December Recap:
Markets rallied in December as governments around the world responded aggressively to the global fallout and investor appetite for risk edged higher. The widely publicized VIX index, a measure of fear in the market, has declined over 50 percent from its November 20 high, which suggests that the fear surrounding stocks has dissipated somewhat and demand for risk-taking increased. Another indication of an increased demand for risk-taking is evident in the S&P 500’s lagging performance compared to riskier asset classes.
While the S&P 500 posted a modest return of 1.06 percent, the S&P 400 Mid Cap Index and S&P 600 Small Cap Index climbed 4.85 percent and 6.10 percent, respectively. Meanwhile, international equities surged with the iShares MSCI EAFE (EFA) climbing 8.88 percent and the iShares MSCI Emerging Markets (EEM) up 10.35 percent. Even more impressive were the returns on REITs, which had been smashed in the prior two months by investors’ preference for businesses that don’t require debt. The Vanguard REIT ETF (VNQ) gained 16.68 percent in December and global REITs increased 10.14 percent.
Most sectors posted gains with the exception being energy stocks. The main culprit for the sector’s poor performance is commodity prices that have plummeted in response to a global recession that has created expectations for decreased global demand. S&P GSCI Commodity Index Fund (GSG), which is about 75 percent devoted to energy with the bulk of that focused directly on crude oil, fell 11.18 percent this month. Greenhaven Continuous Commodity Index Fund (GCC), which tracks an equal weighted basket of 17 commodities, increased 0.64 percent.
The record low yields seen in November were surpassed in December with the two-year falling 21.5 basis points on the month to yield 0.76 percent, and the ten-year fell 70.5 basis points to yield 2.12 percent at the end of 2008. Yields on MBS ended the month flat to Treasuries on a spread basis, after widening out in early December only to snap back in the final week of the year.
The iShares Barclays Aggregate Fund (AGG) was up 6.65 percent due to considerable tightening of credit spreads, the continuing rally in Treasuries and the fund itself moving from a discount to a premium. iShares TIPS fund (TIP) also enjoyed some nice price appreciation as the deflationary scare that hurt TIPS the past two months proved to be short lived.
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Peter Lazaroff, Junior Analyst
Friday, January 2, 2009
Daily Insight
U.S. stocks ended the market’s worst year since the 1930s on a positive note, rising roughly 4% over the final two trading sessions of 2008. Wednesday’s gains may have been helped by a much-better-than expected reading on initial jobless claims, although continuing claims jumped, honing in on the high point reached during the 1981-82 recession.
More likely investors and traders were positioning for the so-called January effect, the tendency of the stock market to rise in the first week or month of January – the definition is not concrete. I don’t buy into this idea, since it seems to occur largely in up markets. In any event, positioning for the New Year is likely what drove stocks higher.
The benchmark S&P 500 declined 38.49% in 2008, resulting in the first 30% slide since the 38.59% plunge in 1937. There have been just two years that exceeded 2008’s decline -- 1931, when the S&P 500 lost 47.07% and 1937 when the index slid 38.59%. The 1931 debacle followed an 11.91% decline in 1929, a 28.48% drop in 1930 and preceded a 14.78% drop in 1932. So I wouldn’t go comparing what occurred in 2008 to the early years of the Great Depression years just yet.
Most other large annual declines in stock prices were followed by strong upside activity. The slide in 1937 was followed by a 24.55% rise in 1938. In 1974 – which we think is a more appropriate comparison -- the broad market fell 29.72% and was followed by a 31.55% surge in 1975. In 2002, the broad market lost 23.37% and was followed by a 26.38% jump in 2003, a year that kicked off the five-year bull market that saw the S&P 500 rise 77% by the time it peaked in October 2007.
That said, investors will be faced with plenty of headwinds this year. If the economy, not just domestically speaking but globally as well, does snap back and lending activity turns a bit more normal we’ll have an inflationary event on our hands as the Fed is printing dollars like mad. The Fed will then have a choice. Stamp out the inflation by raising interest rates, or ignore it for fear that higher rates will push the cost of money to levels that impede corporate profit growth. And even if the Fed doesn’t raise short term rates, one would think the long end to rise, which will affect corporate borrowing costs, and mortgage rates as well.
If inflation does not rise, it will probably mean that the banking system remains in disarray and lending has not returned to normal, which will also be a drag on equity prices.
The likely scenario, based on what is currently known, is that we will rally from these levels, but then run into some trouble a few months later as the previous concerns arise.
There are positives, however – as long-term readers know I do not enjoy this tone of pessimism.
Fed stimulus, fiscal stimulus, trillions in cash on the sidelines, very low gasoline prices and very low mortgage rates should help out. In addition, U.S. businesses are very streamlined these days; inventory levels are much lower than normal heading into recession and that will help to ease the duration of the downturn (less goods to sell off before production ramps up again) – so long as government policy mistakes don’t work against this private-sector efficiency.
But back to last year, if you thought it was a rough year for the U.S. market, it was worse for most overseas bourses. Overall, international stocks within developed markets fell 45.09%, led by a 42% decline in the Nikkei 225 (Japan). Emerging markets got hammered, losing 54.48%, led by a 72% in Russia’s main index.
Jobless Claims
The Labor Department reported initial jobless claims fell 94,000 to 492,000 in the week ended December 27. That’s a very big decline and the first time since October initial claims have moved below the 500k mark. While this decline is very welcome, most of it was likely due to the seasonal adjustment as the week covered the Christmas holiday. The unadjusted level of first-time claims fell only 2,000. Additionally, some suggested winter storms prevented people from filing. We’re not sure of the extent this may have played, possibly government offices closed down as a result.
The four-week average of claims fell 5,750 to 552,250.
Continuing claims jumped 140,000 to 4.506 million in the week ended December 20 – there is a one-week lag between initial and continuing claims data. Continuing claims are closing in on the 1982 peak, but as we’ve touched on many times now, this level of continuing claims is not nearly as bad as it was back then when payroll employment stood at 88 million; today that figure is 136 million, so that context is important. Nevertheless, this high level of claims illustrates labor market conditions are very weak.
In terms of the December payroll survey (job losses for the month), we look for another big decline, maybe another 500,000, as the previous jobless claims reading hit a 26-year high. That previous reading was for the week that corresponds with the December payroll reading – the Bureau of Labor Statistics defines as unemployed those persons who didn’t work in the week of the monthly employment report.
It’s too early to tell, but if I had to throw a guess out there, we should expect the monthly job losses to ease over the next three months. The job market lags the overall economy, so the labor market will remain weak for even after the economy rebounds (although the type of stimulus the Obama Administration will implement will give jobs a short-term boost) but we should see the degree of decline level off by late spring.
