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Friday, February 20, 2009

Afternoon Review

S&P 500 still above November lows
The S&P 500 continued its slow trek towards its November intra-day low of 741.02, but has still yet to reach it. While there is far less panic and fear in today’s market than there was last November, the level of uncertainty still remains very high.

The fate of the financial system’s largest institutions is the biggest question mark at this point in time. Comments from Senate Banking Committee Chairman Christopher Dodd about the possibility of nationalizing banks “for a short time” sent Citigroup and Bank of America tumbling. Both companies’ stocks, at their current levels, are trading more like options that bet on the government’s forthcoming actions. (If anyone has a crystal ball, please contact me.)

The rally that started last November came to an abrupt stop when Treasury Secretary Tim Geithner could not provide specific details on how the government will rescue the financial system. Today, as the S&P 500 flirted with its November lows, the White House announced they will give the details of the financial bailout sometime next week and added that they are against nationalizing banks.

At this point, we can only hope that the details aren’t as opaque as last time.


Quick Hits

Peter Lazaroff, Junior Analyst

Veteran investors get jittery

Acropolis is in the news again with Chris Lissner appearing in today's St. Louis Post-Dispatch.


To view the article click here or on the logo below.


Daily Insight

U.S. stocks continued their losing streak and the Dow hit new lows Thursday, but the S&P 500 still remains above its November 2008 low.

Investors went into defensive sectors yesterday as concerns about rising credit-card defaults dragged financial shares to their lowest level since 1995 and poor earnings from Hewlett-Packard pushed the technology sector down. Energy benefited from surging oil prices, which rose over 12% on the New York Mercantile Exchange after a U.S. government report showed an unexpected drop in inventories.



Market Activity for February 19, 2009


Economic Data

The Labor Department reported the producer price index (PPI) for January jumped 0.8% for the month, but was down 1.0% on a year-over-year basis – both numbers were higher than anticipated. Core PPI, which excludes food and energy, rose 4.2% year-over-year. Although producer prices climbed more than forecast, it’s unlikely these prices increases will hold given the weakening economy and rising unemployment.

Continuing claims surged by 170,000 in the week ended February 7, and initial jobless claims were unchanged at 627,000 last week (the prior week’s number was revised up to 627,000).

Meanwhile, the Philadelphia Fed Business Outlook Survey showed manufacturing in its region shrank the most since 1990.


Fed Releases Longer-Term Economic Projections

The Fed is doing their best to keep public inflation expectations at reasonable levels and has begun to release longer-term projections for inflation, economic growth and unemployment. The goal is to provide the policy, according to Bernanke, is to “provide the public a clearer picture of FOMC participants’ policy strategy for promoting maximum employment and price stability over time.” This, in turn, would stabilize the public’s inflation expectations and keep actual inflation from rising or falling too dramatically.

The Feds minutes, released on Wednesday, indicated that officials are aiming to move public expectations at a 2% rate. Policy makers estimated long-term economic growth at 2.5% to 2.7% and an unemployment rate at 4.8% to 5%. Only time will tell if this self-fulfilling prophecy strategy can work.


Mortgage Relief Program

Sentiment remains that home prices are still way to high by historical standards for the U.S. housing market to stabilize, and Obama’s mortgage-relief plan is only slowing the bottoming process.

Another big concern is that modifying loans will not have a very large impact. According to the December report by the Comptroller of the Currency and the Office of Thrift Supervision, “The number of loans modified in the first quarter that were 30 or more days delinquent was 37 percent after three months and 55 percent after six months. The number of loans modified in the first quarter that were 60 or more days delinquent was 19 percent at three months and nearly 37 percent after six months.”


Have a great day!

Peter Lazaroff, Junior Analyst

Thursday, February 19, 2009

Afternoon Review

Hewlett-Packard (HPQ) -7.89%
While earnings and sales were mostly in line with expectations, Hewlett-Packard’s guidance showed that the world’s largest PC maker can not dodge the recession. To combat the difficult economy the company is cutting pay for most of its employees.

Revenues were down 19 percent in the personal systems group as well as in the imaging and printing segment. Enterprise storage and servers had revenues decline 18 percent, and software revenues were off 7 percent. Services rose 116 percent due to the EDS acquisition.

The company’s downside forecast for the quarter and full-year were well below consensus estimates. Hewlett-Packard’s outlook sent a slew of tech names lower today including IBM, Dell, Intel, EMC, and Cisco.

Going into today, the technology sector was the second-best performing industry in the S&P 500 this year, which is largely due to the safe haven they offer in strong balance sheets.


