real trade gap widened to $46.4 from $42.0 billion in September. Real exports dropped 0.9%; real imports rose 2.8%.

By region, exports picked up a bit in Europe, after a big decline in September; exports to the Pacific Rim fell 0.8%. The biggest export declines came from Japan, down 2.8% for the month, and Asia NICs (Non-industrialized Countries), down a big 9.4%.

Interestingly, exports to South America and OPEC countries, which feel the effects of plunging energy prices as much as anywhere, kept activity upbeat, rising 20% and 36.8%, respectively.

The widening of the real (inflation-adjusted) trade gap means additional pressure will be put on the Q4 GDP report – it’s going to be a doozy. Good news is it shouldn’t take anyone paying attention by surprise when it posts a quite likely negative 6.0% reading – that’s at a real annual rate. If so, it will be the worst GDP reading since the -6.4% posted in Q1 1982.

It is stunning how drastically things change in mid-September and outside of a few areas, we have yet to see any bounce whatsoever.

Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review

Eli Lilly & Co. (LLY) +1.74%
LLY reaffirmed its outlook for fiscal 2008 and raised its targets for 2009 as it expects robust volume growth in sales. While the company expects robust volume growth in sales in 2009, the outlook is dampened by the negative impact of weaker foreign currencies and the impact of generic competition.

LLY is the second U.S. pharmaceutical company in a week – the other being Merck (MRK) – citing slowing demand and international sales declining in value as the U.S. dollar strengthens.

Meanwhile, LLY said it is halfway to meeting its goal of cutting the cost of bringing a new drug to market to $800 million by 2010 from $1.2 billion in 2007.

Drugmakers, which will be subject to continued patent expiration of blockbusters in the next several years, have been looking to cut costs as their pipelines generally aren’t seen as being able to recoup the revenue losses caused by drugs’ generic competition.


Boeing (BA) -3.38%
Boeing said the 787 Dreamliner is now almost two years behind schedule and won’t reach customers until the first quarter of 2010, the fourth delay for the best-selling new aircraft in Boeing’s history.

In separate reports, Boeing plans to offer cheaper weapons systems based on existing technology to counter potential Pentagon budget constraints under the Obama administration. (Related article)


Procter & Gamble (PG) -0.91%
PG said fiscal 2Q sales will rise less than it thought because of the “difficult economic environment,” but reaffirmed its 2Q and full-year earnings guidance. Because of its size, PG has more levers to pull internally to cut costs that other companies may not have.


Quick Hits

• Treasury Bubble Talk Grows as U.S. Gets Free Money
• Level Three Assets Said to Rise at Major Banks
• Bank of America of America to Cut 30,000 to 35,000 Positions
• Auto Bailout Plan Lacks Votes to Pass U.S. Senate

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Peter Lazaroff, Junior Analyst

Fixed Income Recap

Mortgages Continue Tightening
Mortgages rallied strong today, tightening to Treasuries. 15-year collateral outperformed the longer 30-year, while Treasuries were more unchanged on the day.

Mortgages were just slightly tighter before tightening further on news of discussions within Fannie and Freddie of waving new appraisals on refinances to assist homeowners with reducing their mortgage burden. This would allow homeowners who are underwater, and therefore currently unable to refinance, an opportunity to take advantage of today’s lower rate environment. No detail has been given on how lenders would handle the depreciated home values if a plan like this was implemented, but this would obviously be an obstacle.
Prepays on outstanding MBS will accelerate as a result of a plan like this. In an environment where rates are low and new issue is nonexistent, most MBS is priced at a premium. Given this potential risk, we will be very selective as we add new positions.

Daily Insight

U.S. stocks, after spending most of the day in positive territory looked ready to take one of those afternoon headers, but bounced again in the final 90 minutes of trading to close well into plus side.

I’m not sure what sparked the late-session rally that erased what appeared to be a post-lunch fizzle, maybe it was comments about waiving appraisals for refinancing GSE mortgages, which we’ll touch on below. Financial shares ended the day lower, but the group pared its losses late in the day, which helped the indices advance – so maybe the comment to waive appraisals was what did it.

Energy and basic material shares led the advance as the two sectors jumped 4.71% and 2.67%, respectively.

