VIX
The VIX, which measures the cost of using options as insurance against declines in the S&P 500, has dropped over 44 percent since November 20, when it rose to 80.86, the highest in its 18-year history. (The VIX had never closed above 50 before October.)
The VIX measures fear in the market, via the prices investors are willing to pay for protective options. When the VIX hit high levels – such as the high 70s or low 80s – it indicated that there was too much fear and that everyone has already sold. As a result, supply dries up leaving the market susceptible to a rally.
Right now the VIX remains at unusually high levels compared to its historical norm; however, it has fallen quite a bit from where it has been during the past two months. That tells us the fear surrounding stocks has decreased a bit, and demand to actually buy them has crept up a bit.
Volatility may not return to its highs, but it isn’t clear when it will get back to normal, either. Volatility breeds fear, which in turn breeds more volatility. In addition, new leverage exchange-traded funds, off-exchange trading vehicles and other market advancements are adding to the churn. Nevertheless, the lower readings in the past week or two are seen as a positive for the equities market.
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Peter Lazaroff, Junior Analyst
Friday, December 19, 2008
Daily Insight
U.S. stocks extended upon Wednesday’s decline as concerns over global growth remain in play. Oil’s retreat to $36.85 (so much for those predicting $200/barrel with such certainty just five months back) reinforced the worry due to the stunning degree of decline – crude fell nearly 10% yesterday alone.
This may seem obvious -- you say: “Of course the prospects for global growth are pathetic” – but the concern regarding the extent to which the credit chaos has had on the global economic picture actually ebbs and flows on a weekly, sometimes daily, basis.
Indeed, we do get small indications that the pessimism has gone a bit too far. There is a separation between perception and reality that needs to be addressed – energy demand has actually improved over the past couple of months after falling the most since 1982 for the first 10 months of the year. This is the affect of the price mechanism, but it seems to me we’d see demand continue to decline if the world were as “tapped out” as most seem to assume.
(We’ll note, the January crude-oil futures contract expires today so there was added selling pressure yesterday as those who own contracts simply for financial reasons have to sell to avoid taking possession. Although, at these levels, grab a few galvanized swimming pools and let them back the truck up. Do you think the EPA would have an issue with backyard storage?)
Market Activity for December 18, 2008
In addition, while it’s tough to get terribly optimistic about things right now, the statements that accompany tech-sector earnings in particular show what we’re dealing with is more an issue of confidence than actual economic fundamentals being in the dirt. I can sense the reaction now; you’re thinking I’m off my rocker. But a number of economic data sets show business spending collapsed as if a switch had been flipped (generally we see this kind of grind to a halt as the economy contracts), which proves to me that a lack of confidence/caution is half the battle right now – reverse this mindset slightly and you get a decent bounce in activity from these levels.
Take Oracle’s earnings release yesterday. The company stated they have never seen orders canceled to the extent they did in November -- ever. Apparently, companies had the resources to engage in such spending plans just a couple of months back, but now all of a sudden they are pulling orders. This tells me the dramatic economic retrenchment of the past three months is due more to heightened levels of caution than anything else. This is the obstacle that must be addressed.
Don’t get me wrong, the current quarter’s GDP report is going to make a run at the horrible declines in economic activity seen in 1980 and 1982 (which posted -7.8% and -6.4% readings at their nadirs) but confidence is something that can be returned to the marketplace very quickly if the correct strings are pulled – problem is we’re not pulling the correct strings. You know what I’m referring to.
Ease this current level of caution and a tepid rebound in business spending will combine with a stock market rally and a mild bounce from the consumer. Remember, nearly $4 trillion sits in money market accounts and real incomes have been boosted via the 65% plunge in gasoline prices, offsetting some of the damage due to a weak labor market. The fuel is there, now ignite it.
On stocks, we’re 18% above the November 20 low; if we can manage a rally of an additional 20%, you’ll see caution ease.
Jobless Claims
The Labor Department reported initial jobless claims fell 21,000 to 554,000 in the week ended December 13. While it’s nice to see some easing, the figure remains elevated and the jump in the prior week likely portends the December payroll report will show a decline at least as bad as the 500,000-plus drop in November – possibly worse. Next week’s claims data will correspond with the December job market reporting period and we’ll be better able to assess things then.
Despite the decline last week, the four-week average of claims rose 2,750 to 543,750.
It’s important to watch the ISM (both the manufacturing and service-sector surveys) reports, which have seen their employment gauges slide. The manufacturing survey’s employment index has matched the 1990-91 recession low and we’ll be watching to see if it weakens further and moves to the 1981-82 low. If it holds above that mark, we may see the payroll declines at least stabilize.
We’ll also remind everyone, as touched on a couple of times now, the jobless claims figure would have to approach one million to match what occurred at the high point of 1982 when adjusting for payroll growth. Back in 1982 total non-farm payrolls stood at 88 million; today it is 136 million, so 550,000 in claims is not nearly as harsh as it was back then.
That said, claims have risen significantly over the past three weeks (all due to the December 6 weekly claims report that showed a 60,000 increase) and this is a dismal backdrop for the shopping season. As mentioned above, we expect that the 65% decline in gasoline prices, which has boosted real incomes, will offset some of this labor-market weakness and the December spending numbers will post a better-than-expected reading. But this claims data does cause some doubt.
Continuing claims are approaching the peaks hit in 1974 and 1982, but did fall 47,000 to 4.384 million in the week ended December 6 – there’s a one week lag between initial claims and continuing. .
Philly Fed
The Philadelphia Federal Reserve Bank’s general business conditions index showed activity remains depressed, but not to the degree expected. The index rose to -32.9 in December from -39.3 in November – the number was expected to fall to -40.5. Not exactly an inspiring print but the level remains above even the relatively mild 1990-1991 recession.
The new orders index rose to -25.2 from -31.4; but unfilled orders deteriorated.
The employment index declined to -28.7 from -25.2 last month.
Witching Hour (and no, I’m not referring to Def Leppard lyrics)
We’re without any economic releases this morning, but things will remain exciting (if that’s the correct term) as today marks quadruple witching. This is the quarterly event with which we get the expiration of stock-index futures, stock-index options and single-stock futures and options. As a result, it should be a volatile session, especially in the final hour – unfortunately, nothing new these days.
Have a great weekend!
Brent Vondera, Senior Analyst
This may seem obvious -- you say: “Of course the prospects for global growth are pathetic” – but the concern regarding the extent to which the credit chaos has had on the global economic picture actually ebbs and flows on a weekly, sometimes daily, basis.
Indeed, we do get small indications that the pessimism has gone a bit too far. There is a separation between perception and reality that needs to be addressed – energy demand has actually improved over the past couple of months after falling the most since 1982 for the first 10 months of the year. This is the affect of the price mechanism, but it seems to me we’d see demand continue to decline if the world were as “tapped out” as most seem to assume.
(We’ll note, the January crude-oil futures contract expires today so there was added selling pressure yesterday as those who own contracts simply for financial reasons have to sell to avoid taking possession. Although, at these levels, grab a few galvanized swimming pools and let them back the truck up. Do you think the EPA would have an issue with backyard storage?)
Market Activity for December 18, 2008
In addition, while it’s tough to get terribly optimistic about things right now, the statements that accompany tech-sector earnings in particular show what we’re dealing with is more an issue of confidence than actual economic fundamentals being in the dirt. I can sense the reaction now; you’re thinking I’m off my rocker. But a number of economic data sets show business spending collapsed as if a switch had been flipped (generally we see this kind of grind to a halt as the economy contracts), which proves to me that a lack of confidence/caution is half the battle right now – reverse this mindset slightly and you get a decent bounce in activity from these levels.
Take Oracle’s earnings release yesterday. The company stated they have never seen orders canceled to the extent they did in November -- ever. Apparently, companies had the resources to engage in such spending plans just a couple of months back, but now all of a sudden they are pulling orders. This tells me the dramatic economic retrenchment of the past three months is due more to heightened levels of caution than anything else. This is the obstacle that must be addressed.
