**Earnings release was yesterday
T. Rowe Price Group (TROW)** -7.60%
TROW’s fourth quarter earnings fell 87 percent, the second straight decline, as market losses reduced asset-management fees and the company wrote down the value of investments in its own funds.
Assets under management fell 20 percent to $276.3 billion in the quarter. Net outflows from mutual funds were $2.2 billion in the quarter, including $1.4 billion from stock funds and $1.5 billion from bond funds. The company’s target-date retirement funds drew $700 million in net inflows, about half the previous quarter.
On the bright side, T. Rowe is on of the few major U.S. asset managers not to eliminate jobs to compensate for the steep drop in fees.
Despite the negative effect the bear market has on asset managers, T. Rowe’s well-respected brand, solid fund performance, high customer switching costs and scale positions the company well when global markets rebound.
3M (MMM)** -4.88%
3M posted better-than expected earnings for the fourth quarter, but moved its guidance down in anticipation of a steeper decline in sales.
3M’s international sales fell 14 percent and U.S. sales fell 6 percent. Asia-Pacific sales dropped 18 percent and European sales fell 13 percent, while Latin America and Canada dropped 9.2 percent.
CFO Patrick Campbell said the first quarter “will be by far the most difficult quarter we have. As we work through the inventory correction, later in the year, we will see the recovery.” 3M is cutting capital expenditures by 30 percent and it will cease stock buybacks until the “environment improves.”
On the bright side, 3M produced solid free cash flow and returns on invested capital that widely exceeded its estimated cost of capital. 3M faces the same challenges as everyone else, but their pristine balance sheet and prudent cost control will help them
Illinois Tool Works (ITW)** -3.37%
Illinois Tool Works fourth-quarter results came in slightly above their reduced guidance given in December, but the company provided a dismal outlook for 2009.
As cited by most industrial companies, the markets deteriorated considerably throughout the fourth quarter. The company expects its revenue from business acquisitions, ITW’s main growth driver, to fall by more than half this year.
Despite their grim outlook for the U.S. and Europe, the company remains optimistic about its positioning in Asia. In countries such as China and India, the company has heavy exposure to infrastructure projects in its welding and construction units.
Alliant Techsystems (ATK)** +2.16%
Alliant Techsystems said fiscal third-quarter sales rose 11 percent on higher sales of commercial and military ammunition.
The company sees this fiscal 2009 profit coming in at the top of the company’s forecast range, but pension costs and a change in accounting rules for convertible debt put Alliant’s 2010 forecast well below consensus estimates. Although these factors have no real impact on the core and growth operations of Alliant, they are likely to lead to a flat year for earnings in 2010.
In the long-run, Alliant’s competitive advantage from low-cost production and its industry’s high barriers to entry should continue to generate impressive profitability and robust free cash flow.
L-3 Communications (LLL)** +0.86%
L-3 said fourth-quarter earnings rose 29 percent, exceeding estimates, thanks to a gain from a divestiture. The company‘s 2009 outlook trailed its previous forecast because of an increase in pension expenses.
Total revenue for the quarter increased 5 percent due to strong growth in aircraft modernization and maintenance as well as specialized products. The operating margin for the quarter increased from last year in every segment expect for the C3ISR (command, control, communication, intelligence, surveillance and reconnaissance) unit.
Full-year revenue increased 7 percent, driven by double-digit growth in C3ISR and specialized products. These segments should continue to fuel total revenue growth in coming years because the global political landscape and unchanged, if not increasing, U.S. defense budget.
Arch Coal (ACI) -9.53%
Arch Coal’s earnings beat analyst estimates because of higher prices on long-term contracts for the fuel.
Coal companies benefited last year from locking contracts for the fuel as it surged to a record $137.50 a ton for Eastern supplies before the U.S. recession curtailed demand. Arch plans to slow production growth until the economy rebounds. Cash prices for coal in Wyoming’s Power River Basin, where Arch gets about three-fourths of its production, rose 20 percent from a year earlier.
Like rival Peabody Energy (BTU), Arch discussed its expansion into the Asia-Pacific rim, which they expect will “set the stage for increased participation when global economic growth resumes.”
Although coal prices have outperformed other commodities, it is unlikely coal companies will rebound until the oil prices move higher and expectations for the global economy become more optimistic.
Chevron (CVX) -0.14% , ExxonMobil (XOM) -0.68%
Earnings from Exxon and Chevron both exceed expectations largely because of widening margins on refined fuel.
Both companies experienced significant declines in revenue as a global recession eroded fuel demand, spurring a 56 percent drop in oil futures. Still, Chevron and Exxon capitalized from significant overseas refining operations because diesel demand outside the U.S. has remained relatively strong.
While other large oil companies like ConocoPhillips and Occidental Petroleum are cutting their capital budgets, Exxon is increasing their capital spending this year and Chevron plans to maintain their current levels.
Chevron said stock buybacks will be suspended in the current quarter after the company bought back $8 billion in stock last year. Exxon, who has far deeper pockets than their competitors, plans to repurchase $7 billion in shares during the current quarter after spending $32 billion on buybacks in 2008.
Chevron and Exxon’s ability to generate robust cash flows in this difficult environment is very positive sign that both will be able to weather the storm in coming quarters.
Fortune Brands (FO)** -5.07%
Fortune Brands reported disappointing fourth quarter earnings and cut its 2009 earnings forecast well below estimates.
Declining home prices, rising unemployment and tight credit caused consumer confidence to drop to record lows during the quarter. This resulted in consumers purchasing fewer of the company’s discretionary brands including Titleist Golf, MasterLock padlocks, Moen faucets, Jim Beam, etc.
Procter & Gamble (PG) -6.39%
P&G reported revenue that fell more expected and lowered its annual forecast as consumers spent less and the dollar’s gains hurt overseas sales where they get more than half of their revenue.
The company’s revenues were hurt by consumers trading down and buying less expensive versions of necessary items, such as P&G’s Gain laundry detergent instead of Tide. The company also saw consumers purchasing fewer discretionary hair-care products and fine fragrances.
Qualcomm (QCOM)** -1.65%
Qualcomm reported disappointing earnings despite higher revenues that were driven primarily by the mix of higher-end chipsets and higher priced data capable (web browsing, text messages, etc) devices.
The company said it saw “healthy demand” for 3G as CDMA-based device shipments in the quarter were at the high end of its expectations.
Qualcomm did not issue earnings guidance “due to the volatility of financial markets and the impact it has had and may have on our investment portfolio and net income.” They did, however, provide revenue guidance for their second fiscal quarter that translates to a year-over-year revenue decline between 6 and 14 percent.
Eli Lilly (LLY)** -3.03%
Eli Lilly reported earnings that topped expectations and reaffirmed its outlook for 2009. Revenues were basically flat, but fell shy of consensus estimates.
The company said it expects volume growth in sales again in 2009, driven by Cymbalta, Alimta, Cialis, Humalog and the anticipated launches of prasugrel, as well as the Elanco animal health division. However, the negative impact of weaker foreign currencies and the impact of generic competition in certain markets for Gemzar are anticipated to partially offset these positive impacts.
Peter Lazaroff, Junior Analyst
Friday, January 30, 2009
Fixed Income Recap
Supply pressures crushed Treasuries in trading Thursday. The five-year was off 20/32 of a point in price while the ten-year traded lower by almost 2 points by late afternoon. The benchmark curve steepened by 14 basis points, a large move even by today’s standards. A basis point represents .01%.
The seven-year Treasury Note will likely be brought back after a 16 year hiatus according speculation. Just showing how the Treasury is trying desperately to squeeze all demand out of the market by filling every gap along the curve.
The Fed announced $16.8 billion in Agency MBS purchases for seven day period ending yesterday. At this point the Fed appears to have settled into a steady range of $15 to $18 billion per week in purchases.
The Four Primary Risks of Bonds
Credit
Duration
Liquidity
Structure
Credit Risk
Perhaps the most straightforward of the four risks of fixed income investing, credit risk has the potential to be the most severe.
Credit risk, also known as default risk, is the risk that the borrower will not be able to make principal and interest payments in a timely manner. The market prices the risk of default by demanding a higher return for lending money to companies or individuals who are more likely to default.
“High Yield Bonds”, otherwise called “Junk” bonds, are traditionally those who are issued at a higher yield relative to the market, usually by companies with poor credit ratings.
I will talk about the other primary risks of bonds in upcoming issues.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
The seven-year Treasury Note will likely be brought back after a 16 year hiatus according speculation. Just showing how the Treasury is trying desperately to squeeze all demand out of the market by filling every gap along the curve.
The Fed announced $16.8 billion in Agency MBS purchases for seven day period ending yesterday. At this point the Fed appears to have settled into a steady range of $15 to $18 billion per week in purchases.
The Four Primary Risks of Bonds
Credit
Duration
Liquidity
Structure
Credit Risk
Perhaps the most straightforward of the four risks of fixed income investing, credit risk has the potential to be the most severe.
Credit risk, also known as default risk, is the risk that the borrower will not be able to make principal and interest payments in a timely manner. The market prices the risk of default by demanding a higher return for lending money to companies or individuals who are more likely to default.
“High Yield Bonds”, otherwise called “Junk” bonds, are traditionally those who are issued at a higher yield relative to the market, usually by companies with poor credit ratings.
I will talk about the other primary risks of bonds in upcoming issues.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Daily Insight
U.S. stocks ran into a wall yesterday, halting a four-session advance, due to an especially harsh day on the economic data front and the fact that fourth-quarter ex-financial sector profits moved to -14.5% with 50% of S&P 500 members reporting thus far. News out of Washington probably had an effect on the broad market as well.
Financials got clocked, as you can see below, on news the “bad bank” idea is running into snags. This is ridiculous. As policymakers focus on their brainiac fixes they are incapable of seeing the simple solution that’s slapping them in the face – end mark-to-market rules with regard to establishing capital adequacy ratios.