Russian Revanchism and Energy Supply Threats
The Russian economy has been hit exceptionally hard as global growth wanes, oil prices have plummeted (they’re economy is heavily dependent on oil revenue) and the ruble continues to get crushed and will very likely slide further. GDP trends will reverse, from growing 6-7% over the past few years to contraction.
As a result, the Russian populace will become increasingly perturbed and the number of demonstrations will rise. The regime has already countered by expanding the definition of treason (endangering order as they define it) and punishable by up to 20 years in prison. The riot police will be cracking down in force.
In order to take the citizens’ minds off of their eroding circumstance one should assume they’ll seek to reclaim former Soviet satellites, much like the conflict with Georgia last summer. Propaganda will increase to foment anti-American/anti-Western ideology. Further, as the WSJ pointed out last week Russian authorities have rewritten the constitution to grant the president 12-year consecutive years in office. They point out that current President Medvedev will take the fall for the ailing economic state to usher in Putin’s return.
This will likely become quite problematic and the Obama Administration will need to remain on top of things. Over the past couple of days, Russia has cut off gas supplies to Ukraine and threatens to extend this action. This does not only affect Eastern Europe but Western Europe as well. For now, natural gas supplies are well built, so this action by the Russians does not harm energy requirements in the near term, but it is a concerning indication of how Putin and Co. will roll over the next few years.
The West needs to get off of its environmental concerns and think much more logically by increasing energy production. This is serious stuff. We also need to dramatically expand nuclear energy capabilities, which is extremely clean energy production and should be embraced whether you believe in anthropogenic climate change or are more concerned from a national security perspective.
Have a great weekend!
Brent Vondera, Senior Analyst
More likely investors and traders were positioning for the so-called January effect, the tendency of the stock market to rise in the first week or month of January – the definition is not concrete. I don’t buy into this idea, since it seems to occur largely in up markets. In any event, positioning for the New Year is likely what drove stocks higher.
The benchmark S&P 500 declined 38.49% in 2008, resulting in the first 30% slide since the 38.59% plunge in 1937. There have been just two years that exceeded 2008’s decline -- 1931, when the S&P 500 lost 47.07% and 1937 when the index slid 38.59%. The 1931 debacle followed an 11.91% decline in 1929, a 28.48% drop in 1930 and preceded a 14.78% drop in 1932. So I wouldn’t go comparing what occurred in 2008 to the early years of the Great Depression years just yet.
Most other large annual declines in stock prices were followed by strong upside activity. The slide in 1937 was followed by a 24.55% rise in 1938. In 1974 – which we think is a more appropriate comparison -- the broad market fell 29.72% and was followed by a 31.55% surge in 1975. In 2002, the broad market lost 23.37% and was followed by a 26.38% jump in 2003, a year that kicked off the five-year bull market that saw the S&P 500 rise 77% by the time it peaked in October 2007.
That said, investors will be faced with plenty of headwinds this year. If the economy, not just domestically speaking but globally as well, does snap back and lending activity turns a bit more normal we’ll have an inflationary event on our hands as the Fed is printing dollars like mad. The Fed will then have a choice. Stamp out the inflation by raising interest rates, or ignore it for fear that higher rates will push the cost of money to levels that impede corporate profit growth. And even if the Fed doesn’t raise short term rates, one would think the long end to rise, which will affect corporate borrowing costs, and mortgage rates as well.
If inflation does not rise, it will probably mean that the banking system remains in disarray and lending has not returned to normal, which will also be a drag on equity prices.
The likely scenario, based on what is currently known, is that we will rally from these levels, but then run into some trouble a few months later as the previous concerns arise.
There are positives, however – as long-term readers know I do not enjoy this tone of pessimism.
Fed stimulus, fiscal stimulus, trillions in cash on the sidelines, very low gasoline prices and very low mortgage rates should help out. In addition, U.S. businesses are very streamlined these days; inventory levels are much lower than normal heading into recession and that will help to ease the duration of the downturn (less goods to sell off before production ramps up again) – so long as government policy mistakes don’t work against this private-sector efficiency.
But back to last year, if you thought it was a rough year for the U.S. market, it was worse for most overseas bourses. Overall, international stocks within developed markets fell 45.09%, led by a 42% decline in the Nikkei 225 (Japan). Emerging markets got hammered, losing 54.48%, led by a 72% in Russia’s main index.
Jobless Claims
The Labor Department reported initial jobless claims fell 94,000 to 492,000 in the week ended December 27. That’s a very big decline and the first time since October initial claims have moved below the 500k mark. While this decline is very welcome, most of it was likely due to the seasonal adjustment as the week covered the Christmas holiday. The unadjusted level of first-time claims fell only 2,000. Additionally, some suggested winter storms prevented people from filing. We’re not sure of the extent this may have played, possibly government offices closed down as a result.
The four-week average of claims fell 5,750 to 552,250.
Continuing claims jumped 140,000 to 4.506 million in the week ended December 20 – there is a one-week lag between initial and continuing claims data. Continuing claims are closing in on the 1982 peak, but as we’ve touched on many times now, this level of continuing claims is not nearly as bad as it was back then when payroll employment stood at 88 million; today that figure is 136 million, so that context is important. Nevertheless, this high level of claims illustrates labor market conditions are very weak.
In terms of the December payroll survey (job losses for the month), we look for another big decline, maybe another 500,000, as the previous jobless claims reading hit a 26-year high. That previous reading was for the week that corresponds with the December payroll reading – the Bureau of Labor Statistics defines as unemployed those persons who didn’t work in the week of the monthly employment report.
It’s too early to tell, but if I had to throw a guess out there, we should expect the monthly job losses to ease over the next three months. The job market lags the overall economy, so the labor market will remain weak for even after the economy rebounds (although the type of stimulus the Obama Administration will implement will give jobs a short-term boost) but we should see the degree of decline level off by late spring.
Russian Revanchism and Energy Supply Threats
The Russian economy has been hit exceptionally hard as global growth wanes, oil prices have plummeted (they’re economy is heavily dependent on oil revenue) and the ruble continues to get crushed and will very likely slide further. GDP trends will reverse, from growing 6-7% over the past few years to contraction.
As a result, the Russian populace will become increasingly perturbed and the number of demonstrations will rise. The regime has already countered by expanding the definition of treason (endangering order as they define it) and punishable by up to 20 years in prison. The riot police will be cracking down in force.
In order to take the citizens’ minds off of their eroding circumstance one should assume they’ll seek to reclaim former Soviet satellites, much like the conflict with Georgia last summer. Propaganda will increase to foment anti-American/anti-Western ideology. Further, as the WSJ pointed out last week Russian authorities have rewritten the constitution to grant the president 12-year consecutive years in office. They point out that current President Medvedev will take the fall for the ailing economic state to usher in Putin’s return.
