Treasuries were mixed today. The short end sold off as the two-year dropped 1/32 of a point in price while the ten-year traded higher by half of a point. The benchmark curve was flatter on the day by 10 basis points. A basis point represents .01%.
MBS reversed trend today and widened considerably to Treasuries. MBS as a whole underperformed the rest of fixed income as investors struggle to accurately price the Fed’s participation in the market. These wild jumps can be expected when prices are propped up artificially. Thirty-year 5% mortgages were 20 basis points wider to Treasuries after tightening 55 basis points over the past month.
The Four Primary Risks of Bonds
Credit
Duration
Liquidity
Structure
A liquid investment is one that can be bought or sold in a timely manner without a significant movement in the price. Liquidity is often measured by “the bid-ask spread”, or the difference between the price at which someone is willing to purchase or sell a security.
Highly liquid Treasury bills have a very small bid-ask spread. As I am writing one can sell four-week T-bills at 99.980 and buy them at 99.983. The .003 spread is negligible. T-bills benefit from having an ample supply and many market participants, who are constantly buying and selling, therefore providing liquidity. Bid-ask spreads can range from almost nothing to 10% of the price or more, depending on a variety of factors.
In general, bonds are less liquid than stocks simply because of the breadth of the bond market. A company that has one common stock traded on the NYSE can have hundreds of different corporate bond issues that trade independently of each other. More issues of smaller size translate into less market participation per issue and less liquidity.
Many investors buy bonds with no intention of ever selling, meaning they can take added liquidity risk, and often earn additional return for doing so. But liquidity can change quickly, along with your intentions of holding a bond to maturity.
Liquidity risk has been in the news a lot recently. Financial institutions that invested in highly complex, hard to value credit derivatives are seeing the value of those investments decrease due to the lack of liquidity in the market. Banks all across the country are taking huge hits due to illiquidity in their securities portfolios, and their solvency, as defined by their regulatory body, is at risk as a result.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Thursday, February 12, 2009
Wednesday, February 11, 2009
Afternoon Review
Ingersoll-Rand (IR) +12.57%
Ingersoll-Rand topped fourth quarter earnings estimates as the company benefited from large synergies from their recent acquisition of Trane.
Fourth-quarter revenues were lower in each operating segment, with revenue declines ranging from high single-digits to high-teens. Operating margins also came under pressure during the quarter, dropping to 7.5 percent from 9.2 percent.
On the bright side, the profit decline was partially offset by synergies from the Trane acquisition that exceeded expectations. Even more, Ingersoll-Rand expects to generate $175 million to $185 million of additional savings in 2009, which would exceed the prior forecast of $125 million.
Looking ahead, Ingersoll-Rand said it expects declining activity in most of its end markets, leading 2009 revenues to decline between 8 percent and 9 percent. While revenue guidance met consensus estimates, earnings projections of -$0.15 to breakeven are far off from the $0.27 consensus.
Quick Hits
- Buffet, Who Invests ‘Forever,’ Finds Shorter Time Horizons Unprofitable
- A detailed look at how the stimulus bills from the House and Senate stimulus differ
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks slid yesterday, marking the biggest decline since Inauguration Day, on skepticism the Treasury Department’s bank “rescue” plan will work. Geithner’s comments that he is still “exploring a range of different structures” to boost capital adequacy ratios and remove “toxic” assets didn’t do much good on day in which the market was expecting the unveiling of a plan – you know, details?
Well, I guess the new Treasury Secretary has now learned firsthand that big buildups to press conferences only to underperform via a lack of specifics is the surest way to get thumped by the market. At least he delivered his comments with far greater aplomb than his predecessor could ever dream of, but that doesn’t matter much if the message entails zero new information.
As if it needs to be mentioned, financials took the brunt of the damage, down nearly 11% as measured by the S&P 500 index that tracks these shares. As you can see by the chart below, none of the major industry groups escaped the wreckage – maybe utilities, which were the relative winners down just 2.99%.
On the brighter side of things, Intel announced plans to spend $7 billion to upgrade its U.S. factories over the next two years. So while others refrain from capital spending projects, the semiconductor giant is stepping up.
This helps to illustrate U.S. corporations have the cash resources to engage in projects (granted not many quite have the huge cash levels that Intel enjoys) and once we can get some confidence into the market, this is one aspect of the economy that can fire things up. It is a huge mistake by policymakers not to use tax incentives to drive this aspect of the economy.
Market Activity for February 10, 2009
The (new) Financial Rescue Plan
The Treasury Secretary stated the financial “rescue” plan will involve capital injections into banks, new programs to help struggling mortgage borrowers, a significant expansion of the Fed’s consumer lending facility and an entity that will help facilitate the removal of “toxic” assets from bank balance sheets.