Don’t get me wrong, the current quarter’s GDP report is going to make a run at the horrible declines in economic activity seen in 1980 and 1982 (which posted -7.8% and -6.4% readings at their nadirs) but confidence is something that can be returned to the marketplace very quickly if the correct strings are pulled – problem is we’re not pulling the correct strings. You know what I’m referring to.
Ease this current level of caution and a tepid rebound in business spending will combine with a stock market rally and a mild bounce from the consumer. Remember, nearly $4 trillion sits in money market accounts and real incomes have been boosted via the 65% plunge in gasoline prices, offsetting some of the damage due to a weak labor market. The fuel is there, now ignite it.
On stocks, we’re 18% above the November 20 low; if we can manage a rally of an additional 20%, you’ll see caution ease.
Jobless Claims
The Labor Department reported initial jobless claims fell 21,000 to 554,000 in the week ended December 13. While it’s nice to see some easing, the figure remains elevated and the jump in the prior week likely portends the December payroll report will show a decline at least as bad as the 500,000-plus drop in November – possibly worse. Next week’s claims data will correspond with the December job market reporting period and we’ll be better able to assess things then.
Despite the decline last week, the four-week average of claims rose 2,750 to 543,750.
It’s important to watch the ISM (both the manufacturing and service-sector surveys) reports, which have seen their employment gauges slide. The manufacturing survey’s employment index has matched the 1990-91 recession low and we’ll be watching to see if it weakens further and moves to the 1981-82 low. If it holds above that mark, we may see the payroll declines at least stabilize.
We’ll also remind everyone, as touched on a couple of times now, the jobless claims figure would have to approach one million to match what occurred at the high point of 1982 when adjusting for payroll growth. Back in 1982 total non-farm payrolls stood at 88 million; today it is 136 million, so 550,000 in claims is not nearly as harsh as it was back then.
That said, claims have risen significantly over the past three weeks (all due to the December 6 weekly claims report that showed a 60,000 increase) and this is a dismal backdrop for the shopping season. As mentioned above, we expect that the 65% decline in gasoline prices, which has boosted real incomes, will offset some of this labor-market weakness and the December spending numbers will post a better-than-expected reading. But this claims data does cause some doubt.
Continuing claims are approaching the peaks hit in 1974 and 1982, but did fall 47,000 to 4.384 million in the week ended December 6 – there’s a one week lag between initial claims and continuing. .
Philly Fed
The Philadelphia Federal Reserve Bank’s general business conditions index showed activity remains depressed, but not to the degree expected. The index rose to -32.9 in December from -39.3 in November – the number was expected to fall to -40.5. Not exactly an inspiring print but the level remains above even the relatively mild 1990-1991 recession.
The new orders index rose to -25.2 from -31.4; but unfilled orders deteriorated.
The employment index declined to -28.7 from -25.2 last month.
Witching Hour (and no, I’m not referring to Def Leppard lyrics)
We’re without any economic releases this morning, but things will remain exciting (if that’s the correct term) as today marks quadruple witching. This is the quarterly event with which we get the expiration of stock-index futures, stock-index options and single-stock futures and options. As a result, it should be a volatile session, especially in the final hour – unfortunately, nothing new these days.
Have a great weekend!
Brent Vondera, Senior Analyst
Thursday, December 18, 2008
Afternoon Review
General Electric (GE) -8.22%
Standard & Poor’s said it has revised its outlook on GE and its units to negative from stable and affirmed its AAA long-term and A-1+ short-term credit ratings. The negative outlook is based partly on the concerns regarding GE Capital Corps’s future performance and funding. Standard & Poor’s said there is at least a one-in-three chance it will cut GE’s credit rating from the top AAA in the next two years.
This announcement comes two days after GE said it could no longer make business decisions that are harmful to its long-term growth prospects for the sole purpose of maintaining their AAA credit rating.
FedEx (FDX) -2.14%
FedEx said its financial performance is increasingly being challenged by some of the worst economic conditions in the company’s 35-year operating history and it expects conditions to remain difficult through 2009.
FDX has already taken actions to reduce over $1 billion of expenses for all of fiscal 2009 and is now implementing a number of additional cost reduction initiatives, including salary decreases, elimination of merit-based salary increases and suspension of 401 (k) company matching for a minimum of one year.
Ingersoll-Rand (IR) -4.65%
IR cut fourth quarter guidance since it has had lower than expected revenues in all business segments, primarily due to softer North American and sharply declining Western European markets (which the company noted was especially severe over the last six weeks).
Quick Hits
Daily Insight
U.S. stocks fell yesterday, giving back some of Tuesday’s 5% gain as worries over global growth affected investor sentiment. Even a large four-million barrel per day production quota cut by OPEC failed to boost oil prices, illustrating that global growth concerns ruled the session.
Still the decline in the broad market was tepid, for this environment at least. The S&P 500 had been down as much as 1.8% early in the session, bounced to a 0.6% gain in the afternoon but eventually succumbed to the aforementioned concerns falling 1.5% in the final 90 minutes.
Market Activity for December 17, 2008
Utility, technology and energy shares took the brunt of the damage falling 2.92%, 1.73% and 1.59%, respectively. Consumer discretionary and basic material stocks were the only gainers of the 10 major industry groups. (Strange how consumer discretionary shares gained ground on a day global economic worries were the primary concern, but the group was helped by a jump in Macy’s shares after the retailer negotiated a more flexible bank-credit agreement.)
The Dollar
The dollar got clocked yesterday, extending a six-session decline as all of this talk and action of massive fiscal stimulus and the Fed’s latest comments have caused investors to think about fundamentals again. The Fed has flooded the system with dollars, and they signaled they are willing to do much more if they feel necessary. This was setting up for a dollar rout, as much as it pains me to say it, as we’ve touched on for a few weeks now.
The greenback had benefited from the flight-to-safety trade, but it appears some of this trade has moved to gold – up 16% over the past eight sessions. Of course, gold doesn’t pay interest or a dividend, but some don’t seem to care about that right now as the four-week T-bill has traded at a negative yield and 90-day bills trade at 0% -- it’s a crazy world.
Mortgage Applications
The Mortgage Bankers Associations reported their refinancing index rose 6.5% last week. The index has risen four of the past six weeks as the 30-year fixed-rate mortgage has dropped from 6.4% at the beginning of November to 5.18% last week.
The group’s purchases index fell for the second week, declining 4.5% in the week ended December 12, which followed a 17% decline in the prior period.
Crude-Oil
OPEC members agreed to cut production by 4.2 million barrels per day at the cartel’s meeting yesterday. The reduction brings OPEC’s daily production to 24.845 million barrels from 29.045 million which was the official quota back in September. This is a huge reduction and will have on effect on price even with lower levels of demand.
The issue that OPEC generally has to deal with is cheating – individual countries producing more than the quota calls for. When oil prices are rising, especially dramatically like last spring/summer, they have an incentive to keep oil in the ground – it’s free storage and producers are confident a higher price will be captured a month down the road. However, when prices are falling the OPEC members generally produce more than their quota for fear next week will bring less revenue.
(The futures market is currently in contango – future deliveries trade at a higher price than the spot price. This would normally cause producers to allow supplies to build, which is true here in the U.S. but OPEC countries are do dependent and hard-up for oil revenues, they will be cheating.)
Since crude prices have tanked $100 per barrel over the past five months, the members are hurting for revenue – especially countries like Venezuela, Libya and Algeria. The cheating that results will make the reduction less effective. Still, the size of the cut is so large it should push prices higher nevertheless. Not yesterday though.
The market ignored the production cut to focus on the weekly supply report, which was quite bearish and sent crude below $40 per barrel for the first time in four years. It recovered a bit to close above the 40-handle at $40.06.
The Energy Department reported crude supplies rose 525,000 barrels to 321.3 million barrels last week – roughly 5% above the five-year average (effectively more than that considering the drop in demand). Stockpiles have climbed 11% since September 19.