Market Activity for December 10, 2008

The weekly energy report showed gasoline supplies rose 3.7 million in the week ended December 5 – supplies were expected to fall 400,000. Further, an industry report showed demand will fall the most since 1983. Nevertheless, energy stocks shook this data off to focus on what will surely be OPEC production cuts, the likelihood that the massive Federal Reserve liquidity injections will cause prices to soar again and the very low valuations at which oil-integrated, coal and drilling shares trade.

The Economy

The Commerce Department reported wholesale inventories fell well more than expected, declining 1.1% in October vs. the expectation for a 0.2% decline. The underlying sales data, which we watch acutely, slid 4.1% -- down 2.9% ex-petroleum. The ex-petroleum figure applies right not as energy prices have collapsed.



The degree to which inventories declined surely won’t help the fourth-quarter GDP reading, already expected to be lowest reading since the 1981-82 recession (the change in inventories is one segment of the GDP report). We’re probably looking at a negative 5.0% at an annual rate for the final three months of the year.

The sales data is disturbing, but this is for October so it’s not of great surprise as we knew that month, and November for that matter, were horrendous. Everything aspect of the report was down save machinery, drugs and paper products. Durable goods sales were down 4.2%, automotive down 4.5%, furniture sales down 4.0%, electrical goods down 1.9%.

Machinery sales were actually up 1.6% in October, which is a bit surprising.

As a result of sales falling more than stockpiles, the inventory figure rose in October marking the fourth monthly increase. Stockpiles, while rocketing off the all-time low hit in June, remain low but we’ll need to see some rebound in sales over the next few months or we may not be able to state this for much longer.


Budget Buster

In a separate report, the Treasury Department reported the 2009 fiscal-year budget picture continues to deteriorate.

The November deficit jumped for the second month of the new fiscal year as the government began to re-capitalize banks via the TARP. While these funds will collect a yield via preferred shares issued to the Treasury (this is more an investment than a traditional outlay), fact is the Commerce and Housing segment of the budget skyrocketed last month to $95 billion from $980 million a year ago.

These funds will flow back to Treasury, assuming the biggest banks don’t go down and become part of the government, which is not a likely scenario, thankfully. Why? Because the SEC will finally be forced to withdraw mark-to-market accounting rules and return us back to capital adequacy ratio standards that served us so well for a very long time if it came to this. Unfortunately we have trouble stating this with ultimate confidence during these times.

The deficit came in at $164 billion last month, compared to $98 billion in November 2007. The shortfall has widened to $401 billion fiscal year to-date, which is just $54 billion shy of the shortfall for the entire 2008 fiscal year. (The government’s fiscal year begins in October, so we’re just two months into it)

This is really sad considering we made so much progress coming out of the 2001 downturn – lowering the budget shortfall from 3.9% of GDP in early 2004 to the virtually non-existent level of 1.2% by the start of the 2008 fiscal year. .

Budget deficits always rise as we enter recession/downturn as corporate and individual tax receipts decline – of course, government spending never declines. This was certainly the case as we entered the 2001 downturn and it took until 2004 for revenues to pick up again; it’s no coincidence revenues jumped following the May 2003 tax cuts on income and capital – the three years that ran 2005-2007 experienced the largest inflation-adjusted increase in tax revenues ever, jumping $785 billion during that stretch.

The budget will skyrocket this year and next, hitting the highest levels in the post-WWII era. We may hit 10%, as a percentage of GDP, which would exceed the current high of 5.3% touched in 1992. During WWII the budget/GDP ratio hit 24% in 1942, which needless to say is the all-time record.

A tax-rate response is needed again to revive things. This will drive the deficit higher over the next 12-18 months, but this is already occurring. Two years out the revenues will come rolling in again – history has shown this is the result (we have the 1965, 1978, 1982, 1986 1997 and 2003 tax-rate reductions as evidence – 1978 and 1997 were solely cap gains tax cuts) as the stock market will rise and the lower tax on capital will encourage investors to actually realize gains and thus pay the lower tax. Individual receipts and corporate tax receipts will also rebound due to a higher corporate profits and the higher tax base that results from job creation.

Appraisal Industry Bailout Next?

Federal Housing and Finance Agency (FHFA) Director James Lockhart made comments yesterday (just comments to a reporters question, not an official announcement) explaining the agency is considering waiving the new appraisal requirement on refinanced loans (regarding Fannie and Freddie mortgages).