United Natural Foods (UNFI) +8.29%
United Natural Foods rallied in response to higher-than-expected earnings and guidance from Whole Foods Market (WFMI).

United Natural Foods derives about 31 percent of net sales from its relationship with Whole Foods as their primary U.S. distributor. With United Natural set to report earnings next week, it appears some investors are expecting the company to replicate Whole Foods’ earnings surprise. Is this enthusiasm overdone?

A closer look at Whole Foods results showed that the earnings surprise was from vast improvements in cost controls and store/property management. The important number relating to United Natural is sales, which declined 4.9 percent as shoppers are trading down from costly organic and natural products to less-expensive nonorganic goods.

While we expect to see United Natural report lower sales next week, it will be more important to evaluate the company’s progress integrating Millbrook (purchased in November 2007). The company has also invested in several new distribution facilities that will help widen margins and add capacity so the company can take on more business in the long-run.


Boeing (BA) -1.08%
Boeing continues to lose orders for its new 787 Dreamliner, which is now almost two years behind schedule. Boeing’s backlog still stretches out well over six years, but investors should brace themselves for more cancellations as airlines’ demand for the new fuel-efficient plane wane in light of lower fuel prices and less passenger traffic.


Oil surges
Crude oil rose over 12 percent on the New York Mercantile Exchange after a U.S. government report showed an unexpected drop in inventories as imports declined.


Quick Hits

Peter Lazaroff, Junior Analyst

Daily Insight

Most U.S. stocks fell as reports on housing and industrial production showed very weak activity remains the case. The President unveiled his mortgage-relief plan, but the market seemed unenthused.

The Dow rose just a bit as gains in shares of Wal-Mart, Proctor & Gamble and McDonalds offset declines in the industrial components of the index. The broad market and NASDAQ Composite lost a bit of ground. Mid and small-cap stocks were the hardest hit, down a bit more than 1.00%.

Two stocks fell for every one rose on the NYSE. Some 1.3 billion shares traded on the big board, 16% below the three-month daily average.


Market Activity for February 18, 2009

Treasury’s Mortgage Plan

The President announced a plan to help nine million (I don’t know how they come up with these numbers) restructure or refinance their mortgages. The program will use $75 billion to bring down mortgage rates and encourage loan modifications – sharing in the cost of reducing monthly mortgage payments (subsidizing a lower interest rate) by having the government match lender reductions to bring that payment down to 31% of borrowers’ monthly income. The Treasury will also double the amount of stock purchases of Fannie Mae and Freddie Mac to as much as $200 billion for each.

In 2008, 75% of home loans were financed by Fannie and Freddie – they’re just about the only game in town -- and the $400 million in capital injections will help to maintain a positive net worth as the government leans on them to provide liquidity for the mortgage market.

On the Economic Front

The Mortgage Banker’s Association reported their index of mortgage applications jumped 45.7% in the week ended February 13 as the 30-year fixed rate fell just below the 5.00% mark. As we’ve been talking about, this is what homeowners are looking for and if this rate can hold below 5% we’ll see several weeks’ worth of gains.

Again, refinancing activity is driving the mortgage apps index as the segment rose 64.3% last week -- although purchases did rise as well, up 9.1%.


In a separate report, the Commerce Department announced housing starts plunged 17% last month to an annual rate of 466,000 units.

U.S. builders broke ground on the fewest houses on record in January (data goes back to 1959) as tighter credit and labor-market deterioration continued to crush sales. Severe weather in January had an effect as well. Multi-family starts fell 27.9%, while single-family starts dropped 12.2%. Single-family starts are 81% off the January 2006 peak.


Commerce also stated building permits fell 5.1%, marking the seventh-straight monthly decline. This is a sign housing construction will remain depressed, as if we need another.


In yet another release, the Labor Department reported import prices fell 1.1% in January, which brings the year-over-year reading to -12.5%. My how thing have changed. It was just six months back when the YOY reading had hit +21.6% -- this is what occurs when monetary policy goes berserk. Granted, Bernanke and Co. don’t have much choice right now; however, all of the current problems can be traced back to flawed monetary policy earlier in the decade.

The plunge in petroleum prices has had the most effect on import prices, that component is down 55% year-over-year. Excluding fuel, import prices are essentially flat – down just 0.3%.


Finally, the Commerce Department stated industrial production fell 1.8% in January, marking the third-straight month of decline – all were substantial declines (down 1.2% in November, down 2.4% in December and, as stated, down 1.8% last month).