We have no way of knowing how the administration will offer assistance to struggling mortgage borrowers, the design was not explained. On the expansion of the Fed’s consumer lending facility (what’s known as the TALF), it will now include the purchase of securities backed by commercial real estate, increasing the program to $1 trillion from $200 billion. Formerly it only involved credit-card, student-loan and auto-loan debt.
This leaves us with the primary aspects of the plan – additional capital injections and the “bad bank” entity, which is being termed the Public-Private Investment Fund (PPIF).
On the first, I don’t see how it improves things as banks will continue to hoard cash so long as mark-to-market accounting forces them to write-down assets to distressed-market prices – even for assets that are performing as expected. They are unwilling to take on the level of lending that policymakers want, not only because this is a natural reaction in an economic downturn, but also for fear the new assets they take on via additional lending have to be marked-to-disaster and cause further erosion in capital ratios.
On the second, it appears that private investors will be able to buy a stake in the PPIF entity and then a certain amount of losses will be backstopped by the government – much like the original Paulson MLEC plan first suggested in late 2007. But the problem is no one is sure. Maybe, the Treasury will just offer loans to provide the funding for these purchases. A little clarity would be nice. The fund will begin at $500 billion and could rise to $1 trillion – this has become a popular figure.
Here too, the accounting rule is keeping bidders from the market, exacerbating the spiral. Firms are not willing to step in and buy, even if they see prices well-below intrinsic value on many assets, as they fear the endless write-down cycle will continue. (It took eight years into the Great Depression before policymakers got it through their thick skulls to abolish market-based accounting – the 1930s was the last time it was tried. The question is, how long and how much damage will it take this time?)
It is also key to understand that as the government is continually changing the rules, it freezes private capital. Investors are unwilling to step in without some level of certainty.
Monthly Small Business Survey
In the latest small business survey, The National Federation of Independent Business (NFIB) showed their optimism index weakened to 84.1 in January (the lowest level in its 23-year history) from 85.2 in December – 12 months ago the readings was 91.8.
The net percentage of small firms planning to hire was unchanged at -6% (that’s the difference between the percentage of firms increasing hiring minus those decreasing in the next three months) and firms raising selling prices fell to -15% (also a historic low for this survey). The readings were +9% and +8%, respectively, a year ago.
In general, lackluster sales and earnings trends resulted in the optimism index hitting a new low. As a result, hiring remains depressed. We have yet to see an indication (anywhere) that labor-market declines will ease anytime over the next couple of months.
My take is the current level of job losses are not sustainable and we will see the monthly employment declines ease 3-4 months out, but we have no evidence of this thus far. The caveat attached to this comment is that government refrains from policy that does additional harm to business and consumer sentiment.
The degree to which the government is involved makes it even more difficult than normal to gauge the direction of the economy. This is true for the business community as well as sales visibility seems to be as nonexistent as anytime in the post-WWII era.
Another Circus
This morning bank executives will be on Capitol Hill, all set up in a row to be lambasted by members of Congress in another TV sideshow.
Maybe if any of these guys have an ounce of testosterone left in them, they’ll remind the high-and-mighty that it was not that long ago in which they were being pressured to make credit to low-income borrowers more available, or be accused of redlining. When this combined with the easy money mistakes of the Fed, hindsight shows it was the perfect ignition for a boom/bust scenario.
There’s news this morning that Bank of America Chairman/CEO Ken Lewis is taking an eight-hour train ride to Washington, because of all the commotion over corporate jets no doubt. This degree of groveling is embarrassing to watch. We need a little more leadership from top-level business management and a lot less prostration. .
Have a great day!
Brent Vondera, Senior Analyst
Tuesday, February 10, 2009
Principal Financial Group (PFG) -29.59%
Principal Financial earnings (reported after the closing bell yesterday) beat forecasts, but unrealized investment portfolio losses were substantially worse than expected, raising concerns the company may need more capital.
Gross unrealized losses on corporate debt widened to $5.1 billion from $2.8 billion, driven by declines in holdings of banks, insurers and industrial companies. Unrealized losses, which don’t affect net income, are watched by regulators and rating firms to gauge financial strength.
It was no surprise that Moody’s lowered its outlook on Principal to negative saying, “the company’s pension and asset management businesses are highly sensitive to equity market risk, and to the weakening economy. This, together with additional asset impairments, will continue to depress earnings in 2009.” On the other hand, Moody’s admits that “the ultimate economic losses from Principal’s investments are likely to be significantly less than current market values suggest.”