This could be big. While I think it is not the way we want to go, it certainly gets at the heart of the issue for now. Many have not been able to refi, because their home values have declined and thus would no longer have an appropriate loan-to-value ratio– this would remove the obstacle.

We know the government has proposed using Fannie and Freddie to issue 4.50% mortgage loans, so one would assume this rate to be in effect for refis too – just a guess at this point. Cha-Ching!

While we’re changing standards, maybe the authorities can eliminate mark-to-market accounting rules that have led to the financial-sector death spiral, which was a totally arbitrary rule pertaining to capital adequacy ratios put in place just a year ago. It sure makes a heck of a lot more sense than the plethora of Fed facilities and Treasury programs – some of which have shown little if any efficacy.

Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review

FedEx Corp (FDX) -4.13%
FedEx has fallen over 17 percent in the last two sessions in response to the company cutting its annual profit outlook due to dwindling demand. The company commented that despite a meaningful decline in fuel and the domestic exodus of DHL, significantly weaker macroeconomic conditions are offsetting any potential benefit.

During its 35-year history, FedEx has weathered multiple economic cycles and oil supply crises. While short-term results may suffer, the firm’s powerful network is here to stay.


Arch Coal (ACI) +10.34%, Peabody Energy (BTU) +19.07%
Coal producers advanced as the fuel rose to the highest in seven days in Europe, spurred by an increase in the cost to ship it.


Quick Hits

• Table from Bloomberg listing companies that may financially benefit from Obama spending plan
• P&G and Wal-Mart’s Impact

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Peter Lazaroff, Junior Analyst

Fixed Income Recap

FDIC Insured Corporate Bond Issuance Accelerates
As of today, $62.5 million has been issued under the Temporary Liquidity Guarantee Program instituted by the FDIC late last month. Wells Fargo, Morgan Stanley and Regions Financial are among the banks that have joined Goldman Sachs, who was the first to opt into the program.

The new market created with this facility has been very well received. The issues have been bid well at auctions and spreads remain stable. They continue to trade in the open market about 30 basis points over comparable agencies, or about 2.9% for 3 years.

Bills Trade at a Premium
Yields on Treasury Bills have remained at or close to zero for the past few weeks. Treasury Bills are traditionally the safest debt instrument on the market, so it isn’t uncommon to see them trading at very low yields when investors become very sensitive to risk. But for bills, which normally trade at discounts and mature at par, to trade at a premium makes absolutely no sense. Four week bills traded as high as 100.12 today, or negative 5 basis points in yield terms. Investors paying a premium for Treasury Bills are choosing to forfeit some of their principle in exchange for the US Treasury name. Why these people aren’t just staying in cash I do not know.

Treasuries Rally
Treasuries continue to trade near record low yields. With the 2-year at .84% and the 10-year at 2.64% the curve has flattened to 179 basis points from its recent multi year high of 262 basis points on November 11th.

Deflation worries have seemed to subside as of late. If more investors adopt the view that inflation is coming, as a result of the fed pumping large amounts of liquidity into the financial system, then look for the long end of the curve to sell off and the steeper curve to return soon.

Cliff J. Reynolds Jr.
Junior Analyst

Daily Insight

U.S. stocks slid, halting a two-day advance and marked just the third decline in the past 12 sessions, after several companies cut earnings forecasts. We believe the market’s dramatic 42% decline from the October 2007 peak already reflects this bad news, but one never knows and it certainly has an effect on a daily basis when these announcements begin to flow.

FedEx’s forecast was 14% below their guidance just two months back – the stocks dropped 14%. I guess no one cares to pay attention to the fact that a competitor – DHL – has dropped out of the domestic market and fuel costs have plunged. Texas Instruments reported a 50% lower forecast from their October guidance as phones sales have taken a header. Danaher lowered its forecast by 12% citing weaker business activity and additional headwinds due to the 20% jump in the U.S. dollar since mid-July.

Beyond these announcements, the broad market’s 21% rally over the previous 10 sessions likely encouraged traders to take some profits – even bear-market rallies (which are often powerful moves since they’re off of low levels) do not go straight up.

Market Activity for December 9, 2008

Stocks are Cheap

While we’ll have to deal with a weak economy for at least a couple of quarters still, possibly longer if the correct policy responses are not implemented, stocks are cheap. It may take a good deal of patience (which is an essential virtue for investors), but stocks are extremely attractive by a number of measures. We’ve talked about such things as market multiples and dividend yields residing at 15-20 year lows, along with the fact that corporate cash levels sit at all-time highs.