Consumer goods, business equipment, construction supply and machinery were all hit hard last month. The manufacturing component delivered the heaviest blow – this segment makes up 77% of the index and it was down 2.5% last month -- pushed lower by a huge 23.4% plunge in auto-related production. Utility activity was the sole bright spot, up 2.7% for the month.

Activity is very depressed, especially within the manufacturing sector. But when we do get a bounce in activity, or at least a flattening process, inventory dynamics should provide a boost to GDP. The inventory-to-sales ratio has jumped since this debacle truly began in September, but is still meaningfully below recessionary levels. Inventory dynamics remain in place and this will provide a catalyst to growth – if only I knew when. Beyond that there is still a sustainability issue as the government is so involved that it puts the private sector increasingly on edge each day.

I’ll be out of the office for the next three days; either David of Peter will take over during this time.

Have a great day!

Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries sold off today as investors took profits after yesterday’s rally. The two-year was down 5/32 of a point in price while the ten-year traded lower by 3/4 of a point as the benchmark curve was virtually unchanged on the day. A basis point represents .01%.

New issue MBS outperformed comparable Treasuries today after lagging yesterday. MBS tightened seven basis points to +150, reversing about half of the widening that occurred yesterday.

Homeowner Affordability and Stability Plan
Here are a couple bullet points from the housing plan announced today by the Obama administration.

  • $75 billion to help homeowners refinance and reduce their monthly payment through non-traditional means
  • Loans with 80-105% LTV will qualify for the program
  • Efforts will be made to reach homeowners early. Homeowners who are struggling, but are still current on their mortgage will qualify.
  • Sacrifices made by the private mortgage servicers will be matched dollar-for-dollar by the government.
  • The interest rate will be modified to bring the monthly payment to a target of 31% of household gross income. After 5 years the interest rate may be gradually stepped up to the prevailing interest rate at the time of the loan modification. For example a 6% mortgage may be modified to 4%, and after five-years will gradually step up to today’s market rate of 5.15%.
  • Private servicers will receive upfront payments of $1,000 for each loan they modify, and $1,000 per year for 3 years on successfully modified loans that stay current.
  • Homeowners who have their loan modified under this program will be eligible for a $1,000 reduction in principal outstanding each year for five years as long as they stay current.
  • For securitized mortgages these modifications will appear to investors as prepayments.The new mortgage will either be held by the servicer or sold in the secondary market.
  • Responsible homeowners and renters who have chosen to live within their means will be penalized through future taxation in order for the government to reward those who did otherwise. (not explicitly noted in the text of the plan)


Preferred Stock Purchase Agreement

Today the Treasury announced an amendment to its Preferred Stock Purchase Agreement with mortgage agencies Fannie Mae and Freddie Mac. The agreement was originally formed to allow for the Treasury to inject up to $100 billion in capital in each agency, $200 billion total, through investments in preferred stock. The limits were doubled today to $200 billion each, or $400 billion total. The limits on the size of their retained mortgage portfolios were also increased $50 billion, to $900 billion each, leaving room for over $200 billion dollars in mortgage demand from the Government Sponsored Enterprises. That’s on top of the $385 billion of securitized mortgages that the Fed has left to purchase in the open market before June.

The Treasury wasn’t nearing the original limits on capital injections, total government funding may soon reach $50 billion and $16 billion for Freddie and Fannie respectively, but this was a good move to avoid questions from the market. In an environment where the government is being very unclear on many fronts, they aren’t leaving much to the imagination here. The government is dead set on keeping Fannie and Freddie strong in order to use them to strengthen the mortgage market. The solvency of the agencies is pivotal to the Treasuries operations.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

Wednesday, February 18, 2009

Afternoon Review

Curtiss-Wright (CW) +3.29%
Curtiss-Wright’s fourth-quarter earnings declined 9 percent year-over-year, below consensus estimates, mainly due to a higher effective tax rate.

Fourth-quarter sales increased 2 percent as higher sales to the power generation market were mostly offset by declines in oil and gas, commercial aerospace, and the general industrial markets primarily related to the automotive industry. Operating income for the fourth quarter remained flat.

Full-year 2008 net sales and operating income increased 15 percent and 11 percent, respectively, driven by solid organic growth of 6 percent and incremental sales from 2007 and 2008 acquisitions. Organic growth in the commercial markets was driven by a 48 percent increase in the power generation market, while the defense markets were led by strong growth in both the ground and aerospace defense markets, which grew 17 percent and 9 percent, respectively.

CW’s full-year sales and profit gains were particularly impressive considering several external factors, including the Boeing strike, delays on the Eclipse 500 and Boeing 787. New orders received in 2008 increased 19 percent from the year before, and CW’s backlog at year-end was $1.7 billion, up 29 percent. This further demonstrates the strength of the company’s wide portfolio of products that it sells to a diversified set of markets.