Those who rely on book value for valuing investments must be disgusted. The increase in unrealized losses of about $16.08 a share resulted in a decline in the company’s book value (which is basically a measure of all its assets if the company was liquidated immediately) to $7.45 a share from $19.56 a share a quarter earlier, and $26.55 a share a year ago.
Also hurting shares was the lack of visibility in the Obama administrations financial bailout plan and the realization that insurance companies are unlikely to get near term aid.
FedEx (FDX) -6.52%
While most companies looking at Washington to see how the stimulus plan shakes out, FedEx faces the return of a bill that could escalate a lobbying war with organized labor and rival United Parcel Service (UPS).
The legislation contains a provision that specifically targets FedEx’s and its ability to keep more of its express delivery employees from organizing. Without getting into too much detail, FedEx would lose its rights to bargain under the Railway Labor Act if the bill succeeds. As a result, the company could no longer block FedEx Express workers from organizing at a local level.
UPS, founded as a ground-based courier, has not enjoyed the same treatment as FedEx, because the original exemption covers railways and airlines. FedEx was founded as an airline. UPS has been pushing for the exemption to be scrapped for many years.
With the exception of the pilots’ union, FedEx has been very successful at holding off unions. The risk of unionization would increase significantly if FedEx Express was moved out of the Railway Labor Act.
Cisco (CSCO) -4.75%
Cisco’s surprisingly large $4 billion debt sale on Monday follows a string of successful efforts just in the past five weeks to tap the market for corporate debt. The size of the offering and the relatively low-risk premiums attached to the bonds indicate that investors are hungry for debt from highly rated companies.
While Cisco has about $29 billion of cash and investments and roughly $6 billion in debt, only about $3 billion to $4 billion of its cash is held in the U.S.
Cisco said it would use the proceeds of the offering to bolster its domestic cash position for general purposes that may include stock buybacks, debt repayment, acquisitions, investments, capital expenditure and advances to subsidiaries. Many viewed Cisco’s debt offering as a sign that an acquisition is coming.
My feeling has long been that EMC would be a good fit for them. During their conference call last week, Cisco alluded to virtualization software, cloud computing or data center technology as areas of interest – all areas that EMC could provide a boost.
Intel (INTC) -5.57%
Intel announced a $7 billion investment over two years in new manufacturing facilities in the U.S., which it says will help safeguard 7,000 high-wage highly skilled jobs in three states.
While most chipmakers are reducing spending on production capacity, this will be Intel’s largest ever investment for a new manufacturing process, which also represents an acceleration of its move to 32-nanometer technology, allowing it to build faster, smaller chips that consume less energy and cost less to produce.
The company also said it plans to initially use the 32-nanometer process to create chips for use in mainstream desktop computers and laptops. In the past, Intel has often started by using new production recipes to make chips for high-performance desktop PCs or server systems, products that command higher prices and profits.
This should not only allow it to extend its lead in PC microprocessor technology over its rival Advanced Micro Devices, but it will also help it to achieve faster penetration of other markets such as embedded devices and cell phones.
Quick Hits
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks ended yesterday’s session relatively flat (although activity was somewhat volatile throughout the day) as investors hold off and wait for the path Treasury Secretary Geithner will lay out in his press conference this morning.
The S&P 500 managed a small gain, while the Dow was dragged lower by consumer and energy-related shares. A nice day from shares of 3M and GE were not enough to pull the 30-stock index to the plus side
Financial and industry shares pushed the broad market into positive territory by the close as traders await the Geithner announcement and assume if the plan is effective these will be the areas that receive the most benefit – financials for the obvious reasons and industrials simply because of the economic boost that may result.
Decliners just barely beat advancers, 10 stocks fell for every eight that rose. Volume was subdued as 1.2 billion shares traded on the NYSE, 15% below the three-month average.
Market Activity for February 9, 2009
Some Early Signs of Reflation
Metals prices have rebounded from the lows they set following the credit market chaos that began in September. The market, assuming no additional carnage is upon us (no new financial-sector events I should say), seems to be turning its focus from deflation risk to inflation, even if it will take some time still for this to set in.
While the inflation rates that we think are possible due to trillions in liquidity the Fed has pumped in (the cash is being hoarded for now but when lending normalizes it will explode through the system) and another trillion dollars from the fiscal side will not be a pleasant event, it is good for stocks right now to expect the deflation event will not truly occur.
The Baltic Dry Index (a gauge measuring the price of moving raw materials by sea among 26 shipping routes) has also rebounded from it 22-year nadir back in November.
If these trends continue it will help to ease concerns over the state of economic activity and stock prices as a result.
The Burden
We have a number of challenges in front of us, and I’m just not talking purely from an economic perspective. We have entitlement programs that are out of control and demographics will intensive the situation. There are also geopolitical risks that must be dealt with and homeland security is a premium. On the economic front, we have a housing market that remains in a nasty correction, the credit markets are not normal, and joblessness is rising, fast.