Additionally, comments from the White House that sounded like they came from a Russian oligarch rather than a U.S. president didn’t help matters. You want to demand that private-sector firms halt bonuses? Maybe we should understand how our market works first. While there are economic problems right now, we should not forget that top talent is performing well in many cases; if you punish this talent it will move on. And if they can’t move on under the current labor market conditions, these people won’t forget, and they’ll say sayonara the moment they get the chance.
Fire those that have made grave mistakes and reward those that continue to bring value – that’s how we’re set up to prosper. If the government believes it is justified in managing businesses because they have provided taxpayer funded capital, they need to be reminded that beyond the mistakes financial institutions have made the regulatory decision to implement mark-to-market accounting rules just 14 months ago is that which drives the industry, and the economy, into the dirt.
Market Activity for January 29, 2009
Yesterday’s Economic Data
First, the Labor Department reported initial jobless claims rose 3,000 to 588,000 for the week ending January 24. So, we held below the 600k mark that everyone expects the reading to eclipse, but that level will probably be breached within the next couple of weeks as layoff announcements continue to climb.
The four-week average rose for the first time in five weeks, up 24,250 to 542,500. This measure is now nearly back to its mid-December high and as the lower readings of mid-January drop out over the next three weeks you can bet it’s going higher.
Continuing claims rose to a record high of 4.776 million, increasing another 159,000. Although we’ll note that when one adjusts for the size of payroll employment, continuing claims would have to hit 7.5-8.0 million to match the highs of 1974 and 1982. So the current labor market issues are hardly as rough as those past periods.
That said, we better get our priorities straight on attacking the problem, or it will reach those levels.
We must attack the crisis in confidence by slashing tax rates on incomes, capital and corporate profits. The immediate boost to after-income and after-tax return expectations would be the greatest stimulus we can implement right now. Spending much of the stimulus plan on government transfer payments and allowing laid off workers entry into the Medicaid program will not do – this is what passed the House Wednesday night.
Even the infrastructure plans (and one can argue whether or not this is beneficial but at least it is some form of stimulus) make up only 12% of the total package, and even then 80% of which would not be implemented until 2010 and 2011. As former Fed Governor Larry Lindsey summed it up yesterday, we’ll look back a couple of years from now and all we’ll find is we’re two years older and saddled with much more debt by the looks of this current bill.
Back to the labor market, the insured unemployment rate (the jobless rate for those eligible for benefits) rose 0.2% to 3.6%. This reading generally corresponds with a directional move in the overall unemployment rate, so we’ll probably see the jobless rate hit 7.4% when the January data is released early next month.
Next, the Commerce Department reported that durable goods orders fell hard in December, down 2.5% on the headline reading and 3.6% excluding transportation. This report shows as clearly as anything that businesses are in capital preservation mode, unwilling to engage in business equipment plans until they see something that offers some sense of confidence over the foreseeable future.
Every aspect of the report was down, save electrical equipment and military aircraft. Primary metals were down 6.9% for the month, industrial machinery orders fell 5.0% and computers and electronics orders dropped 7.2%. Orders for these three components of the report are down 70%, 53.2% and 27.5%, respectively at an annual rate for the past three months.
And if these two reports weren’t bad enough, the Commerce Department also showed news home sales plunged 14.7% in December to 331,000 units at an annual rate – that’s the lowest level since records began in 1963.
The good news is at these levels it is tough to believe we haven’t bottomed out. Further, the drag this data has on the economy has eased as residential construction makes up just 3.0% of GDP, down from 6.0% three years ago.
In terms of region, sales were weak across the board. The Northeast endured the largest decline, down 28.2% -- although this is a bit deceiving as the prior two months saw strong sales growth. The West region saw sales fall 20.2%; the South was down 12.1% and Midwest new home sales fell 5.6%.
The median price of a new home fell 9.3% on a year-over-year basis. So we add this into the other three major housing indicators and home prices are down 12% on average over the past year.
Despite the decline in home prices, the inventory-to-sales ratio rose to a new high.
Yesterday was indeed a particularly harsh day on the economic data front. Today won’t be much better, although it is expected (so long as it’s not worse than -6.0%), as the preliminary fourth-quarter GDP report registers its weakest reading since 1982.
We’ll get through this, but it would be nice to see a strong, pro-growth agenda that attacks the problem. We don’t need the economy to turn on a dime, recessions are important events that eliminate the weak and provide a stronger base with which to grow when the business cycle begins to expand.
However, if we choose to support businesses that cannot compete on the global stage, and expand transfer payments to the point that government spending reaches 25%-30% of GDP, then one should not expect the economy to rebound with the vigor we’ve become accustomed to.
What we can do immediately is return a higher level of confidence to the market place, but that will take the correct policy response.
Have a great weekend!
Brent Vondera, Senior Analyst
Financials got clocked, as you can see below, on news the “bad bank” idea is running into snags. This is ridiculous. As policymakers focus on their brainiac fixes they are incapable of seeing the simple solution that’s slapping them in the face – end mark-to-market rules with regard to establishing capital adequacy ratios.
Additionally, comments from the White House that sounded like they came from a Russian oligarch rather than a U.S. president didn’t help matters. You want to demand that private-sector firms halt bonuses? Maybe we should understand how our market works first. While there are economic problems right now, we should not forget that top talent is performing well in many cases; if you punish this talent it will move on. And if they can’t move on under the current labor market conditions, these people won’t forget, and they’ll say sayonara the moment they get the chance.
Fire those that have made grave mistakes and reward those that continue to bring value – that’s how we’re set up to prosper. If the government believes it is justified in managing businesses because they have provided taxpayer funded capital, they need to be reminded that beyond the mistakes financial institutions have made the regulatory decision to implement mark-to-market accounting rules just 14 months ago is that which drives the industry, and the economy, into the dirt.
Market Activity for January 29, 2009
Yesterday’s Economic Data
First, the Labor Department reported initial jobless claims rose 3,000 to 588,000 for the week ending January 24. So, we held below the 600k mark that everyone expects the reading to eclipse, but that level will probably be breached within the next couple of weeks as layoff announcements continue to climb.
The four-week average rose for the first time in five weeks, up 24,250 to 542,500. This measure is now nearly back to its mid-December high and as the lower readings of mid-January drop out over the next three weeks you can bet it’s going higher.
Continuing claims rose to a record high of 4.776 million, increasing another 159,000. Although we’ll note that when one adjusts for the size of payroll employment, continuing claims would have to hit 7.5-8.0 million to match the highs of 1974 and 1982. So the current labor market issues are hardly as rough as those past periods.
That said, we better get our priorities straight on attacking the problem, or it will reach those levels.
We must attack the crisis in confidence by slashing tax rates on incomes, capital and corporate profits. The immediate boost to after-income and after-tax return expectations would be the greatest stimulus we can implement right now. Spending much of the stimulus plan on government transfer payments and allowing laid off workers entry into the Medicaid program will not do – this is what passed the House Wednesday night.
Even the infrastructure plans (and one can argue whether or not this is beneficial but at least it is some form of stimulus) make up only 12% of the total package, and even then 80% of which would not be implemented until 2010 and 2011. As former Fed Governor Larry Lindsey summed it up yesterday, we’ll look back a couple of years from now and all we’ll find is we’re two years older and saddled with much more debt by the looks of this current bill.
Back to the labor market, the insured unemployment rate (the jobless rate for those eligible for benefits) rose 0.2% to 3.6%. This reading generally corresponds with a directional move in the overall unemployment rate, so we’ll probably see the jobless rate hit 7.4% when the January data is released early next month.
Next, the Commerce Department reported that durable goods orders fell hard in December, down 2.5% on the headline reading and 3.6% excluding transportation. This report shows as clearly as anything that businesses are in capital preservation mode, unwilling to engage in business equipment plans until they see something that offers some sense of confidence over the foreseeable future.
Every aspect of the report was down, save electrical equipment and military aircraft. Primary metals were down 6.9% for the month, industrial machinery orders fell 5.0% and computers and electronics orders dropped 7.2%. Orders for these three components of the report are down 70%, 53.2% and 27.5%, respectively at an annual rate for the past three months.
And if these two reports weren’t bad enough, the Commerce Department also showed news home sales plunged 14.7% in December to 331,000 units at an annual rate – that’s the lowest level since records began in 1963.
The good news is at these levels it is tough to believe we haven’t bottomed out. Further, the drag this data has on the economy has eased as residential construction makes up just 3.0% of GDP, down from 6.0% three years ago.
In terms of region, sales were weak across the board. The Northeast endured the largest decline, down 28.2% -- although this is a bit deceiving as the prior two months saw strong sales growth. The West region saw sales fall 20.2%; the South was down 12.1% and Midwest new home sales fell 5.6%.
The median price of a new home fell 9.3% on a year-over-year basis. So we add this into the other three major housing indicators and home prices are down 12% on average over the past year.
Despite the decline in home prices, the inventory-to-sales ratio rose to a new high.
Yesterday was indeed a particularly harsh day on the economic data front. Today won’t be much better, although it is expected (so long as it’s not worse than -6.0%), as the preliminary fourth-quarter GDP report registers its weakest reading since 1982.
We’ll get through this, but it would be nice to see a strong, pro-growth agenda that attacks the problem. We don’t need the economy to turn on a dime, recessions are important events that eliminate the weak and provide a stronger base with which to grow when the business cycle begins to expand.
However, if we choose to support businesses that cannot compete on the global stage, and expand transfer payments to the point that government spending reaches 25%-30% of GDP, then one should not expect the economy to rebound with the vigor we’ve become accustomed to.
What we can do immediately is return a higher level of confidence to the market place, but that will take the correct policy response.
Have a great weekend!
Brent Vondera, Senior Analyst
Thursday, January 29, 2009
Daily Insight
U.S. stocks rallied yesterday on news that the government will set up a “bad bank” (similar to the original purpose of the TARP) to purchase, house and eventually sell troubled assets. The plan is expected to be officially announced next week, so we’ll have to wait for specifics until then.