Loans and Mark-to-Market
The Fed continues to pump massive amounts of liquidity into the system, yet banks continue to hoard the cash, unwilling to increase lending. And who can blame them? With mark-to-market accounting rules that determine capital-adequacy ratios, why would they take on assets like car and home loans? Why extend credit lines? Lenders would be holding back in a tough environment already, but even more so due to this rule.
With default rates growing and the housing market showing no sign of reversal just yet, lenders know they’ll just be writing down more assets, which will force them to raise more capital and put up more collateral. This is the insanity of pro-cyclical accounting rules. When asset prices are falling banks have to write-down assets (even those they have no desire to sell), causing them to raise more capital, which forces them to sell more assets, pushing prices down more and thus more write-downs. It’s a death spiral.
Using mark-to-market accounting with which to based capital adequacy ratios was put in place in November 2007; the timing could hardly have been worse. This accounting standard is tantamount to your neighbor having to sell his house today because of special circumstances (and because of the urgency must take a 30% haircut), and you then would be forced you to lower your home’s value by 30%, say from $300,000 to $210,000 – even if you have no desire to sell. Oh, and by the way, you’ll have to come up with $72,000 to keep your LTV at 80%. Wouldn’t that be nice.
If we would have had this standard in place during the S&L crisis we’d still be dealing with the effects. We must return to the former standard, which based capital adequacy on the original cost of an asset; it served us well. Remember, mark-to-market is no better in a rising asset price environment as firms will be required to hold less capital than would otherwise be the case, which obviously carries its own risks.
Sure, if a financial institution is going to sell an asset, then they will have to take the market price and accept the hit to earnings. However, for assets with 10-20 year lives, and most of which continue to kick off cashflows, it makes no sense to continually mark these asset to distressed-market prices. This has greatly exacerbated the current situation.
Have a great day!
Brent Vondera, Senior Analyst
Still the decline in the broad market was tepid, for this environment at least. The S&P 500 had been down as much as 1.8% early in the session, bounced to a 0.6% gain in the afternoon but eventually succumbed to the aforementioned concerns falling 1.5% in the final 90 minutes.
Market Activity for December 17, 2008
Utility, technology and energy shares took the brunt of the damage falling 2.92%, 1.73% and 1.59%, respectively. Consumer discretionary and basic material stocks were the only gainers of the 10 major industry groups. (Strange how consumer discretionary shares gained ground on a day global economic worries were the primary concern, but the group was helped by a jump in Macy’s shares after the retailer negotiated a more flexible bank-credit agreement.)
The Dollar
The dollar got clocked yesterday, extending a six-session decline as all of this talk and action of massive fiscal stimulus and the Fed’s latest comments have caused investors to think about fundamentals again. The Fed has flooded the system with dollars, and they signaled they are willing to do much more if they feel necessary. This was setting up for a dollar rout, as much as it pains me to say it, as we’ve touched on for a few weeks now.
The greenback had benefited from the flight-to-safety trade, but it appears some of this trade has moved to gold – up 16% over the past eight sessions. Of course, gold doesn’t pay interest or a dividend, but some don’t seem to care about that right now as the four-week T-bill has traded at a negative yield and 90-day bills trade at 0% -- it’s a crazy world.
Mortgage Applications
The Mortgage Bankers Associations reported their refinancing index rose 6.5% last week. The index has risen four of the past six weeks as the 30-year fixed-rate mortgage has dropped from 6.4% at the beginning of November to 5.18% last week.
The group’s purchases index fell for the second week, declining 4.5% in the week ended December 12, which followed a 17% decline in the prior period.
Crude-Oil
OPEC members agreed to cut production by 4.2 million barrels per day at the cartel’s meeting yesterday. The reduction brings OPEC’s daily production to 24.845 million barrels from 29.045 million which was the official quota back in September. This is a huge reduction and will have on effect on price even with lower levels of demand.
The issue that OPEC generally has to deal with is cheating – individual countries producing more than the quota calls for. When oil prices are rising, especially dramatically like last spring/summer, they have an incentive to keep oil in the ground – it’s free storage and producers are confident a higher price will be captured a month down the road. However, when prices are falling the OPEC members generally produce more than their quota for fear next week will bring less revenue.
(The futures market is currently in contango – future deliveries trade at a higher price than the spot price. This would normally cause producers to allow supplies to build, which is true here in the U.S. but OPEC countries are do dependent and hard-up for oil revenues, they will be cheating.)
Since crude prices have tanked $100 per barrel over the past five months, the members are hurting for revenue – especially countries like Venezuela, Libya and Algeria. The cheating that results will make the reduction less effective. Still, the size of the cut is so large it should push prices higher nevertheless. Not yesterday though.
The market ignored the production cut to focus on the weekly supply report, which was quite bearish and sent crude below $40 per barrel for the first time in four years. It recovered a bit to close above the 40-handle at $40.06.
The Energy Department reported crude supplies rose 525,000 barrels to 321.3 million barrels last week – roughly 5% above the five-year average (effectively more than that considering the drop in demand). Stockpiles have climbed 11% since September 19.
Loans and Mark-to-Market
The Fed continues to pump massive amounts of liquidity into the system, yet banks continue to hoard the cash, unwilling to increase lending. And who can blame them? With mark-to-market accounting rules that determine capital-adequacy ratios, why would they take on assets like car and home loans? Why extend credit lines? Lenders would be holding back in a tough environment already, but even more so due to this rule.
With default rates growing and the housing market showing no sign of reversal just yet, lenders know they’ll just be writing down more assets, which will force them to raise more capital and put up more collateral. This is the insanity of pro-cyclical accounting rules. When asset prices are falling banks have to write-down assets (even those they have no desire to sell), causing them to raise more capital, which forces them to sell more assets, pushing prices down more and thus more write-downs. It’s a death spiral.
Using mark-to-market accounting with which to based capital adequacy ratios was put in place in November 2007; the timing could hardly have been worse. This accounting standard is tantamount to your neighbor having to sell his house today because of special circumstances (and because of the urgency must take a 30% haircut), and you then would be forced you to lower your home’s value by 30%, say from $300,000 to $210,000 – even if you have no desire to sell. Oh, and by the way, you’ll have to come up with $72,000 to keep your LTV at 80%. Wouldn’t that be nice.
If we would have had this standard in place during the S&L crisis we’d still be dealing with the effects. We must return to the former standard, which based capital adequacy on the original cost of an asset; it served us well. Remember, mark-to-market is no better in a rising asset price environment as firms will be required to hold less capital than would otherwise be the case, which obviously carries its own risks.
Sure, if a financial institution is going to sell an asset, then they will have to take the market price and accept the hit to earnings. However, for assets with 10-20 year lives, and most of which continue to kick off cashflows, it makes no sense to continually mark these asset to distressed-market prices. This has greatly exacerbated the current situation.
Have a great day!
Brent Vondera, Senior Analyst
Wednesday, December 17, 2008
Afternoon Review
Alliant Techsystems (ATK) +0.02% *contact to receive updated tearsheet*
The economic slowdown and subsequent budget constraints by many of the company’s clients has kept ATK’s share price down in recent weeks. Adding injury to insult, funding pressures at NASA and declining satellite activity has brought ATK’s space systems business (36 percent of revenue) into question. Nevertheless, strategic initiatives as well as various recent contract awards should help maintain ATK’s robust free cash flow and profitability.
ATK, the largest supplier of bullets to the U.S. armed forces, raised full-year guidance on October 30 after reporting better-than-expected fiscal second quarter results. The company cited strong armament sales as the primary reason for the outperformance. During the quarter ATK also won many new strategic programs, which led to the signing of several contracts, the largest of which was with the U.S. Navy.
ConAgra (CAG) +7.97%
CAG beat earnings expectations, but operating profits fell by 8 percent to $253 million due to cost inflation. The company reaffirmed its guidance for the full year, which is higher than analysts’ estimates.