However, this economy is spring-loaded because the things that matter most look good. Inventories are low – and thus we do not have the usual bloat that accompanies this point in the business cycle, businesses are streamlined and stuffed with cash, our labor force is highly productive -- thanks to a strong work ethic and capital improvements that drive productivity, and real (inflation-adjusted) wages have jumped over the past few months -- thanks to the plunge in energy prices. We should expect real incomes to remain positive over the long term thanks to the prior point – real wage growth is dependent upon the marginal productivity of labor.
But darn, the private sector continues to get bashed via political rhetoric. By stating lower tax rates (specifically on capital) and freer trade got us into this mess, while ignoring the true reasons – terrible monetary policy mistakes, government intrusion in the housing market (demanding low-income borrowers gain cheap access to credit) and an accounting rule that has exacerbated the whole thing -- is terribly destructive.
Look, investors want to seek out the next innovation and businesses want to invest in new equipment, but capital will remain on strike so long as policy makers, either explicitly or tacitly, continue to state tax rates are going higher and free trade pacts will be destroyed. The government cannot get in the way like it has over the past year, and the concern is it’s pretty obvious the shadow, or economic burden, will extend over the next few years.
If we just refrain from making major mistakes in the future, our economy is poised to bounce back. But if we fail to learn from the most destructive policies of the past – a printing press-minded Fed, higher tax rates (especially during periods of economic vulnerability) and protectionism -- we’re headed for a tough economic road ahead and that means the stock market (savings) will remain mired as well. We should be very careful here.
(Note on the Fed: They have had little choice of late in terms of their monetary and quantitative easing, but they have done what they can for now – the credit troubles have eased substantially. They should not seek to continue to print money in order to drive the cost of money down further – it won’t take long before this policy backfires and they find interest rates are much higher than is accommodative to economic recovery. The market sets prices for a reason and somewhat wider spreads is its way of erasing the credit excesses that resulted from easy money policies of the past. If the Fed looks to drive spreads to normal-economic-situation levels, when things are not normal, it will have consequences.)
Economic Reports for the Week
We were without an economic release yesterday, but get back to it this morning with December wholesale inventories. While this is old data, it will give us a hint to what business inventories will look like when that figure is reported on Thursday. Some will be watching for a larger-than-expected decline as this will affect the Q4 GDP revision to the downside (the inventory component of GDP is what kept the figure from posting a 5.0% real rate of decline).
Later in the week, the most important reports will be the January retail sales figure and initial jobless claims for the week ended February 7.
Of course today the market will be intensely tuned to the Treasury Secretary’s press conference, which will spell out their approach to dealing with the banking sector. The market expects a complete package, he’ll need to deliver.
Have a great day!
Brent Vondera, Senior Analyst
The S&P 500 managed a small gain, while the Dow was dragged lower by consumer and energy-related shares. A nice day from shares of 3M and GE were not enough to pull the 30-stock index to the plus side
Financial and industry shares pushed the broad market into positive territory by the close as traders await the Geithner announcement and assume if the plan is effective these will be the areas that receive the most benefit – financials for the obvious reasons and industrials simply because of the economic boost that may result.
Decliners just barely beat advancers, 10 stocks fell for every eight that rose. Volume was subdued as 1.2 billion shares traded on the NYSE, 15% below the three-month average.
Market Activity for February 9, 2009
Some Early Signs of Reflation
Metals prices have rebounded from the lows they set following the credit market chaos that began in September. The market, assuming no additional carnage is upon us (no new financial-sector events I should say), seems to be turning its focus from deflation risk to inflation, even if it will take some time still for this to set in.
While the inflation rates that we think are possible due to trillions in liquidity the Fed has pumped in (the cash is being hoarded for now but when lending normalizes it will explode through the system) and another trillion dollars from the fiscal side will not be a pleasant event, it is good for stocks right now to expect the deflation event will not truly occur.
The Baltic Dry Index (a gauge measuring the price of moving raw materials by sea among 26 shipping routes) has also rebounded from it 22-year nadir back in November.
If these trends continue it will help to ease concerns over the state of economic activity and stock prices as a result.
The Burden
We have a number of challenges in front of us, and I’m just not talking purely from an economic perspective. We have entitlement programs that are out of control and demographics will intensive the situation. There are also geopolitical risks that must be dealt with and homeland security is a premium. On the economic front, we have a housing market that remains in a nasty correction, the credit markets are not normal, and joblessness is rising, fast.