The market likes this, for now at least, as it moves us closer to finding a solution to the problem. Banks jumped nearly 13%, although it isn’t totally clear current shareholders will benefit. There has been talk that the government will take common equity stakes in some cases, which will further dilute shareholders.
Consumer discretionary, technology, basic materials, industrials and energy shares also performed well. Energy and tech is up 7% over the last three sessions.
The market in general has bounced nicely, up 9% over the last week, after hitting 800 on the S&P 500 on Inauguration Day. It’s important from a psychological perspective to stay above the 700 handle.
Market Activity for January 28, 2009
Crude-Oil
Oil prices for March delivery rose 1.6% yesterday, ending the 10% slide of the previous two sessions. A large reduction in gasoline supplies offset a larger-than-expected increase in crude supplies.
The Energy Department, in its weekly report, stated crude supplies jumped 6.22 million to 338.9 million barrels – over the past couple of weeks supply has moved meaningfully above the five-year average of $305 million barrels. Analysts expected crude supplies to build by 2.9 million.
However, gasoline supplies fell 121,000 barrels – a two million barrel build was expected – and this interrupted a bearish trend that looked to be setting up over prior two sessions.
Refinery runs have been very light over the past few weeks, so the pick up in demand due to the plunge in pump prices is showing increased production may be in order. Refinery margins have been on the rise from the very low levels of November, which should incentive higher refinery run rates.
The crack spread measures the relationship between crude-oil futures and oil product futures, per barrel. When it rises refining profitability is likely to increase and when it falls… you get the point.
Mortgage Applications
The Mortgage Banker’s Association index of applications fell 38.8% in the week ended January 23 – this marks the largest drop in 16 years as refinancing activity plunged. The 30-year mortgage rate rose to 5.22% on average after hitting 4.89% in the week ended January 9. There are a lot of people waiting to refi, but not at this level. They’ve got things set to hit somewhere in the 4% handle.
Purchases also fell but the decline was mild, down 2.5% for the week. We’ve moved to such low levels regarding home sales let’s hope additional downside is contained.
FOMC Meeting
On Rates
The FOMC decided to keep its target range for the federal funds rate at 0%-0.25% as they anticipate the economy will continue to warrant exceptionally low levels of fed funds for some time.
On the Economy
The members stated that information received since they last met in December suggests the economy has weakened further. (No surprise there as we touch on these things daily) The FOMC noted that industrial production, housing starts and employment have continued to decline steeply as consumers and businesses cut back on spending.
Conditions in some financial markets have improved, yet credit conditions for households and firms remain extremely tight. (This is pretty much how it works when the economy is in downturn)
Policy Direction
The FOMC stated that it is “prepared to purchase” Treasuries if it believes such action would be effective in improving private-sector credit conditions. The lone dissenter was Richmond Fed Bank President Lacker as he favored purchasing Treasuries immediately. (This may suggest the Fed is not terribly close to progressing down this road)
And let’s hope so. They have done what they can to unfreeze the credit markets, some of their programs have worked very effectively and may not have longer-term consequences, but other programs will. If they are truly thinking about printing more money to buy Treasury securities in an attempt to keep market rates extremely low (and not just bluffing to push the market into doing the job for them – a long-held axiom is never fight the fed) this would be one of those decisions that have long-run consequences, namely fueling harmful levels of inflation.
We don’t need more of this printing press mentality. They have done enough. Now the fiscal side must work in cooperation with the Fed and slash tax rates on incomes, capital and corporate profits. This will not only assist the Fed currently, as they jam the monetary easing pedal to the floor, but will help them do their job of taking away this stimulus down the road (as a pro-growth tax environment will help to offset monetary tightening) so to keep inflation from totally raging out of control a year to 18 months out – this the old Reagan/Volcker model.
The markets need to see this type of response because for now investors are assuming we’ll get Fed tightening and higher tax rates 18 months out. That spells economic shutdown. Policy makers need to wake up or we’ll find economic weakness returns just when the economy is regaining its footing.
Have a great day!
Brent Vondera, Senior Analyst
The market likes this, for now at least, as it moves us closer to finding a solution to the problem. Banks jumped nearly 13%, although it isn’t totally clear current shareholders will benefit. There has been talk that the government will take common equity stakes in some cases, which will further dilute shareholders.
Consumer discretionary, technology, basic materials, industrials and energy shares also performed well. Energy and tech is up 7% over the last three sessions.
The market in general has bounced nicely, up 9% over the last week, after hitting 800 on the S&P 500 on Inauguration Day. It’s important from a psychological perspective to stay above the 700 handle.
Market Activity for January 28, 2009
Crude-Oil
Oil prices for March delivery rose 1.6% yesterday, ending the 10% slide of the previous two sessions. A large reduction in gasoline supplies offset a larger-than-expected increase in crude supplies.
The Energy Department, in its weekly report, stated crude supplies jumped 6.22 million to 338.9 million barrels – over the past couple of weeks supply has moved meaningfully above the five-year average of $305 million barrels. Analysts expected crude supplies to build by 2.9 million.
However, gasoline supplies fell 121,000 barrels – a two million barrel build was expected – and this interrupted a bearish trend that looked to be setting up over prior two sessions.
Refinery runs have been very light over the past few weeks, so the pick up in demand due to the plunge in pump prices is showing increased production may be in order. Refinery margins have been on the rise from the very low levels of November, which should incentive higher refinery run rates.
The crack spread measures the relationship between crude-oil futures and oil product futures, per barrel. When it rises refining profitability is likely to increase and when it falls… you get the point.
Mortgage Applications
The Mortgage Banker’s Association index of applications fell 38.8% in the week ended January 23 – this marks the largest drop in 16 years as refinancing activity plunged. The 30-year mortgage rate rose to 5.22% on average after hitting 4.89% in the week ended January 9. There are a lot of people waiting to refi, but not at this level. They’ve got things set to hit somewhere in the 4% handle.
Purchases also fell but the decline was mild, down 2.5% for the week. We’ve moved to such low levels regarding home sales let’s hope additional downside is contained.
FOMC Meeting
On Rates
The FOMC decided to keep its target range for the federal funds rate at 0%-0.25% as they anticipate the economy will continue to warrant exceptionally low levels of fed funds for some time.
On the Economy
The members stated that information received since they last met in December suggests the economy has weakened further. (No surprise there as we touch on these things daily) The FOMC noted that industrial production, housing starts and employment have continued to decline steeply as consumers and businesses cut back on spending.
Conditions in some financial markets have improved, yet credit conditions for households and firms remain extremely tight. (This is pretty much how it works when the economy is in downturn)
Policy Direction
The FOMC stated that it is “prepared to purchase” Treasuries if it believes such action would be effective in improving private-sector credit conditions. The lone dissenter was Richmond Fed Bank President Lacker as he favored purchasing Treasuries immediately. (This may suggest the Fed is not terribly close to progressing down this road)
And let’s hope so. They have done what they can to unfreeze the credit markets, some of their programs have worked very effectively and may not have longer-term consequences, but other programs will. If they are truly thinking about printing more money to buy Treasury securities in an attempt to keep market rates extremely low (and not just bluffing to push the market into doing the job for them – a long-held axiom is never fight the fed) this would be one of those decisions that have long-run consequences, namely fueling harmful levels of inflation.
We don’t need more of this printing press mentality. They have done enough. Now the fiscal side must work in cooperation with the Fed and slash tax rates on incomes, capital and corporate profits. This will not only assist the Fed currently, as they jam the monetary easing pedal to the floor, but will help them do their job of taking away this stimulus down the road (as a pro-growth tax environment will help to offset monetary tightening) so to keep inflation from totally raging out of control a year to 18 months out – this the old Reagan/Volcker model.
The markets need to see this type of response because for now investors are assuming we’ll get Fed tightening and higher tax rates 18 months out. That spells economic shutdown. Policy makers need to wake up or we’ll find economic weakness returns just when the economy is regaining its footing.
Have a great day!
Brent Vondera, Senior Analyst
Wednesday, January 28, 2009
Afternoon Review
General Electric (GE) +3.37%
Moody’s Investors Service said it’s evaluating whether to lower the long-term debt rating for GE and GE Capital, a review that takes about 90 days.
GE expects to generate as much as $16 billion in cash this year after capital expenses, which would be more than enough to pay out roughly $13 billion in dividends (at $1.24 per share). Moody’s is examining the sustainability of GE’s cash flow and, more specifically, wants GE Capital to earn enough to restore a larger payment to the parent company in 2010 – GE is expecting $500 million from a reduced payment GE Capital makes to the parent company.
Under GE’s business model, the finance unit gives the parent a percentage of profit that’s redistributed to all of GE’s businesses. In September, GE allowed GE Capital to cut its contribution to 10 percent of the unit’s profit from 40 percent.
CEO Jeff Immelt and GE’s board consider paying the dividend a good way to return value to shareholders. According to Bloomberg, 40 percent of GE’s holders of its 10.5 billion outstanding shares are individual investors. Immelt explained, “It has just been the judgment that this has been the most investor-friendly use of this capital.”
These days it’s not as essential to have the Triple-A to get funding, but it is an important psychological level. (The difference in cost of borrowing prior to the credit crisis was minor from one level to the next; however, that is not the case today amidst credit market turmoil.) While a cut of the dividend and/or rating may create near-term pressure, ultimately removing these overhangs should be good for the stock.
General Dynamics (GD) +7.70%
General Dynamics said fourth-quarter earnings rose 5.7 percent and made a conservative initial forecast for 2009 earnings. The aerospace group posted the largest quarterly gain among the company’s four units, with ships and information technology also rising, while revenue from combat systems declined.
The company acquired Jet Aviation, for $2.2 billion to expand flight-support into Europe, Asia and South America. The added service revenue will help keep the aerospace unit growing amid a global recession that may weaken demand for Gulfstream jets. The Jet Aviation acquisition helped lift quarterly sales at the company’s aerospace unit by 27 percent to $1.53 billion.
For the full year, operating earnings grew significantly faster than revenue and free cash flow from operations totaled 106 percent of net earnings, showing the strong quality of GD’s earnings.