(Even as measured by trough earnings, the multiple on the S&P 500 sits at 14.8, right in line with the long-term average for normalized profits. Assuming trough earnings come in even 33% below what consensus estimates are calling “trough levels” you still come to a P/E of 19, quite low for an earnings trough.)

And on that last corporate-cash point, more and more companies have more cash per share than the value of their stock price. Additionally, cash exceeds both stock price and debt for an increasing number of companies.

The fact that we’re in a disinflationary environment (even deflation-like pressures for the very short term) makes these cash levels more attractive, as a Bloomberg report recently touched on. Very low, or declining price levels, means this cash will buy even more six months down the road. Dividend yields are boosted as well, in real terms.

Now, we don’t expect zero inflation to remain the case for long but for now valuations are extremely low relative to inflation and even when price levels rise this cash may provide a nice catalyst to economic growth – the resources are there for business spending to rebound; it would be extremely helpful if those who will be running the government next year understood this and put in place some policies that would spark optimism and confidence, two things that are in short supply these days. Too bad the Bush Administration has failed to at least offer this type of response here recently, maybe it’s the lame-duck thing.

Which brings us to the next topic:

Credit Crisis Rolls on

The Treasury Department sold $30 billion of four-week bills at 0% and received bids for four times the amount sold as the run for safety continues and money-market managers, foreign central banks etc. care only about getting their dollar back.

We’ll note foreign investors have received a return from these dollar-denominated assets as the greenback has strengthened. The fact that the dollar (compared to a basket of currencies) has jumped 12% over the past three months may have foreigners thinking the run will continue. (The run will likely continue so long as risk aversion remains high, but when things normalize, and it pains me to say this, the massive Fed injections, soaring debt levels and lack of a tax-rate response will very likely result in a weaker dollar over the foreseeable future.)

Treasury sold $27 billion of three-month bills yesterday at a rate of 0.005%. Heck, the three-month bill traded at a negative yield of 0.01% yesterday.

Needless to say the credit chaos continues. Some of this is due to year-end dynamics but it clearly shows risk aversion is heightened to say the least.

We’ve done so much by way of intervention but there is ultimately only one weapon in the government’s arsenal that will get us out of this mess – the Fed can pump all the money it wants to into the system but it cannot make banks lend or consumers and businesses borrow, powerful incentives must be implemented.

We must slash tax rates on capital and incomes; this will get confidence flowing again and as investment dollars come out from under the T-bill rock the stock market will catch fire. As the market rises, optimism will follow, businesses will re-engage in capital outlays and credit will begin to rise. Oh, and disposable (after-tax) income will get a boost, reviving consumer activity. As this combines with the increased activity on the business side the economy will move from stagnation to boom.

Economic Release

The National Association of Realtors reported pending home sales fell at a much less than expected 0.7% in October – a decline of 3.0% was anticipated. This points to a mild decline in existing home sales when the November figure is released in roughly two weeks. Pending home sales is generally a good indication of what occurs the subsequent month on existing sales.

However as we mentioned yesterday, the pending data may not provide the appropriate indication this time around based on the chaotic situation within the credit markets. Pending sales are based on contract signings and some of these potential buyers may have run into trouble actually obtaining a mortgage. Existing home sales are based on contract closings, we’ll see if there is any merit to this thought when existing sales are reported in a couple of weeks.

Mortgage Rates

In any event, mortgage spreads have narrowed nicely over the past 2 1/2 weeks, which has combined with an 80 basis point decline in the 10-year Treasury yield. Fixed mortgage rates moved lower as a result. This should boost home sales for December.

The chart below shows the narrowing in the spread between the 30-year fixed mortgage and the yield on the 10-year Treasury note for which it runs off of. (Notice how the spread hit a high of 2.90 percentage points – which occurred on November 20.) Still, this is much wider than the normal spread of 180 basis points.



Have a great day!



Brent Vondera, Senior Analyst

Afternoon Review

Arch Coal
The struggling U.S. economy, falling prices for competing fuels (crude oil in particular) and waning investor sentiment about the energy sector are the main culprits for Arch Coal’s nearly 80 percent decline since June 19. However, it is hard to ignore the favorable fundamentals for the coal industry.