This will likely become quite problematic and the Obama Administration will need to remain on top of things. Over the past couple of days, Russia has cut off gas supplies to Ukraine and threatens to extend this action. This does not only affect Eastern Europe but Western Europe as well. For now, natural gas supplies are well built, so this action by the Russians does not harm energy requirements in the near term, but it is a concerning indication of how Putin and Co. will roll over the next few years.
The West needs to get off of its environmental concerns and think much more logically by increasing energy production. This is serious stuff. We also need to dramatically expand nuclear energy capabilities, which is extremely clean energy production and should be embraced whether you believe in anthropogenic climate change or are more concerned from a national security perspective.
Have a great weekend!
Brent Vondera, Senior Analyst
Wednesday, December 31, 2008
Afternoon Review
Spotlight: Transocean (RIG) *updated tearsheet attached*
Two weeks ago, I mentioned that Transocean may have some near-term selling pressure following their approval to change the place of their incorporation to Switzerland and their subsequent removal from S&P 500 and the Russell 2000 indices. Transocean tumbled more than 26 percent in the seven trading days following the decision, and today trades at just more than three times earnings (the company’s has typically traded between 12 and 15 times earnings).
Also fueling the share price meltdown was CEO Bob Long’s comment last month that deepwater projects need $60-a-barrel oil to be economic. With oil hovering around $40-a-barrel, fears have grown that projects may be canceled. However, this is not a valid concern for Transocean since only 1 to 2 percent of their contracts can be canceled by client termination, and those particular contracts contain day rates far below market rates.
The deep-water market is positioned to expand substantially in coming years because of large deep-water discoveries, and Transocean has positioned itself as the prime beneficiary. The company’s $41 billion backlog (nearly three times its current market capitalization) and orders extending out to 2020, provide stability for the business and nice visibility into the future.
Noble (NE) is will likely be the next driller to change the place of their incorporation to Switzerland, and thus will be removed from the S&P 500 and Russell 2000 indices as well. Though much smaller than Transocean and less leveraged to the deepwater market, Noble’s $12 billion backlog (double the company’s current market capitalization) gives revenue visibility out to 2016. About 88 percent of Noble’s business is with national oil companies, giant public firms and large independents, thus the risks of customer financing issues are low.
Noble also provides engineering and consulting in addition to contract drilling services, giving the company a diversified revenue stream. Noble is contracted to build the largest ultra deepwater drill ship to be put into service in 2011, for $585 million. Out to 2011-2013, the deepwater market will become a larger proportion of Noble’s revenues, which should allow them to maintain wide margins.
Quick Hits
- Tallying the Trillions in Bailouts to Bankruptcies
- The Deals and No-Deals of 2008
- VIX Declines Below 40 as ‘Sheer Panic’ on Wall Street Recedes
Peter Lazaroff, Junior Analyst
Fixed Income Recap
Treasuries Rally
U.S. Treasuries were higher across the board today on thin trading, despite the gains in the stock market. The two-year ended the day at .73% while the ten-year closed at a yield of 2.06%.
The yield curve has steepened 9 basis points this week to 179 basis points, after flattening considerably over the last month. Like stocks, Treasuries continue to be range bound in an environment where volume is very light and most desks are waiting out the end of the year.
Fed MBS Purchasing Program
Goldman Sachs, Blackrock, PIMCO and Wellington Management were announced as managers for the Federal Reserve’s $500 billion MBS buying program. Actual purchases are expected to start in early 2009 and be completed by June. Only, Fannie Mae, Freddie Mac and Ginnie Mae fixed-rate mortgage-backed securities are eligible for the program.
The market has already begun to price these purchases in, which has significantly lowered fixed rate mortgage yields over the past few weeks. The market is hopeful that the demand from the Fed will spill over to new mortgage originations and continue to re-establish confidence in the overall mortgage backed securities market.
Cliff J. Reynolds Jr.
Junior Analyst
U.S. Treasuries were higher across the board today on thin trading, despite the gains in the stock market. The two-year ended the day at .73% while the ten-year closed at a yield of 2.06%.
The yield curve has steepened 9 basis points this week to 179 basis points, after flattening considerably over the last month. Like stocks, Treasuries continue to be range bound in an environment where volume is very light and most desks are waiting out the end of the year.
Fed MBS Purchasing Program
Goldman Sachs, Blackrock, PIMCO and Wellington Management were announced as managers for the Federal Reserve’s $500 billion MBS buying program. Actual purchases are expected to start in early 2009 and be completed by June. Only, Fannie Mae, Freddie Mac and Ginnie Mae fixed-rate mortgage-backed securities are eligible for the program.
The market has already begun to price these purchases in, which has significantly lowered fixed rate mortgage yields over the past few weeks. The market is hopeful that the demand from the Fed will spill over to new mortgage originations and continue to re-establish confidence in the overall mortgage backed securities market.
Cliff J. Reynolds Jr.
Junior Analyst
Daily Insight
U.S. stocks managed some nice gains on very light volume yesterday, brushing aside manufacturing data that showed activity within the sector remained very weak and housing data showed price declines accelerated in October.
The news that the lending arm of GM will receive $5 billion in TARP funds (at a cost 8%) likely helped the indices advance. While bankruptcy is the best path to viability for the Detroit Three, the market probably doesn’t want to contemplate the ramifications to an already weak labor market that would result.
We’ll note the dire predictions that an additional three million workers will be thrust into the unemployment rolls are a bit hyperbolic; nevertheless, such an event would cause the unemployment rate to jump. Re-organization is a necessary condition to get GM, Chrysler and Ford streamlined for the future, but the marketplace doesn’t want to deal with this reality right now, so stocks get a short-term boost on news of government-assistance.
Unfortunately, the rally in stocks was not accompanied by a decline in Treasuries. We’ll really need to see some money come out the Treasury market as this will signal an easing in risk aversion. So long as money continues to hide under the Treasury market rock, it’s tough to get too excited.
The goods news is intraday swings have become much milder, so we may have entered into this feeling out process, as we’ve termed it – a period in which the market determines which way it wants to go after a serious plunge, such as the 40% slide in the two months that ended November 20. During the 1974 bear market a similar period of relative calm ushered in a powerful rally.
Many seem to believe a robust rally will come in January. We’re not so sure as the de-leveraging event may have not yet fully run its course. The Middle East is also heating up, which won’t help things. Based on what is presently known, we do believe a powerful bear-market rally is on the horizon, but may have to wait a few weeks still. It’s impossible to time.
Market Activity for December 30, 2008
U.S. stocks are headed for their worst year since 1931 as things fell apart when Lehman went down on September 15; the event roiled the money markets and caused the overall credit market to freeze up. The following chart of the S&P 500 Index shows what has occurred from the peak hit in October 2007. It took us basically a year to fall 20% from that peak, but prices began to plunge in the third week of September.
Economic Data
The S&P Case/Shiller Home Price Index, a gauge of the largest 20 metro areas in the U.S., posted its largest decline yet in October.