Looking ahead, CW anticipates another year of growth in 2009 based upon their solid backlog, key positions on long-term defense programs and the continuing demand for advanced power generation technologies. Management has also focused on improving operational efficiency and cutting costs, which should allow the company to maintain its margins.

CEO Martin Benante noted, “the beginning of the year will be particularly challenging as our customers are resetting inventory levels which will shift new orders and existing backlog to later in the year.” Benante also added that CW’s commercial power generation market remains strong and is still “in the early stages of a renaissance.”


Principal Financial Group (PFG) -2.50%
After declining over 38 percent in the past six sessions following a discouraging earnings report, Principal Financial may turn to ‘strategic’ investors in hunt for capital.

Last week, the company reported unrealized investment portfolio losses that were substantially worse than expected, raising concerns the company may need more capital. Moody’s lowered its outlook on Principal to “negative” following the earnings release.


Quick Hits

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks tumbled again, bringing the Dow Industrials to close smack dab on top of the November 20 multi-year low and the S&P 500 closed below 800 for the first time since that date.

Concerns that the global economy will continue to deteriorate, fatigue and complete uncertainty regarding incessant government action, talk of bank nationalization and another investment scam (returns are so much easier to come by if you just make them up) have put capital on strike.

Financials led the beat-down, tumbling 9.80%. Energy and utilities weren’t far behind, down 6.31% and 4.90%, respectively. You think utility stocks are safe? (After all, the group is a traditional area of safety.) You better make sure the one’s you own are good credits and haven’t over-extended the dividend – dividend cuts have smacked the group over the past week.

The lack of clarity makes it impossible to value anything for the near term – as we’ve touched on for some time, you can forget about fundamentals for now, it’s all about the government; the investor is held hostage by the whims of Washington. For the longer-term, looking out at least five years, we’re looking at a buying opportunity that comes along once every 35 years. Problem is you’ll need lots of patience and risk aversion is probably as high as it gets, and understandably so, likely delaying a sustained rebound.


Market Activity for February 17, 2009


Back to the Till

General Motors and Chrysler have come back for another $22 billion (little more than $16 billion for GM and nearly $5 billion for Chrysler). The goods news is GM is shedding programs and bloat that have sapped any inkling of efficiency. The bad news is now that they are on the government dole the high and mighty in Congress will direct what they automakers will produce – forget what the market demands, these central planners clearly know better.

Crude-Oil

Oil moved below $35 per barrel as the commodity is trading on GDP right now – that is, people are focused on very weak economic activity rather than supply/demand fundamentals. It’s not that supply is tight, U.S. crude supplies sit 15% above the five-year average, but I’m not sure this justifies $35 per barrel. (That said, these supply figures are probably not terribly accurate either. There is a lot of crude just floating around in tankers as the contango situation – prices for delivery in future months are higher than for earlier contracts, thus allowing buyers to profit from hoarding oil – is in place.) Still, the point is crude will probably not turn until we see some bottoming in GDP. While the lower GDP figures weigh on demand expectations, to this point world oil demand is just 3% off the peak hit in November 2007. During the 2001 downturn, for instance, demand fell 6% from the peak.


Looking out several months, we shouldn’t forget about a $600 billion stimulus package coming out of China (and our own $800 billion spending spree – even if much is entitlement programs and staggered three years out), which will boost energy demand. Government spending on parade along with the massive liquidity injections via the Fed that have not yet run through the economy should drive inflation rates to unwelcome levels.

One big disappointment is that we continue to allow enraged environmentalists (people who are completely unwilling to compare air quality today to say the 1940s) to block energy production via lawsuits and permit schemes. Oh, and by the way, CO2 levels follow warming trends, not the other way around; warming results from solar activity. Increased CO2 levels result from warming oceans; the solubility of CO2 falls when oceans warm and thus emit more of it.

If we can get our senses, we can take down two birds with one stone by putting in place a policy to drive energy production – this would help to create the supply that will be needed to absorb the money that will explode through the system 6-12 months out – tamping inflation -- and create high-paying technical jobs at the same time. While we watch oil tank for now, I’ve got a feeling we’ll wish we had begun to put such a plan in place when we look back a year from now.