Supplies remain tight and worldwide demand continues to outpace supply, driven largely by developing economies such as India and China. In fact, worldwide demand is expected to outstrip supply by nearly 35 million tons in 2008, a deficit that may widen next year.

Besides favorable long-term fundamentals, Arch Coal’s incumbent status in the Powder River Basin (PRB) is the major driver for the company’s future.

The PRB contains some of the easiest-to-mine coal in the world, costing Arch Coal 20 percent less than their Central Appalachian peers to mine. In addition, PRB coal contains very little sulfur, which makes their coal even more attractive to utilities trying to meet strict emission standards. PRB’s cost advantage and more desirable product has allowed Arch Coal to gain market share, a trend that should continue as Appalachian coal mining gets more expensive.

While Appalachian mines have hundreds of competitors, the PRB is controlled by five producers, with Arch Coal as the second largest. The barriers to entry in PRB are very high since existing producers have already invested billions of dollars and achieved massive economies of scale.

Arch Coal has sold most of its Central Appalachian properties to focus on the West. In doing so, the company shed much of its legacy liabilities, which includes reclamation liabilities, pensions and future health-care expenses. The divesture also freed Arch from union ties, which should yield cost savings and greater operational flexibility in the long run.


Quick Hits

• Market Recap
• Cisco (CSCO), General Electric (GE) and Emcor Group (EME) among winners of Obama’s plan
• Treasury Sells $30 Billion of Four-Week Bills at Zero Percent
  

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Peter Lazaroff, Junior Analyst

Daily Insight

Stocks were juiced yesterday as we received additional specifics on the infrastructure-based stimulus plan that will roll out next year. The most economically sensitive stocks led the market’s advance as a result. To no one’s surprise by now, basic material, machinery/construction-related industrials and medical software firms will receive the largest benefit from the program

We’ve engage in a nice 20% run over the past 11 sessions. It’s difficult to tell whether what we’re seeing here is one of those rallies that extends for a couple of months or one that will prove very short-lived and once again test the low – such as the bounce from the October 27 multi-year low that rallied 18% only to make a new low three weeks later. We get the feeling this one has some legs but it’s tough to say.

There are a lot of companies cutting forecasts as the credit crisis that took hold in October did major damage. We’re seeing forecasts adjusted by 15%-50% from guidance just offered in late October, which helps explain how quickly things have shifted. Stocks may have to deal with this news, meaning we surely haven’t escaped big down days on occasion. However, these forecasts are rearview mirror topics, the stock-market damage that has been done, one would think, reflects worst-case profit scenarios.

Congress and the White House have also neared an agreement to extend a life-line to U.S. auto makers. It appears they’ll throw $15 billion at the three as a sort of bridge to January 20. (At that time Congress will have the numbers to issue additional checks to GM, Ford and Chrysler.) It is being reported the government will take an equity stake; although, specifics have not yet been announce. Odds are they’ll do it via preferred shares yielding 5% for the first five years and increased to 9% after that, this has been their modus operandi regarding other deals.

The US autos really need to enter bankruptcy for government spending to make sense. Then government assistance can take the form of debtor in possession financing. Traditional bankruptcy would force the companies to take substantial measures to reduce costs such as cutting the number of dealerships and product lines that pretend the Detroit Three still enjoy 50% market share instead of the roughly 18% that is currently the case. They’ll also need to bring labor costs closer in line with their global competitors. Currently these costs run 50% above the rest of the market due to a “jobs bank” that pays laid off workers 95% wages and massive legacy outlays.

In an event, stocks like any Detroit Three lifeline for now that does not increase job losses, forgetting for now what is the best route with which to make these companies viable over the longer term.

Market Activity for December 8, 2008


Most major sectors rallied Monday, save the traditional areas of safety – health-care, utilities and consumer staples. Basic materials led the advance; the group has been crushed over the past few months but when the $500 billion (which quickly turns into $1 trillion when the government’s involved) spending plan rolls out mining, construction-equipment and metal production stocks are going to get a kick.

Financial, technology and energy shares enjoyed a very upbeat session as well. Industrial names continue to lag a bit, but this sector will benefit nicely, not just from short-term stimulus but longer term as the traditional economic drivers return to that role – a 15-year era of massive leverage had financials playing the lead.

For the market in general, the good news was we held onto gains for the entire session, with relatively low volatility – relative being the operative word here.