Case/Shiller recorded home prices fell 18.04% on a year-over-year basis. As you can see via the table below, the most significant damage continues to occur in the West, although Miami, Detroit, Tampa and Minneapolis also continue to see exceptionally large declines. This home price index has values down 23.4% from the peak.
We’ll note, as long-term readers know, that this gauge is not a broad representation of what is occurring nationwide. The FHFA (Federal Housing and Finance Agency) offers the broadest measure of home prices. This measure has home prices down 10% from the peak hit in early 2007 (the exact time of the peak depends on the gauge). This measure also has its flaws though. Where Case/Shiller is not a broad index, and subject to a number of cities that saw the greatest speculative fervor at the height of the housing euphoria, the FHFA index fails to cover high-end homes.
In our view averaging the four main home price measures, the two just mentioned along with price data from the new and existing home sales figures, offers the best look at what prices in general have done. This shows average home prices are down roughly 16% from the peak.
For a longer term perspective, home prices in generally are up about 35% since 2000. That means home prices have grown about 3.4% annualized, which is slightly below what I believe to be the long-term average of 5%.
The decline in home prices has been a harsh reality; however, it is a necessary condition to bring sales back. It appears the process of reversion to the mean has run its course, in fact may have moved beyond what is justified. This does not mean prices will bounce back over the next couple of months, we do have a weak job market to contend with, which is the more traditional drag on housing. Nevertheless, we may be very close to the bottom.
In a separate report the Chicago Purchasing Managers Index (PMI), which measures factory activity in the region, edged slightly higher from the prior month’s depressed reading.
The overall activity index came in at 34.1 after posting 33.8 in November – the weakest readings since the spring of 1982. A reading of 50 is the line of demarcation between expansion and contraction.
(For context, Chicago-area manufacturing showed activity expanded 54 of the 55 months that ended in February 2008, which marked the longest run in the survey’s history. In February the index contracted mildly, but bounced back July-September as business spending accelerated. Things collapsed though beginning in October as the credit event caused businesses to cancel spending projects when the credit markets froze up.)
The new orders index moved up to 29.4 from 27.2 last month, while production fell to 31.7 from 34.3. The employment index rose nicely to 39.6 from 33.4; however this level still represents a significant decline in manufacturing jobs. For new readers, these are the sub-indices of the overall report.
Nothing in this report offers an indication the nation’s largest manufacturing region in on the verge of a rebound. The next reading on factory activity comes on Friday via the ISM survey (manufacturing activity for the entire nation).
The US Dollar
The greenback has given up much of the gains recorded in summer and fall and will very likely take a beating in 2009 as the combination of the Federal Reserve’s massive liquidity injections pumps more dollars into the system and the government’s spending spree will cause budget deficits to soar. And we’re not talking about deficits the media has harped on over the past several years, those were child’s play, extremely manageable levels that ran 1.2%-4.0% of GDP. No, the deficits that the government will record for 2009 and 2010 will hit $1 trillion plus, or more than 7% of GDP.
Last spring, the Dollar Index (DXY) hit the very low level of 71 but rallied beginning in July as it benefited from a flight to ultra-safe investments such as Treasury securities. Now though with yields at record lows, that money may move to other currencies, or more likely gold as the safety trade moves to this hard asset. We’d look for, as much as it pains us to say it, the DXY to return to the lows we saw in mid 2008.
This morning we get initial jobless claims for the week ended December 27, a day earlier than usual due to the New Year’s holiday.
Have a great day and happy New Year!
Brent Vondera, Senior Analyst
The news that the lending arm of GM will receive $5 billion in TARP funds (at a cost 8%) likely helped the indices advance. While bankruptcy is the best path to viability for the Detroit Three, the market probably doesn’t want to contemplate the ramifications to an already weak labor market that would result.
We’ll note the dire predictions that an additional three million workers will be thrust into the unemployment rolls are a bit hyperbolic; nevertheless, such an event would cause the unemployment rate to jump. Re-organization is a necessary condition to get GM, Chrysler and Ford streamlined for the future, but the marketplace doesn’t want to deal with this reality right now, so stocks get a short-term boost on news of government-assistance.
Unfortunately, the rally in stocks was not accompanied by a decline in Treasuries. We’ll really need to see some money come out the Treasury market as this will signal an easing in risk aversion. So long as money continues to hide under the Treasury market rock, it’s tough to get too excited.
The goods news is intraday swings have become much milder, so we may have entered into this feeling out process, as we’ve termed it – a period in which the market determines which way it wants to go after a serious plunge, such as the 40% slide in the two months that ended November 20. During the 1974 bear market a similar period of relative calm ushered in a powerful rally.
Many seem to believe a robust rally will come in January. We’re not so sure as the de-leveraging event may have not yet fully run its course. The Middle East is also heating up, which won’t help things. Based on what is presently known, we do believe a powerful bear-market rally is on the horizon, but may have to wait a few weeks still. It’s impossible to time.
Market Activity for December 30, 2008
U.S. stocks are headed for their worst year since 1931 as things fell apart when Lehman went down on September 15; the event roiled the money markets and caused the overall credit market to freeze up. The following chart of the S&P 500 Index shows what has occurred from the peak hit in October 2007. It took us basically a year to fall 20% from that peak, but prices began to plunge in the third week of September.
Economic Data
The S&P Case/Shiller Home Price Index, a gauge of the largest 20 metro areas in the U.S., posted its largest decline yet in October.
Case/Shiller recorded home prices fell 18.04% on a year-over-year basis. As you can see via the table below, the most significant damage continues to occur in the West, although Miami, Detroit, Tampa and Minneapolis also continue to see exceptionally large declines. This home price index has values down 23.4% from the peak.
We’ll note, as long-term readers know, that this gauge is not a broad representation of what is occurring nationwide. The FHFA (Federal Housing and Finance Agency) offers the broadest measure of home prices. This measure has home prices down 10% from the peak hit in early 2007 (the exact time of the peak depends on the gauge). This measure also has its flaws though. Where Case/Shiller is not a broad index, and subject to a number of cities that saw the greatest speculative fervor at the height of the housing euphoria, the FHFA index fails to cover high-end homes.
In our view averaging the four main home price measures, the two just mentioned along with price data from the new and existing home sales figures, offers the best look at what prices in general have done. This shows average home prices are down roughly 16% from the peak.
For a longer term perspective, home prices in generally are up about 35% since 2000. That means home prices have grown about 3.4% annualized, which is slightly below what I believe to be the long-term average of 5%.
The decline in home prices has been a harsh reality; however, it is a necessary condition to bring sales back. It appears the process of reversion to the mean has run its course, in fact may have moved beyond what is justified. This does not mean prices will bounce back over the next couple of months, we do have a weak job market to contend with, which is the more traditional drag on housing. Nevertheless, we may be very close to the bottom.