However, this economy is spring-loaded because the things that matter most look good. Inventories are low – and thus we do not have the usual bloat that accompanies this point in the business cycle, businesses are streamlined and stuffed with cash, our labor force is highly productive -- thanks to a strong work ethic and capital improvements that drive productivity, and real (inflation-adjusted) wages have jumped over the past few months -- thanks to the plunge in energy prices. We should expect real incomes to remain positive over the long term thanks to the prior point – real wage growth is dependent upon the marginal productivity of labor.
But darn, the private sector continues to get bashed via political rhetoric. By stating lower tax rates (specifically on capital) and freer trade got us into this mess, while ignoring the true reasons – terrible monetary policy mistakes, government intrusion in the housing market (demanding low-income borrowers gain cheap access to credit) and an accounting rule that has exacerbated the whole thing -- is terribly destructive.
Look, investors want to seek out the next innovation and businesses want to invest in new equipment, but capital will remain on strike so long as policy makers, either explicitly or tacitly, continue to state tax rates are going higher and free trade pacts will be destroyed. The government cannot get in the way like it has over the past year, and the concern is it’s pretty obvious the shadow, or economic burden, will extend over the next few years.
If we just refrain from making major mistakes in the future, our economy is poised to bounce back. But if we fail to learn from the most destructive policies of the past – a printing press-minded Fed, higher tax rates (especially during periods of economic vulnerability) and protectionism -- we’re headed for a tough economic road ahead and that means the stock market (savings) will remain mired as well. We should be very careful here.
(Note on the Fed: They have had little choice of late in terms of their monetary and quantitative easing, but they have done what they can for now – the credit troubles have eased substantially. They should not seek to continue to print money in order to drive the cost of money down further – it won’t take long before this policy backfires and they find interest rates are much higher than is accommodative to economic recovery. The market sets prices for a reason and somewhat wider spreads is its way of erasing the credit excesses that resulted from easy money policies of the past. If the Fed looks to drive spreads to normal-economic-situation levels, when things are not normal, it will have consequences.)
Economic Reports for the Week
We were without an economic release yesterday, but get back to it this morning with December wholesale inventories. While this is old data, it will give us a hint to what business inventories will look like when that figure is reported on Thursday. Some will be watching for a larger-than-expected decline as this will affect the Q4 GDP revision to the downside (the inventory component of GDP is what kept the figure from posting a 5.0% real rate of decline).
Later in the week, the most important reports will be the January retail sales figure and initial jobless claims for the week ended February 7.
Of course today the market will be intensely tuned to the Treasury Secretary’s press conference, which will spell out their approach to dealing with the banking sector. The market expects a complete package, he’ll need to deliver.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries were mixed today. The short end sold off as the two-year dropped 1/32 of a point in price while the ten-year traded higher by 1/32 of a point. The benchmark curve was steeper on the day by about 3 basis points. A basis point represents .01%.
MBS continue to tighten to Treasuries. Fed buying of agency MBS has definitely had its desired effect as they have tightened more than 60 basis points since the program was implemented at the beginning of the year. February has the potential to be a big month for prepayments as January was slower then expected.
Treasury Inflation Protected Securities (TIPS) were up big today. The on-the-run ten-year TIP was up 1.5% to 104.625, as inflation concerns over monetary easing are making inflation protection look pretty cheap at these levels. Ten-year TIPS were trading in the low 80’s as recently as mid November.
Fed Purchasing
The Fed is about $90 billion into a $500 billion agency MBS buying program aimed at lowering conforming mortgage borrowing costs. Although their explicit guarantee on Fannie and Freddie MBS and senior debt is currently capped at $100 billion for each agency, $200 billion total, they are essentially responsible for all of it at this point. The point is, the Fed is creating liquidity while not taking on any more credit risk on behalf of taxpayers.
Not the same is true however, for what the Fed might begin purchasing in the near future. If this new program is implemented, commercial mortgage-backed securities and small business loans will be bought by the Fed in the open market. Those who support the program claim that the Fed will be getting “more bang for their buck” than if they would go the traditional route and purchased Treasuries. I agree that the effect on credit spreads will be substantial, but supporters of the program appear to be ignoring the added credit risk the Fed will be taking.
The buying and selling of Treasuries through open market operations in order to manipulate the money supply, and therefore interest rates, has long been a primary responsibility of the Federal Reserve. But many argue that with rates being so low, Treasury buying will have little effect.
With the 10 year at 3%, the Fed has a lot of ammo left with regard to lowering rates, even with Fed Funds at .25%. Buying Treasuries, to lower risk free rates, and then allowing the market to price risk without the distraction of government subsidization, is more in line with what the Fed was created to do.