Keynesian Stimulus

You understand our concern, as expressed lately, over these spending programs – the historical record on this type of stimulus proves to be short-lived. Surely government spending is not always a bad thing, but we’re hardly short on public-sector non-defense outlays. Indeed, the federal government has spent $500 billion on infrastructure alone over the past five years. There are things we need to improve, such as a revamped electricity grid, the traffic-control system and making public buildings more efficient. These would be beneficial endeavors.

But this should be coupled with private-sector incentive effects via the tax code that continue to increase rates of productivity and profits that has resulted in the massive job creation we’ve seen over the past 25 years. It is no mystery why U.S. job creation over the past quarter century (up 44.7 million) has outpaced that of the previous 25 years (up 37 million 1958-1983) even as population growth has waned – U.S. population rose 50% 1958-1983 vs. up 32% 1983-2008. The reason for this is the private sector has seen burdens removed – tax and regulatory burdens. Lower tax rates on capital along with labor and corporate incomes will provide additional benefits to overall living standards via higher profits, jobs, incomes and stock-market savings. To forget this axiom will cost us living standard improvements over time.

The Economy

We were without an economic release yesterday, but we’ll get back to it this morning with pending home sales, and then a slew of data Thursday and Friday.

Pending home sales, which are an early indication of how existing home sales will shape up are due out this morning. Pending sales will show additional weakness as it reflects the freeze-up in credit that intensified in November.

This measure may prove a less reliable indicator than usual as we deal with this credit-market event because it measures the signing of contracts. Existing home sales are not counted until the contract is closed, and some who signed a contract may have found it difficult to obtain a mortgage prior to closing. Point is the existing home sales data (due out in two weeks) may show more weakness than pending indicates.

Tomorrow we’ll get the October wholesale inventory reading. This data has a large lag to it as it takes six weeks for the government to compile the figures, so it’s a bit stale. Still we’ll be watching to see how bad the hit actually was to the underlying sales data, which have been down for three months.


On Thursday we’ll get the usual initial jobless claims figure as everyone is familiar with. We’ll watch to see if claims fall for a third week in a row. Claims remain elevated, but after Friday’s very weak payroll report, another drop in claims (even if it is a mild one) may offer a nice boost to stocks.


Import prices for November are also due out. It will show further decline, as all inflation gauges will point to deflation over the short-term. We believe these inflation number will rebound in strong fashion 6-12 months out as the combination of massive Federal Reserve liquidity injections and a huge government stimulus program combine to re-ignite commodity prices.


On Friday, November retail sales will show a large decline in consumer activity took place. This is generally one of the more important indicators, but won’t have the weight this time as everyone expects a really bad number. We’re looking to December right now for some sort of bounce. Indications from the first week of holiday shopping are looking good, the question is whether it will extend through the month.


Also out Friday will be business inventories and producer prices.

Have a great day!



Brent Vondera, Senior Analyst

Afternoon Review

Infrastructure soars
Prospects of Obama’s infrastructure-based stimulus package spurred massive gains in companies with infrastructure-services. Some of the bigger winners today include: EMCOR Group (EME) +19.31%; Jacobs Engineering Group (JEC) +15.18%; Harsco Corporation (HSC) +11.32%; Johnson Controls (JCI) +12.96%; Caterpillar (CAT) +10.87%; Emerson Electric (EMR) 6.26%; Ingersoll-Rand (IR) +5.44%; General Electric (GE) +5.77%

Also receiving a boost was medical record companies like Cerner (CERN), up 12.18 percent, after Obama stressed the importance of adopting digital medical records to save the country billions in healthcare costs.

Internet companies rose as well in response to Obama’s plans to upgrade Internet infrastructure, calling the U.S. rank of 15th in broadband adoption “unacceptable.”


3M Company (MMM) -4.13%
MMM dropped as the company projected 2008 earnings forecast of $5.10 to $5.15, down from their previous estimate of $5.40 to $5.48 a share. The company also projected 2009 EPS that was significantly lower than the consensus estimate.

Weak economic conditions underscore the company’s downside guidance, but the U.S. dollar’s resurgence is particularly challenging for 3M’s products since about two-thirds of their revenues come from abroad.

It should be noted that MMM’s recent downturn is underpinned by a short-term slowdown in the business cycle, not long-term weakness. Instead MMM remains a solid blue chip company that stands out as a strong long-term play for value-oriented investors.