In a separate report the Chicago Purchasing Managers Index (PMI), which measures factory activity in the region, edged slightly higher from the prior month’s depressed reading.
The overall activity index came in at 34.1 after posting 33.8 in November – the weakest readings since the spring of 1982. A reading of 50 is the line of demarcation between expansion and contraction.
(For context, Chicago-area manufacturing showed activity expanded 54 of the 55 months that ended in February 2008, which marked the longest run in the survey’s history. In February the index contracted mildly, but bounced back July-September as business spending accelerated. Things collapsed though beginning in October as the credit event caused businesses to cancel spending projects when the credit markets froze up.)
The new orders index moved up to 29.4 from 27.2 last month, while production fell to 31.7 from 34.3. The employment index rose nicely to 39.6 from 33.4; however this level still represents a significant decline in manufacturing jobs. For new readers, these are the sub-indices of the overall report.
Nothing in this report offers an indication the nation’s largest manufacturing region in on the verge of a rebound. The next reading on factory activity comes on Friday via the ISM survey (manufacturing activity for the entire nation).
The US Dollar
The greenback has given up much of the gains recorded in summer and fall and will very likely take a beating in 2009 as the combination of the Federal Reserve’s massive liquidity injections pumps more dollars into the system and the government’s spending spree will cause budget deficits to soar. And we’re not talking about deficits the media has harped on over the past several years, those were child’s play, extremely manageable levels that ran 1.2%-4.0% of GDP. No, the deficits that the government will record for 2009 and 2010 will hit $1 trillion plus, or more than 7% of GDP.
Last spring, the Dollar Index (DXY) hit the very low level of 71 but rallied beginning in July as it benefited from a flight to ultra-safe investments such as Treasury securities. Now though with yields at record lows, that money may move to other currencies, or more likely gold as the safety trade moves to this hard asset. We’d look for, as much as it pains us to say it, the DXY to return to the lows we saw in mid 2008.
This morning we get initial jobless claims for the week ended December 27, a day earlier than usual due to the New Year’s holiday.
Have a great day and happy New Year!
Brent Vondera, Senior Analyst
Tuesday, December 30, 2008
Afternoon Review
Spotlight: General Electric (GE) *contact for updated tearsheet*
On December 18, S&P cut the outlook for GE to negative and gave the company a 1-in-3 chance of losing its top grade within two years. This announcement came one day after GE’s investor presentation, which suggested that the company’s AAA credit rating could be sacrificed in the name of the dividend.
This does not mean that GE has completely given up on maintaining its top rating. GE plans to shrink GE Capital from 50 percent to 40 percent of total profit. Even more, the company plans to issue $45 billion in long-term debt in 2009, less than the $66 billion it has maturing, and to reduce commercial paper to $50 billion, less than the $75 billion they had planned before.
Bloomberg ran this article today, which showed that the gap between bonds rated AAA and those three steps lower, at AA-, averaged a record 1.12 percent in December as the credit crunch deepened. Before credit markets began unraveling 16 months ago, the difference averaged about 0.06 percent. Insert GE as an example, and an extra percentage point in interest would have cost the company $233 million more in annual payments on the $23.3 billion they raised in the bond market in the first half of 2008.
Despite the increased borrowing costs, shareholders should be pleased with GE giving priority to the dividend and future earnings growth instead of their credit rating. If GE decided to do the opposite, they would be forced to focus on raising capital by selling business units or forgoing opportunities that would benefit the company in the long term.
The financial crisis has called into question the balance sheets of even the most creditworthy institutions. Consequently, GE’s valuations are at multi-decade lows.
With a recent capital infusion as well as government loan and guarantee programs, GE Capital’s funding position appears stable. In addition, strong cash flows are expected from GE’s industrial businesses, enabling the company to maintain its current dividend through the end of 2009.
Quick Hits
- The Financial Crisis Timeline
- GMAC Adds Loans as U.S. Injects $6 Billion to Aid GM
- Billionaire Blowups of 2008
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks fell on concern merger and acquisition (M&A) activity will continue to slow after Dow Chemical’s deal to sell half of its plastics unit to Kuwait was canceled. The funds were slated to help fund Dow’s $16 billion purchase of specialty chemical firm Rohm & Haas. The deal would have provided Dow with $9 billion.
The fact that M&A activity will continue to slow in the current environment is obviously not of great surprise, but the market still comes under pressure each time investors are reminded of this fact.
Kuwait’s decision to pull out means the Dow acquisition is much less likely and this has larger ramification for the market in general as it illustrates the problems related with funding deals right now. Kuwait’s issue was not from a financing perspective so to speak but rather the 75% plunge in the price of oil has them reigning things in. Nevertheless, it keeps the issue in the back of investors’ minds, adding just another concern tugging at sentiment.
Dow shares slid 21% as the failure to sell part of the plastics unit may put the dividend in jeopardy. Most people own the stocks for the dividend. The company will now try to re-negotiate the R&H purchase, probably attempting to shave 10%-15% off the original purchase price. R&H shareholders will likely do the deal at the lower price as they will have a rough time finding other bidders for a while and a price of $70 (original deal was set at $78 per share) is suddenly looking pretty darned good.
For the market in general, the goods news is major indices pared earlier losses. The S&P 500, for instance, was lower by nearly 2% when the afternoon session began, but a late-session rally erased most of those losses. Still nine of the 10 major industry groups lost ground. Energy shares gained ground as the Middle East heats up, pushing oil prices higher.
Market Activity for December 29, 2008
Interestingly, the rally in crude prices early yesterday morning fizzled just after stocks opened yesterday – the spot price jumped nearly 7.7% in pre-market trading but gave most of those gains back by lunch.
However, crude rallied again in the afternoon session to close the day up 6.13%.
They’re a Bank!
Last night it was reported that GMAC will get $5 billion in TARP funds in exchange for super-senior preferred shares yielding 8% to the Treasury Department. GM will get another $1 billion that is supposed to help them finance the lender’s (GMAC) reorganization as a bank holding company – so I guess they got the TARP money before they were officially in a position to be called a bank holding company. That’s what you call making up the rules as you go along.
So GMAC gets $5 billion, GM get $1 billion, which is on top of the roughly $7 billion they received earlier in the month. Maybe this will get GM through the spring. Isn’t that grand?
Some were saying without the TARP funds GM would be forced to eliminate 40% of its 6,500 U.S. dealerships. Yeah, that’s what’s going to occur anyway in time as the GM model pretends as if they still enjoy 50% market share when in reality it’s below 20%.
GM has too many dealerships, too many assembly-line employees and a compensation and layoff structure that makes zero sense in today’s highly competitive world. The checks will fly as the 111th Congress rolls in, but it won’t do a darn bit of good in terms of viability until the firm is forced to streamline
Cash Galore
A story ran yesterday explaining that $8.85 trillion currently sits in bank deposits and money-market funds, which is equal to 70% of the market value of U.S. stocks as measured by the NYSE Composite.