The company’s total backlog grew by $13.6 billion in the fourth quarter to $74.1 billion. For the full year, company-wide operating margins increased by 110 basis points over 2007, to 12.5 percent.
WellPoint (WLP) +4.41%
WellPoint missed estimates for fourth-quarter earnings and will not give a profit forecast until their investor conference on Feb. 24.
Earnings of $0.65 per share were heavily affected by realized investment losses, which totaled $0.69 per share, or $543.2 million. WellPoint recorded a total of $1.1 billion in investment losses for 2008. Another negative was WellPoint’s membership, which has finally begun to feel the effects of rising unemployment.
The company also laid blame on their computers for their mistakes in setting rates too low and keeping elderly customers from receiving drugs – which ultimately led the government to block WellPoint this month from adding Medicare customers.
WellPoint’s medical loss ratio – the percent of premium revenue paid out to health providers – increased to 83.4 percent from 82.9 percent a year ago. Analysts view this percentage as an indicator of future profit. Although the medical cost ratio deteriorated in each quarter of 2008 compared with the prior year, the relative comparisons improved throughout the year. This indicates that the company was successful in raising prices on renewals as the year went on.
AT&T (T) -0.08%
AT&T said fourth-quarter profit fell 24 percent in the fourth quarter, but sales of the heavily subsidized iPhone exceeded expectations. Net income fell to $2.4 billion, or 41 cents a share, as the company recorded costs of 12 cents a share tied to acquisitions and seven cents for workforce reductions.
The company’s legacy businesses – traditional phone lines and advertising from directories – were particularly vulnerable in a weakening economy. The wireless business, however, added nearly 2.1 million net new customers thanks to strong sales of the iPhone.
The company is increasingly reliant on the iPhone for its growth and subsidizes the device to expand its wireless customer base. This quarter, subsidies paid to keep the iPhone 3G priced at $200 weighed on earnings by five cents a share, but AT&T expects the device to be more accretive in 2009 and 2010 as revenue from the more expensive calling plans offset the subsidies.
There is a growing concern among investors that the wireless business, which has been AT&T’s growth engine with years of rapid expansion, may be near saturation. The company wants to move its traditional phone customers to a more expensive bundled service called U-Verse in order to offset slowing wireless and wireline businesses. AT&T plans for U-Verse to reach 30 million homes by 2011.
Despite the prospects of slower future growth, AT&T’s operations continue to generate solid cash flow and its high dividend yield makes the shares a worthwhile investment.
Dover Corporation (DOV) +5.43%
Dover said its fourth-quarter profit dropped 35 percent, but still beat analysts’ expectations as falling demand in most markets offset growth in its energy segment.
Profitability improved in the quarter, with operating margins up 70 basis points over the prior year period and free cash flow made up 13.2 percent of revenue. The company continues to put emphasis on cash flow, which has been used for add-on acquisitions, share repurchases and investment in their businesses. Dover also increased their annual dividend for the 54th consecutive year.
The company reduced six percent of its headcount worldwide and said in the press release: “Further actions have already been taken in the first quarter and we are fully prepared to take additional steps to address any further deterioration in end-market conditions.”
Looking into 2009, Dover sees a continuation of a weak and uncertain global environment. The company expects decreased demand levels across all end markets to have an adverse impact on revenue, but the company is “very focused on protecting margins.”
Boeing (BA) +0.05%
Boeing posted a loss in the year’s final three months after a strike shut factories and faulty parts slowed efforts to restart production.
Boeing faces a potential increase in canceled or deferred orders this year as airlines cope with a drop in travel demand and tight credit. It also must carry development costs on the delayed 787 Dreamliner, which is now due to reach the first customer in early 2010, about two years later than planned.
CEO Jim McNerney said in today’s statement, “The progress we made in many areas of Boeing during 2008 was outweighed by the impact of the strike and our performance on some key development programs.” The Dreamliner delay drew engineers from other programs, causing slowdowns for other models including the 747-8 freighter and intercontinental passenger jet. Boeing said the 747-related expenses cost it $0.61 cents a share.
Boeing plans to deliver 480 to 485 planes this year, less than its July estimate of 500 to 505, and may have to provide $1 billion in financing to customers. Boeing’s order backlog for commercial planes was $279 billion at year-end.
Southern Company (SO) -1.63%
Southern Company, the largest U.S. power generator, said fourth-quarter profit fell 9.1 percent on costs related to leveraged leases on three international energy projects and as the recession curbed use of electricity.
Utility profit fell 9.4 percent as a decline in power demand because of the recession outweighed an increase in rates. The volume of power supplied to industrial customers dropped 10 percent. Southern added about 25,000 new customers from a year ago, about half the growth of previous years.
The company has budgeted $16.4 billion for capital expenditures through 2011, when it expects to begin expanding its Bogtle nuclear plant in Georgia. That’s up from the previous three-year plan of $14.4 billion. Spending on power lines probably will be cut by $200 million in the period because of slower customer growth.
Quick Hits
- FDIC May Run ‘Bad Bank’ in Plan to Purge Toxic Assets
- REITs in U.S. Consider Paying Dividend in Stock to Save Cash
- Robert Rubin Says Mark-to-Market has Done ‘Damage’
Peter Lazaroff, Junior Analyst
Fixed Income Recap
Treasuries rebounded, after selling off the past two days. The curve flattened by about 8 basis points in Tuesday’s trading as yields on the longer end of the curve remain much more volatile than the shorter. A basis point represents .01%.
As I’ve said before, supply concerns are in a battle with Fed buying expectations right now. On the days when large Treasury auction announcements dominate the news, supply worries takeover, and investors become concerned with Treasuries finding a bid. On days when it appears as though the Fed is going to continue its trend of keeping rates as low as possible, investors try to ride the wave of increased demand for Treasuries. Bond prices move inversely to yields.
The Fed will announce its target rate for Fed Funds tomorrow, which currently sits at a range of 0% - .25%, the lowest in history. The market expects the rate to remain unchanged but will listen closely to the comments that accompany the rate announcement tomorrow.
Fannie and Freddie
The two Government Sponsored Entities, who were taken into conservatorship in September of 2008, have begun to draw on the $200 billion of aid that was pledged to them by the Treasury. Freddie Mac is asking for $30 to $35 billion in new capital, on top of the $13.8 billion they received last November, and Fannie Mae is now making their first request of $11 to $16 billion. In addition, the FHFA, is proposing new rules that would trim the retained portfolios of Fannie and Freddie to $250 billion each. They currently sit at $782 billion and $804 billion respectively.
Moves such as this are moving the GSEs more towards the business practices they were initially created for, their guarantee portfolio. During the housing boom of 2003-2006 Fannie and Freddie became large buyers of non-conforming loans, both as a result of their desire to increase earnings and regulation that urged them to help previously unqualified buyers purchase homes.
The market isn’t showing any worry about the solvency of Fannie or Freddie as a result of these capital infusions. Credit spreads on longer senior debt of the agencies that still only carries the implied backing of the U.S. Government, as opposed to shorter debt that has an explicit guarantee, remains unaffected. And the Fed continues to take on more and more securitized agency MBS, as those spreads continue to tighten.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
As I’ve said before, supply concerns are in a battle with Fed buying expectations right now. On the days when large Treasury auction announcements dominate the news, supply worries takeover, and investors become concerned with Treasuries finding a bid. On days when it appears as though the Fed is going to continue its trend of keeping rates as low as possible, investors try to ride the wave of increased demand for Treasuries. Bond prices move inversely to yields.
The Fed will announce its target rate for Fed Funds tomorrow, which currently sits at a range of 0% - .25%, the lowest in history. The market expects the rate to remain unchanged but will listen closely to the comments that accompany the rate announcement tomorrow.
Fannie and Freddie
The two Government Sponsored Entities, who were taken into conservatorship in September of 2008, have begun to draw on the $200 billion of aid that was pledged to them by the Treasury. Freddie Mac is asking for $30 to $35 billion in new capital, on top of the $13.8 billion they received last November, and Fannie Mae is now making their first request of $11 to $16 billion. In addition, the FHFA, is proposing new rules that would trim the retained portfolios of Fannie and Freddie to $250 billion each. They currently sit at $782 billion and $804 billion respectively.
Moves such as this are moving the GSEs more towards the business practices they were initially created for, their guarantee portfolio. During the housing boom of 2003-2006 Fannie and Freddie became large buyers of non-conforming loans, both as a result of their desire to increase earnings and regulation that urged them to help previously unqualified buyers purchase homes.
The market isn’t showing any worry about the solvency of Fannie or Freddie as a result of these capital infusions. Credit spreads on longer senior debt of the agencies that still only carries the implied backing of the U.S. Government, as opposed to shorter debt that has an explicit guarantee, remains unaffected. And the Fed continues to take on more and more securitized agency MBS, as those spreads continue to tighten.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Daily Insight
U.S. stocks added to Monday’s gain, shaking off another extremely weak Case/Shiller report and a consumer confidence (CC) reading that registered a new low. (Long time readers know I normally don’t spend time focusing on the CC reading, but for now you’ve got to keep some eye on it as this is one of those rare periods in which consumer activity has rolled over – a bounce in CC will offer a good indication on the direction of activity.)
The market was strangely quiet yesterday as the broad market traded very steady the entire session, an anomaly these days. Don’t know if this is telling us anything or not, we’ve seen a number of occasions over the past five months that seemed to offer more normal behavior may be on the horizon, only to see things become crazy again – too much government involvement right now to get excited.
Financials led stocks higher, maybe it was leaked the Obama Administration was about to set up a “bad bank” to house troubled assets – I don’t believe the news was actually released until after the bell. In any event, it’s not even clear this will be a plus for bank stocks longer-term as there’s talk of the government taking common equity stakes. Egad! But the shares seem to like it for now.
Industrials performed very well too. Considering the earnings report DuPont put out, the rise in these shares was surprising.
(That report from the chemical giant was just another sign of how things changed on a dime last quarter; we went from withstanding high energy prices and a nasty housing correction with amazing resilience to a real shutdown following the September 15 Lehman collapse in a flash.)