Quick Hits
- A 10-point Checklist for Avoiding a Ponzi Fund
- In Spring 2001 Reporter Questioned Madoff Record
- Stock-Picking Dreams Might Pay in Obamanomics
- Companies that May Benefit From Obama Spending Plan (this list gets longer every week)
--
Peter Lazaroff, Junior Analyst
Fixed Income Recap
FOMC Announces Rate Cut
The Federal Reserve announced a reduction in the Fed Funds Target Rate, the rate at which banks lend to each other overnight, to a target range of between zero and .25%. The market rate has been within this range since the beginning of December, so that part of the announcement was less impactful than the comments that followed.
The Fed announced today that, “The focus of the committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the Federal Reserves Balance sheet at a high level”. Translation, look for expansion of Agency debt and MBS buying by the Fed. The limits currently sit at $100 billion of debt and $500 billion of Agency MBS. Along with other programs aimed at fostering economic growth through lending.
As financial markets remain strained, the Fed is looking for ways to bring liquidity to the system. The Fed’s balance sheet has more than doubled, from about $900 billion to about $2.2 trillion, in the last 6 months, mostly due to the liquidity facilities implemented recently and relaxed standards on collateralized lending to institutions. Today’s announcement foreshadows a future of creative easing by the Fed as they have “thrown in the towel” with regard to the Fed Funds Target.
Treasuries Rally
Treasury yields dropped to record lows across the entire curve today after the Fed made its announcement. The 2-year traded as low as 62 basis points before ending the day at 64.5 basis points while the 10-year ended the day at its low of 2.25%. The shape of the curve remains relatively unchanged from the beginning of the month after the massive flattening that took place in the second half of November. The spread between the two- and ten- year currently sits at 163 basis points.
Mortgages were tighter to comparable Treasuries before the Fed’s announcement this afternoon, after which they rallied along with seemingly every other bond. Thirty-year Fannie 5.5% mortgage pools widened about 3 basis points to Treasuries on the day, while 30-year 5% pools ended the day about where they closed Monday. Investors continue to be worried about accelerating prepays, resulting from rumors of new, more lenient, refinancing programs, causing “up in coupon”, 5.5% compared to 5%, pools to underperform. If there is any truth to these rumors we would expect to see even further underperformance.
Cliff J. Reynolds Jr.
Junior Analyst
The Federal Reserve announced a reduction in the Fed Funds Target Rate, the rate at which banks lend to each other overnight, to a target range of between zero and .25%. The market rate has been within this range since the beginning of December, so that part of the announcement was less impactful than the comments that followed.
The Fed announced today that, “The focus of the committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the Federal Reserves Balance sheet at a high level”. Translation, look for expansion of Agency debt and MBS buying by the Fed. The limits currently sit at $100 billion of debt and $500 billion of Agency MBS. Along with other programs aimed at fostering economic growth through lending.
As financial markets remain strained, the Fed is looking for ways to bring liquidity to the system. The Fed’s balance sheet has more than doubled, from about $900 billion to about $2.2 trillion, in the last 6 months, mostly due to the liquidity facilities implemented recently and relaxed standards on collateralized lending to institutions. Today’s announcement foreshadows a future of creative easing by the Fed as they have “thrown in the towel” with regard to the Fed Funds Target.
Treasuries Rally
Treasury yields dropped to record lows across the entire curve today after the Fed made its announcement. The 2-year traded as low as 62 basis points before ending the day at 64.5 basis points while the 10-year ended the day at its low of 2.25%. The shape of the curve remains relatively unchanged from the beginning of the month after the massive flattening that took place in the second half of November. The spread between the two- and ten- year currently sits at 163 basis points.
Mortgages were tighter to comparable Treasuries before the Fed’s announcement this afternoon, after which they rallied along with seemingly every other bond. Thirty-year Fannie 5.5% mortgage pools widened about 3 basis points to Treasuries on the day, while 30-year 5% pools ended the day about where they closed Monday. Investors continue to be worried about accelerating prepays, resulting from rumors of new, more lenient, refinancing programs, causing “up in coupon”, 5.5% compared to 5%, pools to underperform. If there is any truth to these rumors we would expect to see even further underperformance.
Cliff J. Reynolds Jr.
Junior Analyst
Daily Insight
U.S. stocks jumped yesterday on the Federal Reserve’s version of “shock and awe” as Bernanke & Co. will essentially target fed funds at zero, are willing to sustain the high level of the balance sheet -- and even expand it from here -- and may up the size of their GSE debt and mortgage-backed security purchases. These actions and statements went well-beyond what the market had expected.
Benchmark stocks indices had been up the entire session, despite horribly weak housing data, but the Fed’s afternoon decision provided additional fuel to the rally. The broad market jumped 3.4% in the final 90 minutes of trading.
Market Activity for December 16, 2008
Financial shares led the rally, as the S&P 500 index that tracks the group jumped 11.25%. Basic material, industrial and consumer discretionary shares also outperformed the market.
Economic Data
On the economic front, the Commerce reported builders broke ground on new homes at the lowest level on record – data goes back to 1959. Housing starts plunged 18.9% in November to 625,000 units at an annual pace. Multi-family starts (condos etc.) fell 23.3%; single-family units were down 16.9%.
The degree of weakness was a shock, but the fact that housing starts remained weak was not. Last month’s October building permits figure, showed a 9.3% decline (down 38.2% year-over-year), which was a great indication the reading was going to be very low. Housing starts have declined 72.5% from the January 2006 peak!
Permits for November, which was also out yesterday, do not indicate improvement for December as the figure dropped 15.6% last month to 616,000 – also a record low.
While this news is inauspicious, it is a necessary condition for the housing market to recover. The good news is new homes available for sale have plummeted, so when sales do bounce back the very elevated inventory/sales ratio will fall fast.
In a separate report, the Labor Department reported the consumer price index fell 1.7% in November, the biggest decline in 61 years and follows the 1.0% decline for October. Over the past 12 months, consumer prices are up 1.1% -- that figure was 3.7% in the previous month, 4.9% in September and 5.4% in August – just another illustration how quickly things have changed.
The core CPI was unchanged in November, lowering the year-over-year rate on ex-food and energy prices to 2.0% from 2.2% a month back.
The decline in CPI was virtually completely due to a large 17.0% decline in the overall energy component and a 9.8% in transportation. Gasoline, in particular, plunged 29.5% last month; natural gas was down 5.2%.
This dramatic decline in energy costs is great news for the consumer. As the boys at RDQ Economics point out, energy prices within the CPI fell to their lowest level since February 2007. U.S. consumers spent $670 billion on energy goods and services over the past 12 months – at February 2007 prices, the same level of consumption would have cost just $540 billion. This represents a $130 billion addition to real household incomes. This savings should show up in the December retail sales data.
Energy prices are down some more in December, but the degree of decline will wane and with OPEC planning a production cut oil prices will very likely level out before rising again.
The decline in CPI should not be confused with overall deflation, we’ll point out the food and beverage component rose 0.2% in November and is up 4.1% three-month annualized and 6.0% over the past 12 months. This is an energy-price driven event as we come off of the insanely elevated levels back in the spring and summer of this year.
The Fed has nearly tripled its balance sheet and the trillions in liquidity pumped into the system will combine with an infrastructure-based stimulus package to drive commodity prices and overall inflation higher again.
The price gauges will appear to indicate a deflationary event is upon us for a couple of months still, but it won’t be long before this concern has passed and the Fed will have to start thinking about how they’ll take back some of their easing as the economy slowly and tepidly bounces back. When things do improve, whenever that might be, massive liquidity injections will fire through the system. This is one reason a tax-rate response to the current woes is superior. Such a decision would boost confidence immediately, and offer businesses an incentive to produce over time; we’ll need an increase in goods to absorb all this money that will be flowing. If not, inflation is coming and it will be higher than we’ll like.