Don’t get this confused with the Treasury’s “Aggregator Bank” idea, where the Treasury would buy risky assets from the balance sheets of troubled financial institutions instead of making more capital injections. In our opinion, the “Aggregator Bank” model under TARP, would be much more effective than the capital injections that were made in late 2008, but differs greatly from Federal Reserve Open Market Operations.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
MBS continue to tighten to Treasuries. Fed buying of agency MBS has definitely had its desired effect as they have tightened more than 60 basis points since the program was implemented at the beginning of the year. February has the potential to be a big month for prepayments as January was slower then expected.
Treasury Inflation Protected Securities (TIPS) were up big today. The on-the-run ten-year TIP was up 1.5% to 104.625, as inflation concerns over monetary easing are making inflation protection look pretty cheap at these levels. Ten-year TIPS were trading in the low 80’s as recently as mid November.
Fed Purchasing
The Fed is about $90 billion into a $500 billion agency MBS buying program aimed at lowering conforming mortgage borrowing costs. Although their explicit guarantee on Fannie and Freddie MBS and senior debt is currently capped at $100 billion for each agency, $200 billion total, they are essentially responsible for all of it at this point. The point is, the Fed is creating liquidity while not taking on any more credit risk on behalf of taxpayers.
Not the same is true however, for what the Fed might begin purchasing in the near future. If this new program is implemented, commercial mortgage-backed securities and small business loans will be bought by the Fed in the open market. Those who support the program claim that the Fed will be getting “more bang for their buck” than if they would go the traditional route and purchased Treasuries. I agree that the effect on credit spreads will be substantial, but supporters of the program appear to be ignoring the added credit risk the Fed will be taking.
The buying and selling of Treasuries through open market operations in order to manipulate the money supply, and therefore interest rates, has long been a primary responsibility of the Federal Reserve. But many argue that with rates being so low, Treasury buying will have little effect.
With the 10 year at 3%, the Fed has a lot of ammo left with regard to lowering rates, even with Fed Funds at .25%. Buying Treasuries, to lower risk free rates, and then allowing the market to price risk without the distraction of government subsidization, is more in line with what the Fed was created to do.
Don’t get this confused with the Treasury’s “Aggregator Bank” idea, where the Treasury would buy risky assets from the balance sheets of troubled financial institutions instead of making more capital injections. In our opinion, the “Aggregator Bank” model under TARP, would be much more effective than the capital injections that were made in late 2008, but differs greatly from Federal Reserve Open Market Operations.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Monday, February 9, 2009
Afternoon Review
S&P 500 earnings season enters its final stretch with 68 percent of the companies already reported and 60 companies expected to report this week. Consumer Discretionary, Financials and Consumer Staples will be the most active sectors with each having more than eight companies report this week.
Principal Financial Group (PFG) +1.19%
Set to announce fourth-quarter earnings after the bell, Principle Financial rose on news that regulators may allow insurers to reduce reserves in an effort to bolster its finances.
Principal Financial’s earnings results should reflect that they are suffering from investment losses, market declines and outflows. Yet, the company’s strong retirement services business should soften the blow of the weak insurance landscape.
The most important aspect of their report, however, will be the company’s investment portfolio. In recent quarters, Principal Financial has reiterated its confidence in its investment portfolio and the adequacy of its capital position. While current capital adequacy evaluations by the ratings agencies don’t factor in gross unrealized loss positions, Principal Financial would appear to have a small margin for error in terms of capital positions should that change.
To demonstrate its comfort that only a small fraction of the its $1.1 billion of unrealized losses are likely to turn into realized losses, Principal Financial added a new page of disclosure in its earnings reports showing some stress tests for cumulative after tax losses for CMBS and CMBS CDOs. Aside from CMBS, which has been the main focus, it would be nice to see the company’s allocation to BBB and below fixed maturity investments decrease from 43 percent. According to Credit Suisse, this is among the highest in the life insurance industry that averages 33 percent.
General Electric (GE) +13.87%
Shares of General Electric surged as investors placed bets ahead of the unveiling of the new financial rescue package and GE’s reconsideration of their dividend payment.
GE’s board of directors plan to reevaluate the company’s $1.24 per share dividend in the second half of 2009 citing the global recession, regulatory changes and ratings-service reviews of GE’s Aaa ratings. CEO Jeff Immelt said last week, “We are prepared to run it as a Double-A, we are prepared to run it as a Triple-A…I’m not going to change the way I run the business.”
Many analysts have advocated a dividend cut to give GE more flexibility with its cash. This camp wants to see GE investment in new and existing businesses so that they are stronger when the economy turns.