Market Activity for January 27, 2009
Housing Data
The S&P Case/Shiller Home Price index stated home values for the 20 major metro areas it tracks fell 2.23% in November and are down 18.18% over the past year.
That year-over-year reading continues to deteriorate, although the rate of decline has eased – for October prices were down 18.06% from the year–ago period.
The declines continue to be driven by areas that saw the largest level of speculation during the boom, such as Phoenix and Las Vegas – these are where foreclosures and thus distressed pricing is most evident. Also hurting the figure was increased weakness in Chicago and parts of the Northeast, areas that took a while before things got especially ugly.
Detroit, a special situation, continues to be hammered by the auto-industry malaise and state tax-rate hikes that continue to drive businesses and workers out of Michigan.
So we have existing home prices down 15% over the past year, the FHFA Home Price index down 8% and Case/Shiller down 18%. (Note: Case/Shiller is a month behind as its latest release is for November, the two others have released prices through December). Average the three and you get home prices off by roughly 13% over the past 12 months.
It doesn’t appear home prices will begin to flatten out for several months, especially since we have the weight of the labor market putting an additional drag on the housing market. But mortgage rates are low, and should go lower so long as Treasury Secretary Geithner gets a clue and doesn’t cause Treasury rates to jump via the currency fight he seems to be picking. It may take a 4.50% 30-year mortgage rate to get home sales fired up by the spring/summer, and as we’ve touched on before we think that is the target the Obama Administration will shoot for.
Consumer Confidence
The Conference Board’s index of consumer confidence dropped to a record low in January, falling to 37.7 from 38.6 in December. The present situation index fell to 29.9 from 30.2; the expectations index fell to 43.0 from 44.2.
The good news in the report, and I’m stretching here for a bright side, was consumers’ assessment of the labor market. The percentage of consumers judging jobs as “plentiful” rose to 7.2% from 6.5%, while those viewing jobs as “hard to get” feel to 41.1% from 41.5%. This means the net “plentiful” less “hard to get” index improved to -33.9% from -35.0% in December. This marks the first improvement in a year. The improvement was marginal, but we’ll take it. Now we need to see some help from the ISM surveys and jobless claims.
When consumers are comfortable with their cash savings, as their two major savings vehicles – homes and stocks – have been hit hard, and feel better about the labor market they will increase spending again, but probably not before. This is just one of the reasons we’ve harped on the need of a tax-rate response. Slashing rates on income would immediately drive disposable income higher and speed up recovery. Ignoring this pro-growth response to current economic problems is a big mistake.
Pre-Market Higher
Futures are higher this morning on news the Obama Administration will lay out details of an “aggregator” or “bad bank” with which to buy, house, hold and eventually sell troubled assets. This will remove what’s causing the problems on bank balance sheets. Too bad Paulson chose not to do this even though it was the original plan of the TARP.
I find it hilarious to hear that this “bad bank” will use a net present value accounting, or so it’s being reported. Apparently the government doesn’t want to be hampered by the pernicious mark-to-distressed market accounting that is making things appear worse than they actually are. It is mind-blowing to me that regulators have not yet killed this pro-cyclical accounting standard for one that makes much more sense, such as the standard in place prior to November 2007.
The market will also be watching to see how government Treasury auctions go as they issue close to a trillion in debt over the next several months. Also in focus will be how the commercial paper market reacts as it is weaned from the Federal Reserve CP program and moves back to private investors bidding on this short-term debt. These will be very important develops and we need them to go well.
Have a great day!
Brent Vondera, Senior Analyst
The market was strangely quiet yesterday as the broad market traded very steady the entire session, an anomaly these days. Don’t know if this is telling us anything or not, we’ve seen a number of occasions over the past five months that seemed to offer more normal behavior may be on the horizon, only to see things become crazy again – too much government involvement right now to get excited.
Financials led stocks higher, maybe it was leaked the Obama Administration was about to set up a “bad bank” to house troubled assets – I don’t believe the news was actually released until after the bell. In any event, it’s not even clear this will be a plus for bank stocks longer-term as there’s talk of the government taking common equity stakes. Egad! But the shares seem to like it for now.
Industrials performed very well too. Considering the earnings report DuPont put out, the rise in these shares was surprising.
(That report from the chemical giant was just another sign of how things changed on a dime last quarter; we went from withstanding high energy prices and a nasty housing correction with amazing resilience to a real shutdown following the September 15 Lehman collapse in a flash.)
Market Activity for January 27, 2009
Housing Data
The S&P Case/Shiller Home Price index stated home values for the 20 major metro areas it tracks fell 2.23% in November and are down 18.18% over the past year.
That year-over-year reading continues to deteriorate, although the rate of decline has eased – for October prices were down 18.06% from the year–ago period.
The declines continue to be driven by areas that saw the largest level of speculation during the boom, such as Phoenix and Las Vegas – these are where foreclosures and thus distressed pricing is most evident. Also hurting the figure was increased weakness in Chicago and parts of the Northeast, areas that took a while before things got especially ugly.
Detroit, a special situation, continues to be hammered by the auto-industry malaise and state tax-rate hikes that continue to drive businesses and workers out of Michigan.
So we have existing home prices down 15% over the past year, the FHFA Home Price index down 8% and Case/Shiller down 18%. (Note: Case/Shiller is a month behind as its latest release is for November, the two others have released prices through December). Average the three and you get home prices off by roughly 13% over the past 12 months.
It doesn’t appear home prices will begin to flatten out for several months, especially since we have the weight of the labor market putting an additional drag on the housing market. But mortgage rates are low, and should go lower so long as Treasury Secretary Geithner gets a clue and doesn’t cause Treasury rates to jump via the currency fight he seems to be picking. It may take a 4.50% 30-year mortgage rate to get home sales fired up by the spring/summer, and as we’ve touched on before we think that is the target the Obama Administration will shoot for.
Consumer Confidence
The Conference Board’s index of consumer confidence dropped to a record low in January, falling to 37.7 from 38.6 in December. The present situation index fell to 29.9 from 30.2; the expectations index fell to 43.0 from 44.2.
The good news in the report, and I’m stretching here for a bright side, was consumers’ assessment of the labor market. The percentage of consumers judging jobs as “plentiful” rose to 7.2% from 6.5%, while those viewing jobs as “hard to get” feel to 41.1% from 41.5%. This means the net “plentiful” less “hard to get” index improved to -33.9% from -35.0% in December. This marks the first improvement in a year. The improvement was marginal, but we’ll take it. Now we need to see some help from the ISM surveys and jobless claims.
When consumers are comfortable with their cash savings, as their two major savings vehicles – homes and stocks – have been hit hard, and feel better about the labor market they will increase spending again, but probably not before. This is just one of the reasons we’ve harped on the need of a tax-rate response. Slashing rates on income would immediately drive disposable income higher and speed up recovery. Ignoring this pro-growth response to current economic problems is a big mistake.
Pre-Market Higher
Futures are higher this morning on news the Obama Administration will lay out details of an “aggregator” or “bad bank” with which to buy, house, hold and eventually sell troubled assets. This will remove what’s causing the problems on bank balance sheets. Too bad Paulson chose not to do this even though it was the original plan of the TARP.
I find it hilarious to hear that this “bad bank” will use a net present value accounting, or so it’s being reported. Apparently the government doesn’t want to be hampered by the pernicious mark-to-distressed market accounting that is making things appear worse than they actually are. It is mind-blowing to me that regulators have not yet killed this pro-cyclical accounting standard for one that makes much more sense, such as the standard in place prior to November 2007.
The market will also be watching to see how government Treasury auctions go as they issue close to a trillion in debt over the next several months. Also in focus will be how the commercial paper market reacts as it is weaned from the Federal Reserve CP program and moves back to private investors bidding on this short-term debt. These will be very important develops and we need them to go well.
Have a great day!
Brent Vondera, Senior Analyst
Tuesday, January 27, 2009
Peabody Energy (BTU) +12.0%
Peabody Energy announced fourth-quarter profit soared sevenfold on higher prices contracted during coal’s record surge to $137.50 a ton. The largest producer of coal in the U.S. said coal demand for 2009 will be impacted by the global pullback in steel production and moderate softness in global electricity generation, offset by growth from new generation and increased market share for coal. In response to current economic conditions, global coal production cuts have been accelerating.
In U.S. spot markets, coal was up 20 percent from a year earlier in Wyoming’s Powder River Basin, where Peabody holds the largest reserves. Although coal prices have outperformed other commodities like steel, copper and oil, there is a lack of upside catalyst in the near future for the industry. A global economic recovery should spur new demand for electricity and steel, driving coal stocks higher.
First Cash Financial (FCFS) +9.91%
First Cash reported its fiscal 2008 earnings grew 35 percent due to a 13 percent increase in same-store revenue and a 38 percent revenue increase from its Mexico pawn operations.
The company projects full-year 2009 earnings growth of eight to ten percent, as it expects significant growth in customer traffic and transaction volumes in 2009, especially in Mexico. Most of the 2009 earnings and revenue growth are expected to occur in the second half, as the significant number of new stores added between June and December of last year become more accretive to earnings.
Quarterly revenue increased 15 percent and same-store sales for the fourth quarter increased 8 percent. Pawn revenue in Mexico during the fourth quarter increased by 31 percent, reflecting new store expansions and strong same-store revenue growth in existing stores. In the U.S., total pawn revenue grew by 13 percent year-over-year.
First Cash said it plans to open between 55 and 60 news stores in Mexico this year, and a limited number new pawn stores in the U.S.
Amgen (AMGN) -2.43%
Amgen reported fourth quarter earnings and revenues that missed estimates, while issuing 2009 guidance that represents roughly flat performance compared with 2008 numbers.
Competitive pressures are preventing Amgen from any substantial growth ahead of the launch of osteoporosis drug denosumab, which could be approved at the end of 2009. Amgen’s high-profile anemia drug Aranesp is losing market share to Johnson & Johnson’s Procrit and competes with biosimilars in Europe. Biosimilars are also launching in Europe that will compete directly with neutropenia drug Neupogen – one of Amgen’s best-selling drugs.