The Fed Decision
In a 10-0 decision the Federal Open Market Committee (FOMC) chose to cut the target on the federal funds rate from 1.00% to a range of zero and 0.25% (acknowledging the near-zero effective fed funds rate relative to the target), while stating they will “employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” Good luck with that ladies and gentlemen of the FOMC.
The group of 10 signaled they’re willing to keep the funds rate low by stating, “the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rates rate for some time.”
Nine rate cuts and nearly $2 trillion in emergency lending via roughly 10 new facilities over the past 12 months have yet to fully reverse the credit situation – although certainly facilities like their commercial paper funding program has certainly kept things from fully collapsing.
The statement also noted the Fed has already announced it will purchase “large quantities” of agency debt and mortgage-backed securities (to bring mortgage rates lower) and they “stand ready to expand these purchases as conditions warrant.” They continue to think about whether or not to buy longer-term Treasuries. (At 2.19% on the 10-year we’re not sure how much further they think the yield should go, so it’s unlikely they’ll engage in this action)
All-in-all, the Fed went well beyond expectations. The target FF cut was larger-than-expected; the establishment of a range for the funds rate and the discussion of quantitative easing (focusing on supporting financial markets and stimulating the economy through sustaining the high level of the Federal Reserve’s balance sheet) all suggest they will throw everything at the current situation. Overall, we knew this but to get explicit statements in their language is big.
The fact that they suggested they may up the size of GSE (Fannie and Freddie) debt purchases, while entertaining the thought of buying long-dated Treasuries really takes their actions to a whole new level.
If we could only get a tax-rate response to the economic distress that truly began to take hold in mid-September, we could spark confidence in a sustained way, which is more than half the battle in my view.
Have a great day!
Brent Vondera, Senior Analyst
Benchmark stocks indices had been up the entire session, despite horribly weak housing data, but the Fed’s afternoon decision provided additional fuel to the rally. The broad market jumped 3.4% in the final 90 minutes of trading.
Market Activity for December 16, 2008
Financial shares led the rally, as the S&P 500 index that tracks the group jumped 11.25%. Basic material, industrial and consumer discretionary shares also outperformed the market.
Economic Data
On the economic front, the Commerce reported builders broke ground on new homes at the lowest level on record – data goes back to 1959. Housing starts plunged 18.9% in November to 625,000 units at an annual pace. Multi-family starts (condos etc.) fell 23.3%; single-family units were down 16.9%.
The degree of weakness was a shock, but the fact that housing starts remained weak was not. Last month’s October building permits figure, showed a 9.3% decline (down 38.2% year-over-year), which was a great indication the reading was going to be very low. Housing starts have declined 72.5% from the January 2006 peak!
Permits for November, which was also out yesterday, do not indicate improvement for December as the figure dropped 15.6% last month to 616,000 – also a record low.
While this news is inauspicious, it is a necessary condition for the housing market to recover. The good news is new homes available for sale have plummeted, so when sales do bounce back the very elevated inventory/sales ratio will fall fast.
In a separate report, the Labor Department reported the consumer price index fell 1.7% in November, the biggest decline in 61 years and follows the 1.0% decline for October. Over the past 12 months, consumer prices are up 1.1% -- that figure was 3.7% in the previous month, 4.9% in September and 5.4% in August – just another illustration how quickly things have changed.
The core CPI was unchanged in November, lowering the year-over-year rate on ex-food and energy prices to 2.0% from 2.2% a month back.
The decline in CPI was virtually completely due to a large 17.0% decline in the overall energy component and a 9.8% in transportation. Gasoline, in particular, plunged 29.5% last month; natural gas was down 5.2%.
This dramatic decline in energy costs is great news for the consumer. As the boys at RDQ Economics point out, energy prices within the CPI fell to their lowest level since February 2007. U.S. consumers spent $670 billion on energy goods and services over the past 12 months – at February 2007 prices, the same level of consumption would have cost just $540 billion. This represents a $130 billion addition to real household incomes. This savings should show up in the December retail sales data.
Energy prices are down some more in December, but the degree of decline will wane and with OPEC planning a production cut oil prices will very likely level out before rising again.
The decline in CPI should not be confused with overall deflation, we’ll point out the food and beverage component rose 0.2% in November and is up 4.1% three-month annualized and 6.0% over the past 12 months. This is an energy-price driven event as we come off of the insanely elevated levels back in the spring and summer of this year.
The Fed has nearly tripled its balance sheet and the trillions in liquidity pumped into the system will combine with an infrastructure-based stimulus package to drive commodity prices and overall inflation higher again.
The price gauges will appear to indicate a deflationary event is upon us for a couple of months still, but it won’t be long before this concern has passed and the Fed will have to start thinking about how they’ll take back some of their easing as the economy slowly and tepidly bounces back. When things do improve, whenever that might be, massive liquidity injections will fire through the system. This is one reason a tax-rate response to the current woes is superior. Such a decision would boost confidence immediately, and offer businesses an incentive to produce over time; we’ll need an increase in goods to absorb all this money that will be flowing. If not, inflation is coming and it will be higher than we’ll like.
The Fed Decision
In a 10-0 decision the Federal Open Market Committee (FOMC) chose to cut the target on the federal funds rate from 1.00% to a range of zero and 0.25% (acknowledging the near-zero effective fed funds rate relative to the target), while stating they will “employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” Good luck with that ladies and gentlemen of the FOMC.
The group of 10 signaled they’re willing to keep the funds rate low by stating, “the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rates rate for some time.”
Nine rate cuts and nearly $2 trillion in emergency lending via roughly 10 new facilities over the past 12 months have yet to fully reverse the credit situation – although certainly facilities like their commercial paper funding program has certainly kept things from fully collapsing.
The statement also noted the Fed has already announced it will purchase “large quantities” of agency debt and mortgage-backed securities (to bring mortgage rates lower) and they “stand ready to expand these purchases as conditions warrant.” They continue to think about whether or not to buy longer-term Treasuries. (At 2.19% on the 10-year we’re not sure how much further they think the yield should go, so it’s unlikely they’ll engage in this action)
All-in-all, the Fed went well beyond expectations. The target FF cut was larger-than-expected; the establishment of a range for the funds rate and the discussion of quantitative easing (focusing on supporting financial markets and stimulating the economy through sustaining the high level of the Federal Reserve’s balance sheet) all suggest they will throw everything at the current situation. Overall, we knew this but to get explicit statements in their language is big.
The fact that they suggested they may up the size of GSE (Fannie and Freddie) debt purchases, while entertaining the thought of buying long-dated Treasuries really takes their actions to a whole new level.
If we could only get a tax-rate response to the economic distress that truly began to take hold in mid-September, we could spark confidence in a sustained way, which is more than half the battle in my view.
Have a great day!
Brent Vondera, Senior Analyst
Tuesday, December 16, 2008
Afternoon Review
General Electric (GE) +5.72%
GE, the world’s biggest maker of power-plant turbines, won an order valued at about $3 billion to provide electricity-generating equipment and services to Iraq. It is the largest single order in the history of the GE Energy segment with GE providing 56 of its 9E models turbines capable of supplying 7,000 megawatts of electricity (nearly doubling the country’s generating capacity).
The order comes amid concern the slowing global economy may crimp the pace of deliveries as some utilities struggle for cash for capital investments. In the third quarter, GE Energy had $7.9 billion in orders, up 18 percent. This new award adds to the $4 billion already ordered by countries including Saudi Arabia, Kuwait and Qatar over the past two years.
In separate news, GE reaffirmed its outlook for the fourth quarter and full-year 2008, but said that it will no longer provide specific quarterly earnings guidance. The company also reiterated its dividend, which has been a point of concern for many investors.
ITT Corporation (ITT) +8.88%
ITT reaffirmed its 2008 earnings forecast and said 2009 profit will be higher than the average estimates (according to Bloomberg). Revenue is projected to be down 2 percent to 6 percent from anticipated 2008 sales, including the expected negative impact of foreign currency exchange.