Quick Hits
- Goldman Sachs CEO: Do not destroy the essential catalyst of risk
- Central Banks Sacrifice Independence as Crisis Grows
- Ruin Your Health With the Obama Stimulus Plan
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks rallied Friday despite another really rough jobs report as traders anticipated the announcement Geithner was supposed to deliver today regarding the bank rescue. Apparently, they had high hopes on the direction the administration would take -- too bad the market will have to wait another day as the announcement has been delayed; they’re paying with fire in this market environment.
The financial press reported the depressing jobs report sparked the rally as this would force Congress to pass the stimulus package. I’m not sure about this one as the market understands what we’re getting doesn’t exactly inspire the equity investor. Besides, the Senate is still working to pass the thing and then it will move on to the House to be worked some more.
More likely, traders didn’t want to be out of the market, or short, just ahead of the Geithner announcement.
From a more fundamental aspect – unfortunately we don’t hear that much these days as everyone is focused on government’s response (which is exactly the problem) – longer-term investors may have stepped in simply as a result of the magnitude of job losses last month. We lost 598,000 payroll positions in January and this marks the third-straight month of darn-near 600k declines. Such outsized losses should not continue for much longer, and some of the buying may have been driven by this thought.
As we mentioned on Friday, it will take additional mistakes out of Washington to keep this level of job losses going. The trade fight some politicians, ignorant of history, seem to be sparking could certainly do it but we’re not there yet.
Financials led the market higher as concerns over bank nationalization eased. Technology and consumer discretionary shares were among the other strong relative performers.
Market Activity for February 6, 2009
The Jobs Report
Well, so much for that quirk in the seasonal adjustment I was expecting. The Labor Department reported payroll positions were slashed by 598,000 in January. Over the past 12 months 3.5 million jobs have been lost, with 70% occurring since September and 50% in the past three months. No other data set shows more clearly the degree to which things changed since the day Lehman went down – September 15.
Goods-producing industry job losses led the declines, shedding 319,000 positions in January – 111,000 construction jobs and a massive decline of 207,000 manufacturing positions.
Service-producing industries lost 279,000 jobs, although the degree of decline has eased relative to the previous two months – professional and business services led the industry, shedding 121,000.
Education and health services continue to buck the trend, adding 54,000 positions last month – this segment has not shown a month of decline during this period of labor-market malaise.
The unemployment rate jumped to 7.6% -- the highest since September 1992 -- from 7.2% in December. The Household Survey (separate from the payroll survey as it includes the self-employed) showed a decline of 1.239 million jobs last month. It is this survey the Bureau of Labor Statistics uses to calculate the unemployment rate.
On the bright side, hourly earnings continue to show remarkable resilience, up 0.3% last month and 3.9% over the past year. Real wages, as we touched on in Friday’s letter, have exploded to the upside as the plunge in energy costs drive inflation to zero.
The labor market continues to shed jobs at an alarming rate and the streak of monthly declines has extended to 13 months – although the vast majority of this damage occurred in the last five months. The credit event that occurred with the collapse of Lehman sent the equity markets plunging and business financing – especially for small businesses – into chaos. As a result, the consumer pulled back with stunning quickness as their savings (in stocks) plunged and businesses canceled spending plans as they saw the economic contraction that would ensue.
The focus should be set on returning confidence to the consumer, business and investor – anything less will be a failure.
Another Delay
Stock-index futures are lower today after the Senate delivered a bill Friday evening that is junk. This doesn’t surprise the street as Congress has signaled the direction for some time now, but confirms what’s being presented as stimulus is laden with entitlement spending and transfer payments – programs that can have a lasting affect on suppressing growth as it will be very difficult to take them away; those that try to make them temporary will be demonized.
Stocks are also trading lower this morning as the administration has delayed Geithner’s official announcement on their bank rescue plan until tomorrow. This is the second delay now, and one wonders what’s going on. They say they are focused on the stimulus plan today, but I don’t know how a 30-minute press conference limits focus on getting the spending spree passed. They’ve got it passed anyway; it just won’t be a bipartisan event.
On the bank rescue, if it’s even correct to call it that, word is Geithner will propose incentives to encourage private money to buy troubled assets. That means government guarantees protecting against a certain amount of losses will be their tool.
Geez, why don’t they just eliminate mark-to-market, since this is what’s exacerbating the problem. And you want incentives? Place a five-year moratorium on capital gains taxes related to these specific investments – that will bring bids in and the government won’t have to keep printing money to backstop losses. We are wasting so much time and money just to keep a flawed accounting standard in place it makes one wonder…I’ll refrain from writing what I’m thinking right now.
The Geithner plan is also expected to include the “bad bank” idea and more capital injections – it’s pretty clear the government is enjoying the increased control these injections bring.