Amgen will rely on its newer drugs to keep earnings steady in the near term, but the company’s more than $5 billion in annual free cash flow gives them plenty of flexibility for acquisitions and share buybacks to further boost growth. The firm had almost $10 billion in cash and about $10 billion in debt at the end of last year.
During the fourth quarter, Amgen repurchased approximately 13 million shares of its common stock at a total cost of $700 million.
St. Jude Medical (STJ) +11.14%
St. Jude Medical reported net sales increased 11 percent to $1.1 billion, which earnings slightly topped analysts’ estimates. The company was aided by higher sales of implantable cardioverter defibrillators, and it said it achieved strong growth across all of its product platforms in 2008.
Quarterly sales in the company’s Cardiac Rhythm Management – the major driver for the company – rose seven percent compared with the same year-ago period to $680 million.
EMC Corporation (EMC) -2.73%
EMC met expectations with 12 percent revenue growth for 2008. Still, normally robust fourth-quarter sales were up only 4 percent from a year ago.
The storage sector has been seen as a safer place than other areas of IT for riding out the economic storm; however, this sector is showing signs that it will succumb to the slumping global economy.
Given that the company chose not to provide any revenue guidance, it is hard to expect the situation to improve in the short term. However, the slowdown represents deferrals of storage purchase decisions rather than permanent cancellations. Long-term, EMC’s position in the highly demanded unified storage and networked storage markets will keep driving profits.
EMC subsidiary VMware, on the other hand, is losing its technological advantage and the landscape for virtualization technologies – which save companies a significant amount in IT expenses – is getting increasingly competitive.
DuPont (DD) +0.39%
DuPont posted a loss in the fourth quarter and trimmed its outlook for 2009, saying it does not “underestimate the difficulties presented by the current environment.”
Revenues fell 16.7 percent year-over-year to $5.82 billion, short of the $6.17 billion consensus. Look ahead to the first quarter, DuPont expects earnings between $0.50 and $0.70 per share, well shy of the $0.72 consensus. DuPont expects global macroeconomic conditions for the first quarter of 2009 to be similar to the fourth quarter, with very weak demand in most of its key markets, excluding agriculture.
DuPont said it will deliver about $730 million in fixed cost reductions in 2009, but expects to continue an appropriate level of spending for high-growth, high-margin businesses, including seed products and photovoltaics.
Quick Hits
- Pfizer Deal to Buy Wyeth Leaves Doubt (online or print subscription required)
- Pfizer’s Kindler Resorts to a Megadeal as Research Falls Flat
- GE Capital Leads Commercial Paper ‘Test’ as Fed’s Buying Ebbs
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks ended the day higher after another volatile session. The broad market began the session with a bang, up 2.5% out of the gate, only to slide 3.0% from the intraday peak to move into negative territory just after lunch. A rally in the final 90 minutes moved the major indices back to the black.
Job cut announcements continue to roll on. This event has accelerated over the past couple of weeks, and generally is something that puts pressure on the market as it has an obvious adverse effect on consumer activity and thus profits. However, the market may begin to gain some ground on this news; while it’s a harsh reality, this is also the benefit of economic downturns as firms come out of it more streamlined and powered for increased levels of growth.
Unfortunately, we also have the government in the mix, and well more than is usually the case, so the market is also struggling with having to deal with the whims of Washington
Most sectors gained ground yesterday, health-care, basic materials and financials were the losers.
Market Activity for January 23, 2009
Pfizer officially announced its purchase of Wyeth for $68 billion in order to boost pipeline potential as their biggest products come off patent 2010-2015, the largest being Lipitor. Wyeth’s promise in Alzheimer drugs, along with pneumonia and depression drugs already on the market, were what Pfizer was after.
This looks like a smart deal for Pfizer, although the stock price didn’t exhibit that yesterday, down 10% on news the company will cut its dividend payout in half to save $4 billion per year
And speaking of cash, Wyeth has a net cash position ($14.1 billion cash - $11.5 billion in debt) and Pfizer will use that cash to help finance the deal. Pfizer already has huge cash reserves of $30 billion, but a lot of this is overseas and they simply won’t repatriate the bread because of the harmful 35% tax incursion on doing so.
This is a topic we’ve spent much time on. Many U.S. firms have substantial cash overseas from international operations, but won’t bring it home because of the tax – they have already paid the corporate tax rate levied in the country in which the business occurred, why would they take another 35% hit on top of it? They won’t.
We’ve got to get serious here. There are responses to the current economic environment that can accomplish both short and long-term good. The repatriated tax should be slashed to 5%. This will bring massive amounts of capital back home, boost the economy and increase government revenues too. Five percent of something is a heck of a lot more than 35% of nothing. The sooner Washington understands this the better it is for everyone.
The Economic Data
The National Association of Realtors (NAR) reported existing home sales unexpectedly rose in December. Total existing home sales increased 6.5% to an annual rate of 4.74 million units from 4.45 million in November. Breaking down the two components, single-family resales rose 7.0% and multi-family increased 2.1%.
The median price for a single-family existing home fell 2.8% in December and has been hammered over the past year, down 15% -- nearly all of this damage has occurred since September.
The rise in sales for December was spurred by a 7.4% increase in the South and a 13.6% jump in the West region – NAR noted that distressed properties accounted for 45% of all sales, particularly true for the West.
The West region saw prices plunge 11.6% in December and the Northeast endured an 8.5% drop (although sales still dropped) – that’s for the month! The median price of an existing home in the Midwest and South held steady – up 3.2% in the South and flat in the Midwest.
The inventory of existing homes, relative to the current sales pace, fell nicely last month, which is a good sign.
However, before we get excited about this move, the figure has to trend down close to six month’s worth. When sales bounce back, which will be delayed now due to the weakness in the labor market, this supply figure will fall fast. Unfortunately, we could be a year from this happening based on what is currently known. What we need to see for now is existing home sales to stabilize around these levels. Let’s accomplish that first and then have some patience, additional patience I should say, regarding the rebound.
Our feel is the Obama Administration may attempt to move the 30-year fixed mortgage rate to 4.0%-4.5% -- maybe by issuing Treasury debt and using Fannie and Freddie to write mortgages in this range. They can finance this via the 30-year T-bond, which currently carries a 3.38%. This could help the housing market bounce faster than it would otherwise occur. The Fed is already engages in pushing mortgage rates lower, but some more could be in the works.
This is not the way I would do it; there is no free lunch and every action has its cost, but then no one is really asking my opinion. In any event, the administration may want to lay off on the China bashing, or they could find out quite quickly that that 3% handle on the 30-year becomes 5%.
The Conference Board’s Leading Economic Indicators (LEI) index rose 0.3%, the first increase in six months – a decline of 0.2% was expected. The positive result was due to an increase in M2 money supply for the month. If this component would have been flat, LEI would have been down 0.4%. This is really not a great indicator right now due to the Fed’s aggressive easing campaign.
Have a great day!
Brent Vondera, Senior Analyst
Job cut announcements continue to roll on. This event has accelerated over the past couple of weeks, and generally is something that puts pressure on the market as it has an obvious adverse effect on consumer activity and thus profits. However, the market may begin to gain some ground on this news; while it’s a harsh reality, this is also the benefit of economic downturns as firms come out of it more streamlined and powered for increased levels of growth.
Unfortunately, we also have the government in the mix, and well more than is usually the case, so the market is also struggling with having to deal with the whims of Washington
Most sectors gained ground yesterday, health-care, basic materials and financials were the losers.
Market Activity for January 23, 2009
Pfizer officially announced its purchase of Wyeth for $68 billion in order to boost pipeline potential as their biggest products come off patent 2010-2015, the largest being Lipitor. Wyeth’s promise in Alzheimer drugs, along with pneumonia and depression drugs already on the market, were what Pfizer was after.
This looks like a smart deal for Pfizer, although the stock price didn’t exhibit that yesterday, down 10% on news the company will cut its dividend payout in half to save $4 billion per year
And speaking of cash, Wyeth has a net cash position ($14.1 billion cash - $11.5 billion in debt) and Pfizer will use that cash to help finance the deal. Pfizer already has huge cash reserves of $30 billion, but a lot of this is overseas and they simply won’t repatriate the bread because of the harmful 35% tax incursion on doing so.
This is a topic we’ve spent much time on. Many U.S. firms have substantial cash overseas from international operations, but won’t bring it home because of the tax – they have already paid the corporate tax rate levied in the country in which the business occurred, why would they take another 35% hit on top of it? They won’t.
We’ve got to get serious here. There are responses to the current economic environment that can accomplish both short and long-term good. The repatriated tax should be slashed to 5%. This will bring massive amounts of capital back home, boost the economy and increase government revenues too. Five percent of something is a heck of a lot more than 35% of nothing. The sooner Washington understands this the better it is for everyone.
The Economic Data
The National Association of Realtors (NAR) reported existing home sales unexpectedly rose in December. Total existing home sales increased 6.5% to an annual rate of 4.74 million units from 4.45 million in November. Breaking down the two components, single-family resales rose 7.0% and multi-family increased 2.1%.
The median price for a single-family existing home fell 2.8% in December and has been hammered over the past year, down 15% -- nearly all of this damage has occurred since September.
The rise in sales for December was spurred by a 7.4% increase in the South and a 13.6% jump in the West region – NAR noted that distressed properties accounted for 45% of all sales, particularly true for the West.
The West region saw prices plunge 11.6% in December and the Northeast endured an 8.5% drop (although sales still dropped) – that’s for the month! The median price of an existing home in the Midwest and South held steady – up 3.2% in the South and flat in the Midwest.
The inventory of existing homes, relative to the current sales pace, fell nicely last month, which is a good sign.