This is a theme we’ve touched on for a couple of months now, yet we focus specifically on money-market funds as this is a more natural area for cash to flow into equities.
Logically, bank deposit accounts are higher as households increase cash savings after the stock market has gotten crushed by 45% (from the October 2007 peak) and home prices are down roughly 15% on average – these are the two largest savings vehicles for U.S. residents. As those savings vehicles have declined people have chosen to boost cash savings and I’m not sure this money should be included among the funds that will potentially move to stocks any time soon.
Still, specifically regarding money market funds there is $3.8 trillion in cash, which could theoretically by 48% of the S&P 500.
Of course, this money needs a compelling reason to enter the market, and with concerns heightened right now it may take a little while to flow into stocks. Once we get a couple of months out and the Obama stimulus plan begins to get off the ground, we should see these funds seek some risk -- the market is cheap from both an earnings-multiple standpoint and a dividend-yield perspective, especially compared to rates along the Treasury curve.
This is one of those rare occasions in which the investor can pick up shares at prices that offer superior long-term returns – December 1974 is probably the last time such an opportunity presented itself. However, over the short term things will remain highly precarious.
We’re not at all convinced a rally from these levels, whenever it happens, will have sustainability however (talking months not years) – the market will need to see concerns ease over future trade pacts, tax rates, how the Fed is going to deal with eventually removing some of the liquidity it’s pumped in and the degree to which regulations will increase, among other things. But the cash is available to spark a rally and as this occurs it should remove some of the caution currently in the marketplace and bring with it a bit of optimism.
It’s a crisis in confidence that needs to be addressed, which is why a tax-rate response could go very far in building optimism as it would spark a stock market rally as quick as anything can. However, this does not seem to be in the cards (ok, it’s not at all probable) considering the make up of Washington after January 20. The policy that will be put in place over the next few months is all we have to go on right now.
Economic Data
We’ve had a couple of quiet days in terms of economic reports, but get back to it today with the S&P Case/Shiller Home Price Index (October) and Chicago-area manufacturing activity. Tomorrow we get initial jobless claims for the week ended December 27 – a day ahead of the normal schedule as Thursday is a holiday.
Have a great day!
Brent Vondera, Senior Analyst
The fact that M&A activity will continue to slow in the current environment is obviously not of great surprise, but the market still comes under pressure each time investors are reminded of this fact.
Kuwait’s decision to pull out means the Dow acquisition is much less likely and this has larger ramification for the market in general as it illustrates the problems related with funding deals right now. Kuwait’s issue was not from a financing perspective so to speak but rather the 75% plunge in the price of oil has them reigning things in. Nevertheless, it keeps the issue in the back of investors’ minds, adding just another concern tugging at sentiment.
Dow shares slid 21% as the failure to sell part of the plastics unit may put the dividend in jeopardy. Most people own the stocks for the dividend. The company will now try to re-negotiate the R&H purchase, probably attempting to shave 10%-15% off the original purchase price. R&H shareholders will likely do the deal at the lower price as they will have a rough time finding other bidders for a while and a price of $70 (original deal was set at $78 per share) is suddenly looking pretty darned good.
For the market in general, the goods news is major indices pared earlier losses. The S&P 500, for instance, was lower by nearly 2% when the afternoon session began, but a late-session rally erased most of those losses. Still nine of the 10 major industry groups lost ground. Energy shares gained ground as the Middle East heats up, pushing oil prices higher.
Market Activity for December 29, 2008
Interestingly, the rally in crude prices early yesterday morning fizzled just after stocks opened yesterday – the spot price jumped nearly 7.7% in pre-market trading but gave most of those gains back by lunch.
However, crude rallied again in the afternoon session to close the day up 6.13%.
They’re a Bank!
Last night it was reported that GMAC will get $5 billion in TARP funds in exchange for super-senior preferred shares yielding 8% to the Treasury Department. GM will get another $1 billion that is supposed to help them finance the lender’s (GMAC) reorganization as a bank holding company – so I guess they got the TARP money before they were officially in a position to be called a bank holding company. That’s what you call making up the rules as you go along.
So GMAC gets $5 billion, GM get $1 billion, which is on top of the roughly $7 billion they received earlier in the month. Maybe this will get GM through the spring. Isn’t that grand?
Some were saying without the TARP funds GM would be forced to eliminate 40% of its 6,500 U.S. dealerships. Yeah, that’s what’s going to occur anyway in time as the GM model pretends as if they still enjoy 50% market share when in reality it’s below 20%.
GM has too many dealerships, too many assembly-line employees and a compensation and layoff structure that makes zero sense in today’s highly competitive world. The checks will fly as the 111th Congress rolls in, but it won’t do a darn bit of good in terms of viability until the firm is forced to streamline
Cash Galore
A story ran yesterday explaining that $8.85 trillion currently sits in bank deposits and money-market funds, which is equal to 70% of the market value of U.S. stocks as measured by the NYSE Composite.
This is a theme we’ve touched on for a couple of months now, yet we focus specifically on money-market funds as this is a more natural area for cash to flow into equities.
Logically, bank deposit accounts are higher as households increase cash savings after the stock market has gotten crushed by 45% (from the October 2007 peak) and home prices are down roughly 15% on average – these are the two largest savings vehicles for U.S. residents. As those savings vehicles have declined people have chosen to boost cash savings and I’m not sure this money should be included among the funds that will potentially move to stocks any time soon.
Still, specifically regarding money market funds there is $3.8 trillion in cash, which could theoretically by 48% of the S&P 500.
Of course, this money needs a compelling reason to enter the market, and with concerns heightened right now it may take a little while to flow into stocks. Once we get a couple of months out and the Obama stimulus plan begins to get off the ground, we should see these funds seek some risk -- the market is cheap from both an earnings-multiple standpoint and a dividend-yield perspective, especially compared to rates along the Treasury curve.
This is one of those rare occasions in which the investor can pick up shares at prices that offer superior long-term returns – December 1974 is probably the last time such an opportunity presented itself. However, over the short term things will remain highly precarious.
We’re not at all convinced a rally from these levels, whenever it happens, will have sustainability however (talking months not years) – the market will need to see concerns ease over future trade pacts, tax rates, how the Fed is going to deal with eventually removing some of the liquidity it’s pumped in and the degree to which regulations will increase, among other things. But the cash is available to spark a rally and as this occurs it should remove some of the caution currently in the marketplace and bring with it a bit of optimism.
It’s a crisis in confidence that needs to be addressed, which is why a tax-rate response could go very far in building optimism as it would spark a stock market rally as quick as anything can. However, this does not seem to be in the cards (ok, it’s not at all probable) considering the make up of Washington after January 20. The policy that will be put in place over the next few months is all we have to go on right now.