In the meantime the market has to deal with more uncertainty. The administration should have learned from the previous occupants not to wave proposals in the market’s face only to delay or change plans. Stocks may just offer them another lesson today. We shall see.
Have a great day!
Brent Vondera, Senior Analyst
The financial press reported the depressing jobs report sparked the rally as this would force Congress to pass the stimulus package. I’m not sure about this one as the market understands what we’re getting doesn’t exactly inspire the equity investor. Besides, the Senate is still working to pass the thing and then it will move on to the House to be worked some more.
More likely, traders didn’t want to be out of the market, or short, just ahead of the Geithner announcement.
From a more fundamental aspect – unfortunately we don’t hear that much these days as everyone is focused on government’s response (which is exactly the problem) – longer-term investors may have stepped in simply as a result of the magnitude of job losses last month. We lost 598,000 payroll positions in January and this marks the third-straight month of darn-near 600k declines. Such outsized losses should not continue for much longer, and some of the buying may have been driven by this thought.
As we mentioned on Friday, it will take additional mistakes out of Washington to keep this level of job losses going. The trade fight some politicians, ignorant of history, seem to be sparking could certainly do it but we’re not there yet.
Financials led the market higher as concerns over bank nationalization eased. Technology and consumer discretionary shares were among the other strong relative performers.
Market Activity for February 6, 2009
The Jobs Report
Well, so much for that quirk in the seasonal adjustment I was expecting. The Labor Department reported payroll positions were slashed by 598,000 in January. Over the past 12 months 3.5 million jobs have been lost, with 70% occurring since September and 50% in the past three months. No other data set shows more clearly the degree to which things changed since the day Lehman went down – September 15.
Goods-producing industry job losses led the declines, shedding 319,000 positions in January – 111,000 construction jobs and a massive decline of 207,000 manufacturing positions.
Service-producing industries lost 279,000 jobs, although the degree of decline has eased relative to the previous two months – professional and business services led the industry, shedding 121,000.
Education and health services continue to buck the trend, adding 54,000 positions last month – this segment has not shown a month of decline during this period of labor-market malaise.
The unemployment rate jumped to 7.6% -- the highest since September 1992 -- from 7.2% in December. The Household Survey (separate from the payroll survey as it includes the self-employed) showed a decline of 1.239 million jobs last month. It is this survey the Bureau of Labor Statistics uses to calculate the unemployment rate.
On the bright side, hourly earnings continue to show remarkable resilience, up 0.3% last month and 3.9% over the past year. Real wages, as we touched on in Friday’s letter, have exploded to the upside as the plunge in energy costs drive inflation to zero.
The labor market continues to shed jobs at an alarming rate and the streak of monthly declines has extended to 13 months – although the vast majority of this damage occurred in the last five months. The credit event that occurred with the collapse of Lehman sent the equity markets plunging and business financing – especially for small businesses – into chaos. As a result, the consumer pulled back with stunning quickness as their savings (in stocks) plunged and businesses canceled spending plans as they saw the economic contraction that would ensue.
The focus should be set on returning confidence to the consumer, business and investor – anything less will be a failure.
Another Delay
Stock-index futures are lower today after the Senate delivered a bill Friday evening that is junk. This doesn’t surprise the street as Congress has signaled the direction for some time now, but confirms what’s being presented as stimulus is laden with entitlement spending and transfer payments – programs that can have a lasting affect on suppressing growth as it will be very difficult to take them away; those that try to make them temporary will be demonized.
Stocks are also trading lower this morning as the administration has delayed Geithner’s official announcement on their bank rescue plan until tomorrow. This is the second delay now, and one wonders what’s going on. They say they are focused on the stimulus plan today, but I don’t know how a 30-minute press conference limits focus on getting the spending spree passed. They’ve got it passed anyway; it just won’t be a bipartisan event.
On the bank rescue, if it’s even correct to call it that, word is Geithner will propose incentives to encourage private money to buy troubled assets. That means government guarantees protecting against a certain amount of losses will be their tool.
Geez, why don’t they just eliminate mark-to-market, since this is what’s exacerbating the problem. And you want incentives? Place a five-year moratorium on capital gains taxes related to these specific investments – that will bring bids in and the government won’t have to keep printing money to backstop losses. We are wasting so much time and money just to keep a flawed accounting standard in place it makes one wonder…I’ll refrain from writing what I’m thinking right now.
The Geithner plan is also expected to include the “bad bank” idea and more capital injections – it’s pretty clear the government is enjoying the increased control these injections bring.
In the meantime the market has to deal with more uncertainty. The administration should have learned from the previous occupants not to wave proposals in the market’s face only to delay or change plans. Stocks may just offer them another lesson today. We shall see.
Have a great day!
Brent Vondera, Senior Analyst
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