However, before we get excited about this move, the figure has to trend down close to six month’s worth. When sales bounce back, which will be delayed now due to the weakness in the labor market, this supply figure will fall fast. Unfortunately, we could be a year from this happening based on what is currently known. What we need to see for now is existing home sales to stabilize around these levels. Let’s accomplish that first and then have some patience, additional patience I should say, regarding the rebound.
Our feel is the Obama Administration may attempt to move the 30-year fixed mortgage rate to 4.0%-4.5% -- maybe by issuing Treasury debt and using Fannie and Freddie to write mortgages in this range. They can finance this via the 30-year T-bond, which currently carries a 3.38%. This could help the housing market bounce faster than it would otherwise occur. The Fed is already engages in pushing mortgage rates lower, but some more could be in the works.
This is not the way I would do it; there is no free lunch and every action has its cost, but then no one is really asking my opinion. In any event, the administration may want to lay off on the China bashing, or they could find out quite quickly that that 3% handle on the 30-year becomes 5%.
The Conference Board’s Leading Economic Indicators (LEI) index rose 0.3%, the first increase in six months – a decline of 0.2% was expected. The positive result was due to an increase in M2 money supply for the month. If this component would have been flat, LEI would have been down 0.4%. This is really not a great indicator right now due to the Fed’s aggressive easing campaign.
Have a great day!
Brent Vondera, Senior Analyst
Monday, January 26, 2009
Afternoon Review
Caterpillar (CAT) -8.38%
Caterpillar, often a barometer of various segments of the U.S. economy, posted disappointing earnings and announced 20,000 job cuts. CEO James Owens, an economist, provided a bleak outlook for the world economy in its earnings release.
The U.S. market, where construction has been weak, saw sales fall four percent while sales outside North America rose 13 percent and made up 64 percent of total sales, up from 60 percent a year earlier. Machinery and engine sales gained 6.7 percent while the company’s financial arm posted a 2.4 percent increase in financial-products revenue despite turbulence in the financial markets.
The financial crisis continues to hinder Caterpillar’s ability to issue corporate bonds. Its finance arm has been driven to offer sharply higher yields on recent bond sales to lure investors
2008 was the company’s sixth consecutive year or record sales and revenue. The company has benefited from a five-year boom led by emerging markets in big need for the heavy construction equipment made by Caterpillar. During that time, the work force rose nearly 50 percent to 101,000 as revenue more than doubled.
Pfizer (PFE) -10.32%
Pfizer agree to pay $68 billion, or about $50.19 per share, to acquire rival Wyeth, in the largest pharmaceutical deal in nearly a decade. Wyeth shareholders will receive $33 a share in cash and 0.985 a share in Pfizer stock. The deal is set to close “no earlier than later in the third quarter.”
Pfizer is paying for the acquisition with roughly one-third in borrowed money, one-third in stock and one-third from cash reserves. Pfizer will borrow $22.5 billion from a number of banks to finance the deal. Under the loan agreement, the banks can withhold financing if Pfizer’s credit rating falls below a certain threshold. If that occurs, Pfizer would have to pay Wyeth a reverse breakup fee of $4.5 billion. That potential penalty is very high by historical norms and underscores the difficulty of completing deals in the current environment. As it turns out, the other big M&A news today was that Dow Chemical won’t close its $15 billion merger with Rohm & Haas on time.
In order to protect its credit rating, Pfizer plans to cut its quarterly dividend, which was 32 cents last quarter, by half. That should save the company more than $1 billion per quarter. Pfizer believes the deal will lead to annual savings of $4 billion by the end of the third year and will be accretive to earnings in the second full year after closing.
The combined company will have 17 products that generate more than $1 billion in annual sales. However, Pfizer has a poor history of large acquisitions that destroyed shareholder wealth. The company’s reliance on growth-by-acquisition instead of strong in-house research and smart licensing could eventually take its toll.
On the earnings front, Pfizer’s fourth quarter net income fell to $26 million, or four cents a share, down from $2.72 billion, or 40 cents a share, a year earlier. Excluding one-time items, earnings rose to 65 cents from 50 cents.
Quest Diagnostics (DGX) +9.85%
Despite slowing revenue growth, Quest beat Wall Street targets in the fourth quarter as operating margins expanded. In efforts increase margins further, the firm is in the middle of a plan to reduce costs by $500 million by the end of 2009.
Clinical testing revenue rose 2.3 percent despite a 0.4 percent decline in volume of drug-abuse testing, which is sensitive to job-hiring volume, dropped. Quest offers a variety of tests, from routine blood work to sophisticated genetic tests, and no one type provides a large portion of its revenue.
Management reiterated that all major managed-care contracts have been renewed or expanded into 2010 and beyond. This is a good sign for Quest, considering the upheaval in managed-care contracting just a couple of years prior.
The company’s shares had been in decline earlier this month, as Quest admitted it provided possibly wrong results for thousands of vitamin D tests in the past two years. The company said it had fixed the problem and is offering free retests, but the incident could raise call for more regulation of diagnostic testing just as it is playing a more important role in guiding medical treatment.
Danaher (DHR) +9.29%
Danaher reported a lower fourth quarter profit, but still topped earnings estimates, as
the manufacturer of bar code readers, medical products and Craftsman tools accounted for restructuring charges related to its acquisition of test and measurement equipment maker Tektronix.
Revenue increased 1.3 percent to $3.18 billion and gross margins rose to 54.3 percent from 53.8 percent.
CEO H. Lawrence Culp expects 2009 to be a difficult year, but anticipates Danaher will outperform given its strong balance sheet and businesses. Danaher is vulnerable to challenges in the retail environment, as shoppers cut back on their discretionary spending. Same-store sales have been steadily falling at stores like Sears and Kmart, with categories such as home appliances and tools feeling the impact of the housing slump.
Kimberly-Clark (KMB) -0.63%
Kimberly-Clark posted an 8.1 percent drop in fourth quarter net income and projected 2009 results below analysts’ expectations. The company also announced that they won’t buy back stock this year because of a quadrupling in 2009 pension costs.
KMB reported fourth-quarter net income of $419 million, or $1.01 a share, down from $456 million, or $1.07 a share, a year earlier. The stronger dollar cut the bottom line by 20 cents a share. On the bright side, gross margin widened to 31.6 percent from 30.7 percent as commodity costs were down “dramatically.”
CEO Thomas Falk said, “Economic weakness impacted our categories more than anticipated, particularly in North America and Europe,” adding the company believes some of the effects are temporary, reflecting inventory reductions by both retailers and consumers.
Trade-down also affected sales. The continuing downturn in the economy has led some consumers to shift to private-label from name-brand goods and to use up products in their pantries rather than spending on new ones.
General Electric (GE) +3.24%
General Electric’s, and finance arm GE Capital’s, AAA debt ratings are not “immediately affected” by the company’s fourth-quarter earnings results, Standard & Poor’s said.
Still, for GE Capital there are signs that 2009 will be even more difficult than the ratings agency assumed when S&P revised the outlook on the both companies to negative on Dec. 18, 2008, S&P said. GE Capital would have reported a significant net loss for the quarter, were it not for a substantial tax credit, the ratings company said.
Quick Hits
- Pfizer-Wyeth: What’s To Keep It From Falling Apart?
- Heard on the Street: GE’s Approaching Date With Destiny
- Bernanke Risks ‘Very Unstable’ Bond Market as He Ponders Buying Treasuries
- In October 2007, Financials made up 22.3% of the S&P 500. Today, they are just 9.7% of the index.
Peter Lazaroff, Junior Analyst
Fixed Income Recap
Treasuries continued their selloff today, as the curve flattened by about 7 basis points, or .07 percentage points. Bond prices move inversely to yields. Supply concerns will continue to dictate Treasury performance in the near-term. With the plethora of government spending just now beginning to show itself, increased issuance is all but guaranteed to continue.
Only so much paper can be gobbled up at these levels. We saw the yield on the 10 year Treasury, which is tracked closely by the 30 year mortgage, increase by 25 basis points this week. The government must find a balance between funding the stimulus through fiscal spending and promoting economic growth through monetary easing. The Treasury announced $40 billion in two-year notes and $30 billion in five-year notes to be auctioned off next week. The question is, how much of this new supply is the Fed going to have to purchase themselves in order to keep rates low?
The Curve
Also referred to as the term structure of interest rates, curves show what a specific type of bond is yielding across a range of maturities. The graph below shows yield in percent on the vertical axis and time to maturity in years on the horizontal axis. The white line shows the current Treasury curve and the green line shows it as of 12/23/08.
Notice how the two curves in the graph are different shapes. It may be difficult to see from the graph, but since December 23rd the yield on the 2-year has dropped, 11.5 basis points, (or .115 percentage points), from .915 to .80% while the yield on the 10-year has risen 43.2 basis points, from 2.173% to 2.605%. This shift would be considered flattening.
There are curves for municipal bonds, agencies, etc., but in general terms, “the curve” refers to the Treasury curve. Curves are generally upward sloping, although not always. In theory, investors require higher rates of return in exchange for taking more risk. Simply put, the longer the bond, the more risky it is, the higher the yield, which generates the upward sloping curve.
The area of the curve from the 2-year to the 10-year is considered the benchmark curve. When analyzing the shape, (i.e. steepness or flatness) this is area most concentrated on. I plan on discussing curve shape next week.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Only so much paper can be gobbled up at these levels. We saw the yield on the 10 year Treasury, which is tracked closely by the 30 year mortgage, increase by 25 basis points this week. The government must find a balance between funding the stimulus through fiscal spending and promoting economic growth through monetary easing. The Treasury announced $40 billion in two-year notes and $30 billion in five-year notes to be auctioned off next week. The question is, how much of this new supply is the Fed going to have to purchase themselves in order to keep rates low?
The Curve
Also referred to as the term structure of interest rates, curves show what a specific type of bond is yielding across a range of maturities. The graph below shows yield in percent on the vertical axis and time to maturity in years on the horizontal axis. The white line shows the current Treasury curve and the green line shows it as of 12/23/08.