Economic Data
We’ve had a couple of quiet days in terms of economic reports, but get back to it today with the S&P Case/Shiller Home Price Index (October) and Chicago-area manufacturing activity. Tomorrow we get initial jobless claims for the week ended December 27 – a day ahead of the normal schedule as Thursday is a holiday.
Have a great day!
Brent Vondera, Senior Analyst
Monday, December 29, 2008
Afternoon Review
Spotlight: 3M Company (MMM) *contact for updated tearsheet*
3M’s highly diverse business portfolio, healthy international mix, continuing commitment to R&D and an intensive focus on productivity has contributed to the company’s high profitability and strong cash flows.
Considered a highly reliable barometer of the general health of the economy, 3M stock has fallen in tandem with the market. However, 3M has historically turned crisis or recession into opportunity by utilizing its very solid finances (currently almost $3 billion in cash) to buy quality companies at low valuations.
3M generates significant free cash flow and has plenty of financial flexibility to continue to invest for organic growth, concurrently still pursue business portfolio realignment activities and also reward shareholders materially.
Dow Chemical (DOW) -20.79%, Rohm & Haas (ROH) -16.08%
Dow’s acquisition of Rohm & Haas hit a major snag as a Kuwait backed out of a deal in which a state-owned petroleum company was to pay Dow $7.5 billion for a 50 percent stake in several chemical plants. The deal was to become effective in less than a week, and Dow had intended to use the money to help finance its $15.3 billion purchase of Rohm & Haas.
Kuwait’s decision is a result of significantly lower energy prices compared to when the deal was struck about one year ago, making the deal less attractive. The deal would have given Dow much needed access to low-cost natural gas, which they consume in huge quantities to make its chemicals.
In July, Dow offered $78 per share for Rohm & Haas in an $18 billion deal, but Dow is coming under pressure from lenders and shareholders to renegotiate its offer price in light of the current situation. For years, Dow has been trying to reposition itself, moving away from producing low-margin commodity chemicals and into the higher-margin specialty chemicals business. These events present a major setback for Dow’s plans.
Quick Hits
- Democrats May End Minimum Tax on Municipal Bonds to Spur Market
- Cash at 18-Year High Makes Stocks a Buy at Leuthold
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks gained additional ground on Friday, extending upon the market’s Christmas Eve advance to mark the first back-to-back gains in three weeks. The broad market, as measured by the NYSE Composite, now stands 19% above the five-and-half year low hit on November 20. The S&P 500 is roughly 16% above the November 20 close, which was a six-year low for that measure.
Energy shares led Friday’s advance as Middle East tensions heat up to drive crude prices higher. Basic materials also performed well with industrial and consumer discretionary shares helping the benchmark indices as well.
Market Activity for December 26, 2008
We were without an economic release on Friday, and absent one today also. Trading activity is also subdued as many take the final few days of the year off and have probably accomplished most or their end-of-year positioning and tax-loss harvesting. Nevertheless, there is still plenty to talk about.
Lending and FASB No.159
Government officials continue to state that they want banks to make more loans, yet they fail to pull the correct strings. The government’s unwillingness to suspend mark-to-market accounting rules with which to base capital adequacy ratios (officially FASB rule159 put in place November 2007) is one of the major reasons their pleas are being ignored.
Mark-to-market is a reason banks have halted lending as the accounting change carries elevated write-down risk. Make no mistake, we’re not ignoring the fact that falling asset prices and rising default rates are playing a role, but based on the former standard the seemingly endless write-down cycle would not be occurring and thus affecting capital adequacy is such a pernicious manner. (We’ll add, this rule is just as harmful in a rising asset-price environment as it would encourage firms to hold less capital.)
Another issue is how the Treasury has changed the TARP, using the funds to inject capital into banks, rather than buying up “troubled” assets. The original plan would have allowed the government to house those assets – removing them from bank balance sheets -- until the market returns to normal and can then be sold at prices that more closely align to intrinsic value rather than distressed price levels that currently have little if any bids coming in. Changing the plan was a big mistake in my view as the decision does not address that which has firms so fearful.
The idea to inject capital assumed that banks would increase lending activity as they would be able to withstand current asset write-downs with these additional funds. However, as banks increase loans obviously they’re taking on more loan assets, assets that are subject to huge write-downs even if the institution has zero desire to sell the asset and the asset is producing cash flows. This is what the capital injection plan misses. So long as mark-to-market instructs that banks continually write-down assets in this distressed asset-backed market banks will simply hoard the cash, as they are doing.
In the meantime, the Treasury and the Federal Reserve continue to target housing in a very circuitous manner. The various Federal Reserve facilities (while some have worked quite well) and Treasury Department programs that have been implemented make the government even more the Rube Goldberg machine that it always has been than and entity that efficiently attacks the issue – an endless cycle of write-downs and capital raises that cause banks to become increasingly cautious.
We must allow the housing correction to run its natural course, reverting to the mean after years of outsized growth – in terms of both credit and prices. What we must attack is that which has exacerbated the painful process of reversion – the accounting change. By eliminating mark-to-market, specifically with regard to basing capital adequacy ratios, and returning to the original cost model banks will not have this incessant capital-eroding write-down problem and lending, while remaining logically subdued, will increase from these very low levels of activity.
Gold and Oil on the Run
Gold prices have rallied 4% the past two sessions as Middle East tensions rise again. Concerns of an inflationary event over the next 12 months may also be playing a role as the metal has jumped 15% since December 5.
Normally gold has to compete with interest paying assets but with Treasury rates so low, in fact non-existent on the short end, we’ve got money flowing into the hard-asset safe-haven once again. The price of gold has been surprisingly held back considering all that has occurred.
Oil prices have also found some life, jumping 6.7% on Friday and up another 7.7% this morning as Israel attacks the Gaza Strip, which is where Hamas’ second favorite weapon, Katyusha rockets, are being fired.
This back-to-back rally in crude is pretty meaningless relative to the 75% plunge over the past five months, as the chart below illustrates.
Still, as things heat up in the Middle East especially if Iran gets involved via its proxy Hezbollah, the crude trade may have some staying power -- too early to tell just yet.
In any event, Middle East tensions are not going away and when you combine geopolitical risks with the massive liquidity injections via the Fed (causing an inflationary event when lending begins to increase) we find it hard to believe oil will stay at these levels for an extended period of time.
Friday’s Letter
I went back and read Friday’s letter to notice I rambled on there in the first half while talking about short-term equity-market trends – accept my apologies for the complete lack of brevity.
A much better way to deliver the point is to say we believe there’s a heightened potential for a strong bear-market rally to occur. Although, I’m not convinced it will happen in January as many seem to be predicting. The de-leveraging process has probably not yet played out, so we may have to wait until February/March for a potential spike.
Certainly, there are many concerns tugging at investor sentiment. Indeed, there are a number of issues on the horizon as well. However, as the de-leveraging process runs its course, a spike from these levels is likely in our view.