The company said its management will recommend that the board approve a dividend increase of 22 percent to 85 cents for next year at its February meeting. ITT also said the board approved an indefinite extension of the company’s $1 billion share repurchase program that was set to expire in November 2009. ITT has bought back about $431 million of its common stock under this program.
Johnson Controls (JCI) -1.09%
JCI withdrew its 2009 guidance due to “the rapid decline in global automotive production and uncertain industry conditions.” The company’s lowered production estimates for 2009 (made just two months ago) from 12.3 million vehicles to 9.3 million vehicles in North America, and 21.2 million vehicles to 16.2 million vehicles in Europe.
Actions to reduce costs and the performance of its building efficiency and power solutions businesses should keep JCI profitable in 2009, according to the company.
Transocean (RIG) -0.23%
Transocean received approval to change the place of their incorporation from the Caymans to Switzerland. This is likely to result in the company being removed from the S&P 500 and the Russell 2000 indices. This implies approximately 45.1 million shares are to be sold, which may put some near-term selling pressure on the stock.
Bank of America (BAC) +7.02%
BAC traded lower for most of the day (until the Fed’s rate cut decision) in response to an analyst saying the bank will need to raise more capital to offset rising loan losses.
Quick Hits
- Another View: Blaming the SEC (this article was written by a former SEC employee)
- This article shows that not all real estate is depreciating in value.
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks fell for only the fourth time in the past 16 sessions, and even as the indices lost some ground the degree of decline was pretty much a moral victory as the benchmark’s appeared destined for a 5% header with about an hour left. But stocks rallied in the final half-hour to pare earlier losses.
The NASDAQ took the brunt of the damage, falling 2.10%, erasing Friday’s nice move in which the tech-laden index outperformed the broad market.
There was a sense on Friday that technology firms will participate in next year’s stimulus program, which is true, but weak manufacturing and industrial production reports reminded traders of the downbeat business spending environment. New York-area manufacturing showed business spending on tech-equipment contracted significantly over the past month and the industrial production survey drew the same conclusion.
Market Activity for December 15, 2008
Among sectors, financials led the decline, falling 3.99%, after a Merrill Lynch analyst stated credit costs in the U.S. will get worse – not sure this of great surprise. Relative winners were consumer staples, energy and basic material shares – down 0.20%, 0.28% and 0.38%, respectively.
The Economy
The New York Federal Reserve Bank reported manufacturing activity in the region remained very depressed, hitting a record low. (We’ll note the index only goes back to 2001, so when we say record low it’s not saying a lot; still we know other factory surveys that have been around for decades are hitting their lowest levels in nearly 30 years.)
The index known as Empire Manufacturing registered -25.8, the lowest in the survey’s history. Factory activity in the New York-region has been extremely weak for three months now (the global economic situation changed on September 15) – certainly this area of the country is one of the hardest hit as it is home to the financial industry.
Forward looking indicators, like the new orders index of the survey, remain near record lows as illustrated below.
The outlook among respondents did improve a bit, rising to 19.5 – a number around 40 would be seen in more normal circumstances.
The capital spending index held near the November low, coming in at -10.6 for December. The technology spending index hit a new low of -12.8, so no help in this regard.
In a separate report, the Commerce Department reported industrial production slipped 0.6% in November. Manufacturing output, or lack thereof, put the most pressure on the reading, falling 1.4% last month.
(On the chart below we explain the September decline just to clarify why such outsized weakness occurred.)
Utilities and mining production rose 1.6% and 2.5%, respectively. Business equipment was also up, rising 3.2% for the month – this was helped by a jump in aerospace orders.
Consumer goods production fell 0.7%, motor vehicle production fell 2.8% and construction supply output declined 3.3%.
The decline in manufacturing output was actually worse than it appeared because a 12.8% jump in aircraft production helped the reading. That jump in aircraft output occurred as the Boeing strike came to an end. The auto industry continues to weigh heavily on factory output – the segment is down 21.4% year-over-year. Still, excluding autos, manufacturing is down 6.3% YOY.
We believe industrial production will remain weak for a few months still, but do not think a mild rebound should be ruled out. The decline in business spending is due more to caution that a lack of resources and once the current bout of pessimism wanes, even slightly, we should get a bounce in this segment.
Machinery orders are holding in there, but high-tech equipment has been hurt for three months. Firms will look to add more tech equipment as productivity improvement will remain in focus as average selling prices fall.
I may be reaching at optimism here, but do believe a mild rebound is on the horizon.
Going for Zero
The Fed ends its two-day meeting today, which means we’ll get their rate decision this afternoon. I won’t go against the consensus expectation for a 50 basis point (1/2 percentage point) cut by predicting they’ll do nothing – the implied probability of a 50 bps cut is 100%. However, cut right now is meaningless since what the Fed does is set a target for where fed funds (FF) should trade; the actual rate is already close to zero, 0.125% as of yesterday.
Beyond the cut, people will be focused on the language, which will key in on what is called quantitative easing – which is simply providing liquidity in ways separate from traditional FF rate cutting by setting up lending facilities, as they have been engaging in for exactly a year now. They will also mention what Bernanke calls the “second quiver,” which includes options such as buying longer-term Treasuries to inject even more cash into the system.
But again, I don’t see what this does to improve spreads – that’s what they say they’re targeting by executing these purchases. Treasury yields are already near record lows – the yield on the 10-year sits at 2.48% for goodness sakes. The problem is not a high risk-free rate, but an issue of confidence, which has spreads very wide. Ten-year BB+ rated industrials are trading 1100 basis points over Treasuries, that’s higher than typical junk spreads.
Yes, spreads should be wide because default rates are up and the market is going to demand a lot more return to compensate for this risk. However, some of this widening is due to a crisis of confidence and the most efficient way to counter this situation is to slash tax rates on income and capital. This is not the Federal Reserve’s decision to make, of course. The legislative and executive branches need to get this done – it’s been a big mistake by the Bush Administration to ignore this tool.
Is the implementation of broad-based tax cuts realistic with a central-planner entering the White House in 35 days? Certainly not.. But it’s still the correct remedy. Combine this with the elimination of mark-to-market accounting rules with which capital adequacy ratios are based upon (put in place just 13 months back; the timing could have hardly been worse) and I think most would be stunned how far these simple actions would get us in leaving the worst of this mess behind us.
But go ahead and target fed funds at 0.50%, even though the rate trades closer to zero. Go ahead and buy long-term Treasuries. Go ahead and triple the Federal Reserve’s balance sheet, from 6% of GDP a year ago to 17% today. We hope it works.
Have a great day!
Brent Vondera, Senior Analyst
The NASDAQ took the brunt of the damage, falling 2.10%, erasing Friday’s nice move in which the tech-laden index outperformed the broad market.
There was a sense on Friday that technology firms will participate in next year’s stimulus program, which is true, but weak manufacturing and industrial production reports reminded traders of the downbeat business spending environment. New York-area manufacturing showed business spending on tech-equipment contracted significantly over the past month and the industrial production survey drew the same conclusion.
Market Activity for December 15, 2008
Among sectors, financials led the decline, falling 3.99%, after a Merrill Lynch analyst stated credit costs in the U.S. will get worse – not sure this of great surprise. Relative winners were consumer staples, energy and basic material shares – down 0.20%, 0.28% and 0.38%, respectively.
The Economy
The New York Federal Reserve Bank reported manufacturing activity in the region remained very depressed, hitting a record low. (We’ll note the index only goes back to 2001, so when we say record low it’s not saying a lot; still we know other factory surveys that have been around for decades are hitting their lowest levels in nearly 30 years.)
The index known as Empire Manufacturing registered -25.8, the lowest in the survey’s history. Factory activity in the New York-region has been extremely weak for three months now (the global economic situation changed on September 15) – certainly this area of the country is one of the hardest hit as it is home to the financial industry.
Forward looking indicators, like the new orders index of the survey, remain near record lows as illustrated below.
The outlook among respondents did improve a bit, rising to 19.5 – a number around 40 would be seen in more normal circumstances.