Notice how the two curves in the graph are different shapes. It may be difficult to see from the graph, but since December 23rd the yield on the 2-year has dropped, 11.5 basis points, (or .115 percentage points), from .915 to .80% while the yield on the 10-year has risen 43.2 basis points, from 2.173% to 2.605%. This shift would be considered flattening.
There are curves for municipal bonds, agencies, etc., but in general terms, “the curve” refers to the Treasury curve. Curves are generally upward sloping, although not always. In theory, investors require higher rates of return in exchange for taking more risk. Simply put, the longer the bond, the more risky it is, the higher the yield, which generates the upward sloping curve.
The area of the curve from the 2-year to the 10-year is considered the benchmark curve. When analyzing the shape, (i.e. steepness or flatness) this is area most concentrated on. I plan on discussing curve shape next week.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Daily Insight
U.S. stocks ended a pretty good session on Friday, especially after a triple-digit decline in pre-market futures gave the impression things were going to be rough. A couple of good earnings reports out of the tech sector and what appeared to be an increased chance of a decent tax response making it into the stimulus bill helped the broad market rally about two hours into trading.
(Let’s hope Congress gets the message the market is sending, which looked to be the case on Friday. However, what we heard on the Sunday morning talk shows was not altogether helpful. President Obama’s chief economic advisor made pretty clear his disdain for current tax rates, and what they are calling tax cuts in the stimulus bill are mostly government transfer payments to those that escape federal taxes on income.)
At this point, I don’t see even the higher current-year allowances on business spending write-offs in the bill, but there are some good ideas the Senate may be able to force into the legislation. Tax cut proposals from the House were completely ignored last week, but the Senate works a little different and if the Obama Administration wants a bipartisan bill, they’ll have to compromise a bit. The market is showing investors do not like what they have seen thus far – the S&P 500 is down 7.8% for the month.
Most of the 10 major sectors within the S&P 500 managed to gain ground on Friday. Industrials took it on the chin, however, as shares of GE lost 10%.
Market Activity for January 23, 2009
Concentrate on Your Own Currency
We were without an economic release on Friday, so the big news of the day was statements from the soon-to-be Treasury Secretary Tim Geithner. In written comments to members of Congress, Geithner expressed the administration believes China is “manipulating” their currency. A red light goes off in my head when I see politicians and policymakers engaging in this talk.
Look, China is likely to devalue their currency for fear a substantial deterioration in domestic growth will trigger levels of unemployment that result in social unrest. The Chinese government, of course, does not want this to occur. They’ve learned their old ways of tamping uprisings don’t work real well, at least in an overt sense, as it damages economic ties with trading partners and have since used economic responses to quell these events.
What that means is they will devalue their currency to boost exports. The Treasury Secretary can engage in all of the currency rhetoric he wants; what he needs to concentrate on is policy that sends the world the message the U.S. is the place in which capital will remain the most welcome and best treated, to borrow the Walter Wriston adage. He can do this by recommending broad-based tax rate reductions on income, corporate profits and especially capital along with reminding the Fed that sound monetary policy is in our best long-run interest.
For now, he seems set on vilifying the Chinese. (We should recall our trade deficit with China grew so wide over the previous few years not because of Chinese currency manipulation but primarily because the Federal Reserve kept real interest rates negative a few years back that encouraged credit expansion – when the Fed effectively subsidizes debt, you’re going to get more debt and naturally higher levels of consumption.)
Furthermore, one cannot state that they believe in a strong dollar, but in the same breath say China must strengthen their currency. To achieve this China must reduce their foreign currency reserves, much of which is in U.S. dollars. Such action will not boost the value of the dollar, but weaken it. What’s more, when we’re about to engage in $1 trillion in Treasury debt offerings over the next year, picking this fight is that much worse.
In addition, we can call on the Chinese to boost the value of their currency (the Yuan) but even if China becomes less competitive in terms of a manufacturing base, it’s not going to bring certain types of factory jobs back to the U.S. They will simply move to Thailand or Vietnam, not Cleveland or Raleigh.
Don’t do it Geither; you’re playing with fire. A trade war, especially right now is in no ones interest, and that’s putting it mildly. Ignorant politicians have already jumped on Geithner’s comments by stating if we can’t work things out diplomatically we can do it legislatively. Read that as tariffs. Be very careful Mr. Treasury.
Earnings Season
This week marks the heart of fourth-quarter earnings season and will give us a very good sense of how profit results will shape up for what was a horrendously weak period. Forget overall S&P 500 earnings results right now, pro-cyclical accounting rules are in the process of putting the financial sector six feet under. What we should concentrate on are ex-financial results. If we can get past the season with a decline in ex-financial profits that doesn’t exceed 10%, I think the market can rally on the news, all else held constant. We’ll have a good idea by the end of this week.
Today we get back to economic data as the Leading Economic Indicators (LEI) index for December is out and existing home sales for last month too.
LEI is going to post another decline, weighed down by labor market indicators such as jobless claims and hours worked. The housing market will also continue to pressure the number as building permits are very weak.
Existing home sales for December will make another new low.
We need a confidence boost and nothing can accomplish this like immediate and “permanent” reductions in tax rates – investors and consumers need certainty! The Bush Administration failed to include this in their response to the economy’s woes and it doesn’t seem President Obama is too interested either as he’s focusing on public works programs and government transfer payments.
But maybe the market is successful in sending a clear message to policy makers. If this means another move lower, so be it; getting Washington’s attention will be very helpful to stock prices over the next year. To engage in stimulus without driving after-tax returns on incomes and capital higher just doesn’t seem very serious to me. It makes one believe there’s some other agenda in play.
Have a great day!
Brent Vondera, Senior Analyst
(Let’s hope Congress gets the message the market is sending, which looked to be the case on Friday. However, what we heard on the Sunday morning talk shows was not altogether helpful. President Obama’s chief economic advisor made pretty clear his disdain for current tax rates, and what they are calling tax cuts in the stimulus bill are mostly government transfer payments to those that escape federal taxes on income.)
At this point, I don’t see even the higher current-year allowances on business spending write-offs in the bill, but there are some good ideas the Senate may be able to force into the legislation. Tax cut proposals from the House were completely ignored last week, but the Senate works a little different and if the Obama Administration wants a bipartisan bill, they’ll have to compromise a bit. The market is showing investors do not like what they have seen thus far – the S&P 500 is down 7.8% for the month.
Most of the 10 major sectors within the S&P 500 managed to gain ground on Friday. Industrials took it on the chin, however, as shares of GE lost 10%.
Market Activity for January 23, 2009
Concentrate on Your Own Currency
We were without an economic release on Friday, so the big news of the day was statements from the soon-to-be Treasury Secretary Tim Geithner. In written comments to members of Congress, Geithner expressed the administration believes China is “manipulating” their currency. A red light goes off in my head when I see politicians and policymakers engaging in this talk.
Look, China is likely to devalue their currency for fear a substantial deterioration in domestic growth will trigger levels of unemployment that result in social unrest. The Chinese government, of course, does not want this to occur. They’ve learned their old ways of tamping uprisings don’t work real well, at least in an overt sense, as it damages economic ties with trading partners and have since used economic responses to quell these events.
What that means is they will devalue their currency to boost exports. The Treasury Secretary can engage in all of the currency rhetoric he wants; what he needs to concentrate on is policy that sends the world the message the U.S. is the place in which capital will remain the most welcome and best treated, to borrow the Walter Wriston adage. He can do this by recommending broad-based tax rate reductions on income, corporate profits and especially capital along with reminding the Fed that sound monetary policy is in our best long-run interest.
For now, he seems set on vilifying the Chinese. (We should recall our trade deficit with China grew so wide over the previous few years not because of Chinese currency manipulation but primarily because the Federal Reserve kept real interest rates negative a few years back that encouraged credit expansion – when the Fed effectively subsidizes debt, you’re going to get more debt and naturally higher levels of consumption.)
Furthermore, one cannot state that they believe in a strong dollar, but in the same breath say China must strengthen their currency. To achieve this China must reduce their foreign currency reserves, much of which is in U.S. dollars. Such action will not boost the value of the dollar, but weaken it. What’s more, when we’re about to engage in $1 trillion in Treasury debt offerings over the next year, picking this fight is that much worse.
In addition, we can call on the Chinese to boost the value of their currency (the Yuan) but even if China becomes less competitive in terms of a manufacturing base, it’s not going to bring certain types of factory jobs back to the U.S. They will simply move to Thailand or Vietnam, not Cleveland or Raleigh.
Don’t do it Geither; you’re playing with fire. A trade war, especially right now is in no ones interest, and that’s putting it mildly. Ignorant politicians have already jumped on Geithner’s comments by stating if we can’t work things out diplomatically we can do it legislatively. Read that as tariffs. Be very careful Mr. Treasury.
Earnings Season
This week marks the heart of fourth-quarter earnings season and will give us a very good sense of how profit results will shape up for what was a horrendously weak period. Forget overall S&P 500 earnings results right now, pro-cyclical accounting rules are in the process of putting the financial sector six feet under. What we should concentrate on are ex-financial results. If we can get past the season with a decline in ex-financial profits that doesn’t exceed 10%, I think the market can rally on the news, all else held constant. We’ll have a good idea by the end of this week.
Today we get back to economic data as the Leading Economic Indicators (LEI) index for December is out and existing home sales for last month too.
LEI is going to post another decline, weighed down by labor market indicators such as jobless claims and hours worked. The housing market will also continue to pressure the number as building permits are very weak.
Existing home sales for December will make another new low.
We need a confidence boost and nothing can accomplish this like immediate and “permanent” reductions in tax rates – investors and consumers need certainty! The Bush Administration failed to include this in their response to the economy’s woes and it doesn’t seem President Obama is too interested either as he’s focusing on public works programs and government transfer payments.
But maybe the market is successful in sending a clear message to policy makers. If this means another move lower, so be it; getting Washington’s attention will be very helpful to stock prices over the next year. To engage in stimulus without driving after-tax returns on incomes and capital higher just doesn’t seem very serious to me. It makes one believe there’s some other agenda in play.
Have a great day!
Brent Vondera, Senior Analyst
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