What’s more, rallies are typical after sharp dives in equity prices such as the two moves we endured in October in November.
Have a great day!
Brent Vondera, Senior Analyst
Energy shares led Friday’s advance as Middle East tensions heat up to drive crude prices higher. Basic materials also performed well with industrial and consumer discretionary shares helping the benchmark indices as well.
Market Activity for December 26, 2008
We were without an economic release on Friday, and absent one today also. Trading activity is also subdued as many take the final few days of the year off and have probably accomplished most or their end-of-year positioning and tax-loss harvesting. Nevertheless, there is still plenty to talk about.
Lending and FASB No.159
Government officials continue to state that they want banks to make more loans, yet they fail to pull the correct strings. The government’s unwillingness to suspend mark-to-market accounting rules with which to base capital adequacy ratios (officially FASB rule159 put in place November 2007) is one of the major reasons their pleas are being ignored.
Mark-to-market is a reason banks have halted lending as the accounting change carries elevated write-down risk. Make no mistake, we’re not ignoring the fact that falling asset prices and rising default rates are playing a role, but based on the former standard the seemingly endless write-down cycle would not be occurring and thus affecting capital adequacy is such a pernicious manner. (We’ll add, this rule is just as harmful in a rising asset-price environment as it would encourage firms to hold less capital.)
Another issue is how the Treasury has changed the TARP, using the funds to inject capital into banks, rather than buying up “troubled” assets. The original plan would have allowed the government to house those assets – removing them from bank balance sheets -- until the market returns to normal and can then be sold at prices that more closely align to intrinsic value rather than distressed price levels that currently have little if any bids coming in. Changing the plan was a big mistake in my view as the decision does not address that which has firms so fearful.
The idea to inject capital assumed that banks would increase lending activity as they would be able to withstand current asset write-downs with these additional funds. However, as banks increase loans obviously they’re taking on more loan assets, assets that are subject to huge write-downs even if the institution has zero desire to sell the asset and the asset is producing cash flows. This is what the capital injection plan misses. So long as mark-to-market instructs that banks continually write-down assets in this distressed asset-backed market banks will simply hoard the cash, as they are doing.
In the meantime, the Treasury and the Federal Reserve continue to target housing in a very circuitous manner. The various Federal Reserve facilities (while some have worked quite well) and Treasury Department programs that have been implemented make the government even more the Rube Goldberg machine that it always has been than and entity that efficiently attacks the issue – an endless cycle of write-downs and capital raises that cause banks to become increasingly cautious.
We must allow the housing correction to run its natural course, reverting to the mean after years of outsized growth – in terms of both credit and prices. What we must attack is that which has exacerbated the painful process of reversion – the accounting change. By eliminating mark-to-market, specifically with regard to basing capital adequacy ratios, and returning to the original cost model banks will not have this incessant capital-eroding write-down problem and lending, while remaining logically subdued, will increase from these very low levels of activity.
Gold and Oil on the Run
Gold prices have rallied 4% the past two sessions as Middle East tensions rise again. Concerns of an inflationary event over the next 12 months may also be playing a role as the metal has jumped 15% since December 5.
Normally gold has to compete with interest paying assets but with Treasury rates so low, in fact non-existent on the short end, we’ve got money flowing into the hard-asset safe-haven once again. The price of gold has been surprisingly held back considering all that has occurred.
Oil prices have also found some life, jumping 6.7% on Friday and up another 7.7% this morning as Israel attacks the Gaza Strip, which is where Hamas’ second favorite weapon, Katyusha rockets, are being fired.
This back-to-back rally in crude is pretty meaningless relative to the 75% plunge over the past five months, as the chart below illustrates.
Still, as things heat up in the Middle East especially if Iran gets involved via its proxy Hezbollah, the crude trade may have some staying power -- too early to tell just yet.
In any event, Middle East tensions are not going away and when you combine geopolitical risks with the massive liquidity injections via the Fed (causing an inflationary event when lending begins to increase) we find it hard to believe oil will stay at these levels for an extended period of time.
Friday’s Letter
I went back and read Friday’s letter to notice I rambled on there in the first half while talking about short-term equity-market trends – accept my apologies for the complete lack of brevity.
A much better way to deliver the point is to say we believe there’s a heightened potential for a strong bear-market rally to occur. Although, I’m not convinced it will happen in January as many seem to be predicting. The de-leveraging process has probably not yet played out, so we may have to wait until February/March for a potential spike.
Certainly, there are many concerns tugging at investor sentiment. Indeed, there are a number of issues on the horizon as well. However, as the de-leveraging process runs its course, a spike from these levels is likely in our view.
What’s more, rallies are typical after sharp dives in equity prices such as the two moves we endured in October in November.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Mortgage Refinance Applications Highest Since 2003
The Mortgage Bankers Association reported a 62% increase in refinance applications for the week ending December 19th to 6,758 applications, on a seasonably adjusted basis, from 4,156 the week prior. However, the number of actual refinances resulting from the applications remains to be seen.
The capacity for banks to lend is very constrained, 1 in 5 homeowners are under water on their mortgage (although appraisals may be waived later), and the market’s appetite for securitized mortgages remains thin. These factors point to a refi-boom less than that of 2003, where applications peaked at 9,977 the week ending May 30th.
Nonetheless, Bloomberg consensus speeds, which are the benchmark models for estimating individual prepayment characteristics of a mortgage backed security, have been revised aggressively, and likely have farther to go. As refinances increase and prepays speed up, MBS shortens as principle is paid back to the bondholder sooner.
As I have noted before, times of heavy refinancing reward those who avoid high coupon (high premium) MBS and stick to dependable structure in CMOs. We have been selective in buying MBS and have stayed away from this type of paper.
Cliff J. Reynolds Jr.
Junior Analyst
The Mortgage Bankers Association reported a 62% increase in refinance applications for the week ending December 19th to 6,758 applications, on a seasonably adjusted basis, from 4,156 the week prior. However, the number of actual refinances resulting from the applications remains to be seen.
The capacity for banks to lend is very constrained, 1 in 5 homeowners are under water on their mortgage (although appraisals may be waived later), and the market’s appetite for securitized mortgages remains thin. These factors point to a refi-boom less than that of 2003, where applications peaked at 9,977 the week ending May 30th.
Nonetheless, Bloomberg consensus speeds, which are the benchmark models for estimating individual prepayment characteristics of a mortgage backed security, have been revised aggressively, and likely have farther to go. As refinances increase and prepays speed up, MBS shortens as principle is paid back to the bondholder sooner.
As I have noted before, times of heavy refinancing reward those who avoid high coupon (high premium) MBS and stick to dependable structure in CMOs. We have been selective in buying MBS and have stayed away from this type of paper.
Cliff J. Reynolds Jr.
Junior Analyst
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