The capital spending index held near the November low, coming in at -10.6 for December. The technology spending index hit a new low of -12.8, so no help in this regard.
In a separate report, the Commerce Department reported industrial production slipped 0.6% in November. Manufacturing output, or lack thereof, put the most pressure on the reading, falling 1.4% last month.
(On the chart below we explain the September decline just to clarify why such outsized weakness occurred.)
Utilities and mining production rose 1.6% and 2.5%, respectively. Business equipment was also up, rising 3.2% for the month – this was helped by a jump in aerospace orders.
Consumer goods production fell 0.7%, motor vehicle production fell 2.8% and construction supply output declined 3.3%.
The decline in manufacturing output was actually worse than it appeared because a 12.8% jump in aircraft production helped the reading. That jump in aircraft output occurred as the Boeing strike came to an end. The auto industry continues to weigh heavily on factory output – the segment is down 21.4% year-over-year. Still, excluding autos, manufacturing is down 6.3% YOY.
We believe industrial production will remain weak for a few months still, but do not think a mild rebound should be ruled out. The decline in business spending is due more to caution that a lack of resources and once the current bout of pessimism wanes, even slightly, we should get a bounce in this segment.
Machinery orders are holding in there, but high-tech equipment has been hurt for three months. Firms will look to add more tech equipment as productivity improvement will remain in focus as average selling prices fall.
I may be reaching at optimism here, but do believe a mild rebound is on the horizon.
Going for Zero
The Fed ends its two-day meeting today, which means we’ll get their rate decision this afternoon. I won’t go against the consensus expectation for a 50 basis point (1/2 percentage point) cut by predicting they’ll do nothing – the implied probability of a 50 bps cut is 100%. However, cut right now is meaningless since what the Fed does is set a target for where fed funds (FF) should trade; the actual rate is already close to zero, 0.125% as of yesterday.
Beyond the cut, people will be focused on the language, which will key in on what is called quantitative easing – which is simply providing liquidity in ways separate from traditional FF rate cutting by setting up lending facilities, as they have been engaging in for exactly a year now. They will also mention what Bernanke calls the “second quiver,” which includes options such as buying longer-term Treasuries to inject even more cash into the system.
But again, I don’t see what this does to improve spreads – that’s what they say they’re targeting by executing these purchases. Treasury yields are already near record lows – the yield on the 10-year sits at 2.48% for goodness sakes. The problem is not a high risk-free rate, but an issue of confidence, which has spreads very wide. Ten-year BB+ rated industrials are trading 1100 basis points over Treasuries, that’s higher than typical junk spreads.
Yes, spreads should be wide because default rates are up and the market is going to demand a lot more return to compensate for this risk. However, some of this widening is due to a crisis of confidence and the most efficient way to counter this situation is to slash tax rates on income and capital. This is not the Federal Reserve’s decision to make, of course. The legislative and executive branches need to get this done – it’s been a big mistake by the Bush Administration to ignore this tool.
Is the implementation of broad-based tax cuts realistic with a central-planner entering the White House in 35 days? Certainly not.. But it’s still the correct remedy. Combine this with the elimination of mark-to-market accounting rules with which capital adequacy ratios are based upon (put in place just 13 months back; the timing could have hardly been worse) and I think most would be stunned how far these simple actions would get us in leaving the worst of this mess behind us.
But go ahead and target fed funds at 0.50%, even though the rate trades closer to zero. Go ahead and buy long-term Treasuries. Go ahead and triple the Federal Reserve’s balance sheet, from 6% of GDP a year ago to 17% today. We hope it works.
Have a great day!
Brent Vondera, Senior Analyst
Monday, December 15, 2008
Afternoon Review
AT&T (T) -3.73%
AT&T fell after Goldman Sachs downgraded the company citing the potential for peak dilution from remaining growth initiatives, cyclical exposure in certain businesses and an accelerated pension hit.
JPMorgan Chase & Co (JPM) -7.47%
JPM was downgraded by Merrill Lynch who said the firm may post a fourth-quarter loss and a $2.8 billion writedown.
Quick Hits
Peter Lazaroff, Junior Analyst
Fixed Income Recap
Agencies and Mortgages Tighten
Yields on Agency debt has tightened dramatically to comparable Treasuries due to recent direct buying by the Federal Reserve Bank of New York. Two-year Agencies are currently at 89 basis points over Treasuries, compared to 120 basis points this time last week.
The Fed has announced they will be buying benchmark Fannie, Freddie and Federal Home Loan Bank issues ranging in maturities from 2012 to 2017. Despite only buying the middle part of the yield curve, spreads have tightened across all maturities, in anticipation of more buying in the future.
MBS has followed agencies by tightening to Treasuries over the past week, again as a result of a buying plan announced by The New York Fed. The Fed has yet to announce specific issues that they plan to buy, but most signs point to fixed rate 30-year MBS pools.
As year end approaches, dealers are avoiding adding to their inventories, leaving the street with little to offer buyers. As a result, bids on odd-lots have continued to deteriorate, beyond what we saw last month, and show no sign of improving before year end.
TARP Money for Autos
The Bush administration announced this afternoon that it is considering tapping into the unused cash from the Troubled Asset Relief Program to rescue GM and Chrysler. The initial plan to allocate $14 billion in money directly from the Treasury failed to pass Congress Thursday night. It seems unclear why TARP money would be easier to allocate than the plan that failed to pass, because the TARP money would also need Congressional approval. Perhaps putting a different label on the same thing is enough to woo decision makers.
Cliff J. Reynolds Jr.
Junior Analyst
Yields on Agency debt has tightened dramatically to comparable Treasuries due to recent direct buying by the Federal Reserve Bank of New York. Two-year Agencies are currently at 89 basis points over Treasuries, compared to 120 basis points this time last week.
The Fed has announced they will be buying benchmark Fannie, Freddie and Federal Home Loan Bank issues ranging in maturities from 2012 to 2017. Despite only buying the middle part of the yield curve, spreads have tightened across all maturities, in anticipation of more buying in the future.
MBS has followed agencies by tightening to Treasuries over the past week, again as a result of a buying plan announced by The New York Fed. The Fed has yet to announce specific issues that they plan to buy, but most signs point to fixed rate 30-year MBS pools.
As year end approaches, dealers are avoiding adding to their inventories, leaving the street with little to offer buyers. As a result, bids on odd-lots have continued to deteriorate, beyond what we saw last month, and show no sign of improving before year end.
TARP Money for Autos
The Bush administration announced this afternoon that it is considering tapping into the unused cash from the Troubled Asset Relief Program to rescue GM and Chrysler. The initial plan to allocate $14 billion in money directly from the Treasury failed to pass Congress Thursday night. It seems unclear why TARP money would be easier to allocate than the plan that failed to pass, because the TARP money would also need Congressional approval. Perhaps putting a different label on the same thing is enough to woo decision makers.
Cliff J. Reynolds Jr.
Junior Analyst
Daily Insight
U.S. stocks, after getting off to a poor start, rallied 3.4% from the day’s low to manage a solid gain. Technology shares led the advance, jumping 5.52% on Friday as the next stimulus plan will not only boost activity within the industrial sector, but tech-equipment too.
The session began lower by roughly 3.0% probably due to pre-market news that the Senate didn’t have the votes to pass the auto bailout.
It came down to Senate Republicans demanding the UAW become competitive with the industry from a perspective of compensation – a “jobs bank” that pays the laid off 95% of wages and zero premium requirement for retirees has total compensation costs among the Detroit Three 52% higher than the transplants, as they’re being called. Frankly, the deal the Senate was working out would have been beneficial to workers relative to the alternative, which is bankruptcy.
But then the President rode to the “rescue” as he commented the administration would find a way to use TARP funds to keep the D3 going for a few months. Stocks often think short-term on a day-to-day basis and bounced from the session’s lows on these comments.