Illinois Tool Works (ITW) +1.39%
ITW issued downside earnings and revenue guidance for the fourth quarter. The company said the latest forecast reflects significant further weakening in North American and international lend markets, the negative impact from currency translation and higher than originally anticipated restructuring costs in the quarter.


Dow Chemical (DOW) +7.21%
Dow announced today that it will cut about 5,000 full-time jobs (11 percent of its work force), close 20 facilities and sell some non-strategic businesses as the company looks to speed its restructuring and cut costs. The nation’s largest chemical producer by revenue also said it will temporarily shut about 180 plants and cut about 6,000 contractor jobs in light of the reduced operations.

Once fully implemented, Dow expects the layoffs and site closures to result in roughly $700 million in annual operating savings by 2010. Those savings are anticipated to occur on top of the previously announced synergies derived from the aniticipated Rohm and Haas (ROH) acquisition.

This blog post charts a selection of job cuts by major companies in the fourth quarter.


Dell (DELL) +12.04%
Bloomberg reported that Dell (the world’s second largest computer maker) and Lenovo Group (China’s biggest computer maker) may be interested in acquiring Positivo Informatica SA, Brazil’s biggest computer maker.

The Brazilian currency’s drop, the worst in the past three months among the 16 most-actively traded currencies, has made companies in the country acquisition targets.

This would be no simple transaction because Positivo’s poison pill by-laws would value the company at seven times its current market value.

Positivo shares have outperformed the Bovespa since October 21, when the company reported net revenue rising 36 percent as laptop sales almost doubled.


AT&T (T) +6.50%
Wal-Mart Stores (WMT) is reportedly planning to offer Apple’s iPhone (which runs exclusively on AT&T’s network) by the end of December. A partnership with Wal-Mart would bring the iPhone to the world’s biggest retailer, building on a deal Apple made in September with Best Buy, the largest U.S. electronics chain.

The pricing and release date of the iPhones in Wal-Mart stores is all speculation at this point, but it is clear that Apple is aggressively attacking the smartphone and mobile computer market. AT&T should reap the benefits of customers buying iPhones, and thus switching to their network. Increasing the number of current customers using smartphones would provide AT&T with a boost since smartphone customers tend to have higher monthly bills.


Arch Coal (ACI) +19.78%
Reuters reports that ACI expects production to be flat or slightly lower while overall output for the U.S. coal industry will slow. CEO Steven Leer said, “We see there’s going to be tremendous opportunity to acquire assets…within every crisis there is enormous opportunity.”

ACI, as well as other coal stocks, surged in response to Obama’s infrastructure-based stimulus package.


Quick Hits

• Majority of Modified Loans Fail Again, Regulator Says
• Cheapest Stocks Since 1995 Show Cash Exceeds Market
• Central Bank Cash May Hamper Money Markets, BIS Says
• Obama Bonds to Give Buyers Taste of Japan Lost Decade

--

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks shook off the worst monthly jobs report in 34 years, boosted by financial shares (namely insurance stocks) after a forecast from Hartford Financial was far better than estimated. Also, traders and investors may have figured the significant level of job losses over the past three months may be signaling the worst monthly declines have been seen. (Not saying this with a lot of confidence, but even when we view the rough 1974 and 1981-82 recessions, one can see after three months of 320K-533K in payroll cuts the declines become milder.

Stocks began the session a little more than 3% to the downside, but reversed course as we entered the afternoon session to rally 7% from the day’s nadir.


As mentioned, financials led the advance; the shares – as measured by the S&P 500 index that tracks the sector -- jumped 8.63%. Technology and consumer discretionary shares also outperformed the broad-market, adding 3.91% and 3.67%, respectively.

We were a bit surprised to see industrial shares lag most sectors, as a massive stimulus package (centered on infrastructure projects) will benefit the group, but these shares have enjoyed a nice run over the past couple of weeks so it was probably just a function of money moving to financials and tech shares.

Market Activity for December 5, 2008


The Economy

Wow, so much for estimates!

The Labor Department reported non-farm payrolls declined 533,000 in November, blowing past the 335,000 decline expected. The unemployment rates fell less than estimated, coming in at 6.7% vs. the 6.8% expected – the figure was lower as 398,000 people removed themselves from the labor pool. The bright side is average hourly wages rose 0.4% and on a year-over-year basis accelerated to 3.7%. With energy prices falling like a rock, this means real wages have moved positive again – the growth in real wages came to halt a few months back as fuel prices jumped 65% in a five-month span prior to the current plunge.