Obviously, the best long-term strategy is to cut dealerships, payrolls, and plants (along with the “jobs bank” and a zero-premium health-care policy, which I believe will change anyway in 2010). The D3 no longer have 50% market share, but something closer to 18%; it’s about time they began to manage the business to reflect this reality. Still, President Bush likely does not want an additional flood of layoffs in his final month in office – one supposes this is why he’s stepping in.
Market Activity for December 12, 2008
Then we had the Bernard Madoff scandal, a Ponzi Scheme, (taking another bite out of confidence). This could have pressured stocks, but didn’t; maybe we’re onto a rally with additional staying power. The broad-market has bounced 18% from the November 20 low; it will be tough to extend this rally through the year but maybe this strength in the face of bad news is telling us something.
Economic Data
The Labor Department reported the producer price index (PPI) for November slid 2.2% for the month and was up 0.4% on a year-over-year basis – that’s a huge deceleration from the prior month, which had PPI up 5.2% YOY.
Core PPI, ex food and energy, rose 0.1% for the month and was up 4.2% year-over-year, down slightly from a reading of 4.4% in the prior month.
This core figure is showing that the plunge in inflation gauges over the past two months is largely due to the rapid decline in energy prices from their Fed-induced heights of July 2008. Oil prices in particular doubled in a 10-month time span, driving crude per barrel to $145. The slide from those heights has brought the inflation indices down with it but there are underlying factors that shows prices will rebound.
Take core intermediate goods for instance. These are goods, ex-fuel, used to make finished product. While these prices are lower, they remain somewhat elevated and sticky.
When banks begin to lend in a more normal way, all that liquidity the Fed has pumped into the system will flow through to the economy. This money will find an environment in which there are less goods out there as production has been cut – to much money chasing too few goods will cause inflation to rise again.
Further, when this combines with an infrastructure-based stimulus program, commodity prices will rebound, making an inflationary event inevitable in my view. Too bad I don’t know whether this will take six, 12 or 18 months to occur – it would certainly be helpful to know this, but it’s pretty much a done deal.
In a separate report, the Commerce Department stated retail sales fell for the fourth-straight month. For November overall sales were down 1.8%, which was less than the expected decline of 2.0%, but still a very significant decline. This follows a very large drop of 2.9% in October.
Certainly, consumer activity is going to remain weak for a while. We have a lot of people that lack the means to expand activity due to a weak labor market and mortgage interest-rate resets for those that chose a lower adjustable rate three years back. That said, the majority of consumers have the means, but have shut down in a spate of caution due to all of the news over the past three months. Surely, a 40% decline in stock prices is having a huge effect on sentiment.
That said when we exclude auto and gas-station sales, activity rose for the first time in three months – up 0.3% in November. This may be an indication retail sales are set to bounce. This is not to say we’ll see a multi-month rebound, but we should halt the four-month decline streak when the December number is released.
One of the factors behind the slump in retail sales has been the dramatic decline in gasoline prices. Gas-station receipts make up 9% of the overall figure, so when this component falls 14.7%, as it did in November, it accounted for 1.3% of the 1.8% drop -- 72% of the move.
Again, under normal circumstances this decline in pump prices would allow for increases in other segments. Things are not normal right now and we’re not trying to say activity will bounce back in a sustained way, but the rise in ex-auto, ex-gasoline retail sales is setting up for a nice month-over-month increase when the December data is released.
This Week
We’ve got a plethora of data out this week, beginning this morning with industrial production (November) and the NAHB (Nat Assc. Of Homebuilders) Housing Market Index.
Later in the week, we’ll get the Fed rate decision, housing starts, CPI, jobless claims (of course) and Philadelphia-area manufacturing.
Have a great day!
Brent Vondera, Senior Analyst
The session began lower by roughly 3.0% probably due to pre-market news that the Senate didn’t have the votes to pass the auto bailout.
It came down to Senate Republicans demanding the UAW become competitive with the industry from a perspective of compensation – a “jobs bank” that pays the laid off 95% of wages and zero premium requirement for retirees has total compensation costs among the Detroit Three 52% higher than the transplants, as they’re being called. Frankly, the deal the Senate was working out would have been beneficial to workers relative to the alternative, which is bankruptcy.
But then the President rode to the “rescue” as he commented the administration would find a way to use TARP funds to keep the D3 going for a few months. Stocks often think short-term on a day-to-day basis and bounced from the session’s lows on these comments.
Obviously, the best long-term strategy is to cut dealerships, payrolls, and plants (along with the “jobs bank” and a zero-premium health-care policy, which I believe will change anyway in 2010). The D3 no longer have 50% market share, but something closer to 18%; it’s about time they began to manage the business to reflect this reality. Still, President Bush likely does not want an additional flood of layoffs in his final month in office – one supposes this is why he’s stepping in.
Market Activity for December 12, 2008
Then we had the Bernard Madoff scandal, a Ponzi Scheme, (taking another bite out of confidence). This could have pressured stocks, but didn’t; maybe we’re onto a rally with additional staying power. The broad-market has bounced 18% from the November 20 low; it will be tough to extend this rally through the year but maybe this strength in the face of bad news is telling us something.
Economic Data
The Labor Department reported the producer price index (PPI) for November slid 2.2% for the month and was up 0.4% on a year-over-year basis – that’s a huge deceleration from the prior month, which had PPI up 5.2% YOY.
Core PPI, ex food and energy, rose 0.1% for the month and was up 4.2% year-over-year, down slightly from a reading of 4.4% in the prior month.
This core figure is showing that the plunge in inflation gauges over the past two months is largely due to the rapid decline in energy prices from their Fed-induced heights of July 2008. Oil prices in particular doubled in a 10-month time span, driving crude per barrel to $145. The slide from those heights has brought the inflation indices down with it but there are underlying factors that shows prices will rebound.
Take core intermediate goods for instance. These are goods, ex-fuel, used to make finished product. While these prices are lower, they remain somewhat elevated and sticky.
When banks begin to lend in a more normal way, all that liquidity the Fed has pumped into the system will flow through to the economy. This money will find an environment in which there are less goods out there as production has been cut – to much money chasing too few goods will cause inflation to rise again.
Further, when this combines with an infrastructure-based stimulus program, commodity prices will rebound, making an inflationary event inevitable in my view. Too bad I don’t know whether this will take six, 12 or 18 months to occur – it would certainly be helpful to know this, but it’s pretty much a done deal.
In a separate report, the Commerce Department stated retail sales fell for the fourth-straight month. For November overall sales were down 1.8%, which was less than the expected decline of 2.0%, but still a very significant decline. This follows a very large drop of 2.9% in October.
Certainly, consumer activity is going to remain weak for a while. We have a lot of people that lack the means to expand activity due to a weak labor market and mortgage interest-rate resets for those that chose a lower adjustable rate three years back. That said, the majority of consumers have the means, but have shut down in a spate of caution due to all of the news over the past three months. Surely, a 40% decline in stock prices is having a huge effect on sentiment.
That said when we exclude auto and gas-station sales, activity rose for the first time in three months – up 0.3% in November. This may be an indication retail sales are set to bounce. This is not to say we’ll see a multi-month rebound, but we should halt the four-month decline streak when the December number is released.
One of the factors behind the slump in retail sales has been the dramatic decline in gasoline prices. Gas-station receipts make up 9% of the overall figure, so when this component falls 14.7%, as it did in November, it accounted for 1.3% of the 1.8% drop -- 72% of the move.
Again, under normal circumstances this decline in pump prices would allow for increases in other segments. Things are not normal right now and we’re not trying to say activity will bounce back in a sustained way, but the rise in ex-auto, ex-gasoline retail sales is setting up for a nice month-over-month increase when the December data is released.
This Week
We’ve got a plethora of data out this week, beginning this morning with industrial production (November) and the NAHB (Nat Assc. Of Homebuilders) Housing Market Index.
Later in the week, we’ll get the Fed rate decision, housing starts, CPI, jobless claims (of course) and Philadelphia-area manufacturing.
Have a great day!
Brent Vondera, Senior Analyst
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