Job losses within the goods-producing sectors (construction, manufacturing and computers/electronics) helped to push the payrolls figure lower, as has been the case for nearly a year now, but it was a collapse in service-sector jobs (namely retail, trade and transportation) that made the difference last month; the 533,000 decline in payrolls was the worst reading since December 1974. The service sector shed a massive 370,000 positions last month.


Education, health-care and government jobs remain the only areas of increase. Health-care remains pretty strong, picking up another 43,000 jobs in November and 408,000 year-to-date.

The unemployment rate rose to 6.7% in November from 6.5% for October. The increase would have been larger but labor-force participation dropped 0.3% to 65.8%. The number of people who want a job but quit looking for one in the past four weeks (want is known as “discouraged workers”) rose 398,000.

The jobless rate has jumped from the historically low level of 4.7% just 12 months ago. Although, that low jobless rate was likely a bit artificial –the over-investment within the housing market pushed the unemployment rate below 5.0%. The construction job losses, as the housing bubble popped, had not begun to show up until early this year. Still, even adjusting for this, to see the jobless rates jump nearly two-percentage points this fast is disturbing.


This report suggests the fourth-quarter GDP reading may drop in real terms by more than 5% at an annual rate. This would put the recession on par with the nasty 1981-82 recession. The large downward revisions to the previous two months’ worth of data (showing jobs losses were 199,000 more than previously estimated) show the credit-market chaos that began in September had more effect that previously thought.

That said, with these revisions we now see payrolls declined 403,000 for September, 320,000 for October and this November reading of 533,000. Even the harsh recessions of 1974 and 1981-82 showed declines of this magnitude proved the worst was over. This may prove true this time, one can’t know at this point. We’re going to see payrolls declines for several months still at least, but the worst may already have been witnessed.

The goods news was that average hourly wages rose a healthy 0.4% in November – double the expectation – and accelerated to 3.7% on a year-over-year basis. This is helpful.

This degree of labor market deterioration shows the bold changes in tax rates we discussed on Friday is very much needed. We acknowledge the likelihood of this occurring in the next Congress is remote. Ok, it’s a big fat dream.

But eventually this will occur and that’s when the economy will be put on a footing that will drive profits, job and income growth longer-term. (It has been just over a year since we ended the record double-digit profit growth streak – 20 consecutive quarters. We can do it again but it won’t occur via spending, it will take higher after-tax returns on capital, corporate and labor income.

For now what we’ll get is Keynesian-style approaches like publicly funded infrastructure projects.

Mortgage Stats

Mortgage delinquencies rose to a post-WWII high to hit 6.99% -- this is for the third quarter. Delinquencies measure mortgages that are 30 days past due. Mortgages that are seriously delinquent – 90 days past due and headed for foreclosure – rose from 4.50% to 5.17%.


As the next two charts show, the bulk of the damage is in the sub-prime market.




You’re about to be Stimulated

In a YouTube address on Saturday, the President-elect outlined his stimulus plan, which will focus on energy, road and bridges, schools, broadband and electronic health records -- the energy part of the plan was strangely vague.

The program will probably grow in size, possibly approaching a figure close to $1 trillion now that we’ve received very weak jobs numbers the past three months. The issue with these types of stimulus is that history has shown they just don’t have staying power. No doubt, you throw $700 billion - $1 trillion to infrastructure projects, among other things, GDP will get a boost over the next year. Problem is such programs lack incentives and activity generally fizzles out as a result. This is why a bold and substantial tax-rate response would be preferred, but such spending can still juice stocks and the economy over the short term.

The big concern is when we look back 18 months from now and find the budget deficit has grown by a multiple of four, you know what comes next – proposals to raise tax rates.

This would be exactly the wrong thing to do as the Fed will be in the process of removing the massive levels of liquidity they have pumped into the system. You slash tax rates when the Fed is fighting a significant inflationary event, which will be the case a year to 18 months out. This prescription worked masterfully in 1982 and if we ignore that lesson we’ll regret it. An environment of higher tax rates and much tighter monetary policy is not conducive to growth, to say the least.

Have a great day!



Brent Vondera, Senior Analyst