On the Economic Front

The New York Federal Reserve Bank’s survey of the area’s factory activity (known as the Empire Manufacturing Index) fell to -34.7 in February (lowest level since records began in 2001) from -22.2 for January. In ISM terms (as longer-term readers know ISM is the nationwide factory activity index), Empire improved a bit to 40.2 from 40.0 – still quite depressed but not the substantial deterioration headline Empire printed. The headline reading on Empire is based on sentiment, not the weighted average of new orders, shipments, delivery times, inventories and employment like ISM.


While the new orders and employment sub-indices of the report declined, inventories, shipments and delivery times improved.

The decisive point is that New York-area manufacturing activity remains very weak, surely due to weak housing-related production as the area is hit hard by the financial sector woes, to put it mildly. But when we properly weight the major components activity was not as bad as the headline figure showed.

The question, since the weighted reading was boosted by a meaningful improvement in the inventory index is whether or not this is a fake out or manufacturers are actually feeling much better about inventory levels. If so, we could begin to see sustained factory activity improvements a couple of months out. We’ll get the Philly Fed index later in the week, and since this a better indication of what is occurring on the national level it will help to provide evidence as to whether we’ve seen bottom in factory activity or not.

In a separate report, the Treasury Department showed international demand for longer-term U.S. financial assets rose in December (quite a lag to this data) by more than expected. Total net purchases of stocks and bonds rose $34.8 billion in the final month of the year after posting one of the rare declines in November – net selling of U.S. assets was $25.6 billion that month.

Demand for corporate debt drove the increase as spreads widened, making these securities more attractive after five-straight months of decline. Demand for U.S. stocks was upbeat, rising $3.9 billion.

Net purchases of U.S. longer-term assets have risen $520 billion over the past 12 months. Some say the difference between the trade deficit and this measure of foreign investment inflows is what determines the value of the dollar. That is, if the trade deficit is larger than the investment inflow, the dollar will fall in value, and vice-versa.

But this hasn’t proven to be the case, as we’ve talked about within this letter for a few years now. While the dollar was declining 2003-2007, the inflow of investment to U.S. assets was outpacing the level of trade deficit, yet now that the trade deficit has outpaced the investment inflows, the dollar has strengthened. This is the opposite of what the so-called pundits state should occur.

The fact is there are a number of variables that go into currency fluctuations – for now the dollar is benefiting from the safety trade as global investors rush into the Treasury market. Overall though, there are two simple things to remember for those that desire a strong currency, which should be a goal: One is sound monetary policy; the other is low tax rates, especially on capital. An economy that remembers these two things will have both a strong currency and rising levels of prosperity.

Signed

The stimulus bill was signed yesterday. Too bad -- and I say this in jest because personally I would rather they had scrapped it for something that incentivizes the private-sector -- the spending doesn’t occur as quickly as the boondoggle was passed. More than $200 billion will be spent after 2010 (so much for what Keynes called “priming the pump”), $584 this year and next.

And speaking of the impact on growth, one thing we did not touch on yesterday was what is termed as the “crowding out” effect. Normally, I don’t give much credence to this argument, but at the level of budget deficits we’re now sowing there may be something to say about this thought. One would think bond yields to eventually rise as the Treasury market is flooded with supply, and as this occurs it will have an effect on mortgage rates, corporate borrowing costs and of course dampen any nascent housing rebound just as it may begin to materialize.

I have to say, instead of stimulating, this legislation just may actually depress economic activity. I use the word “may” out of kindness. I do not believe it is a likelihood, but rather a certainty that any actual stimulant that is in the plan will be completely offset by this effect, at which point we are left with only the debt. It may not be long before the Hope Express runs out of track.

Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries rallied today as stocks sold off considerably. The two-year was up 6/32 of a point in price while the ten-year traded higher by more than two points as the benchmark curve was flatter on the day by 14 basis points. A basis point represents .01%.

TIC (Treasury International Capital System) flows for the month of December were released today showing that foreign investors may have the appetite to support Treasuries at these levels. The report showed net foreign purchases of U.S. Treasury bonds increased by $41 billion in the month of December. The looming increase in Treasury debt issuance is really controlling the market, so the large jump in prices today can be expected from news like this, even considering its lagging nature.

New issue MBS widened to comparable Treasuries today as mortgages underperformed the fast rallying ten-year Treasury. MBS widened thirteen basis points to +157 and 25 basis points wider from the twelve month low of +132 reached last week.

The Four Primary Risks of Bonds

Credit
Duration
Liquidity
Structure

The timing and order of cash flows generated from a bond is referred to as the bond’s structure. Investors have their pick from many different kinds of structure to fit their risk tolerance and overall investment strategy.

The most common bond structure is a simple bullet structure where the bond holder receives an interest payment every six months until maturity when the entire principal value is received at par. The interest income allows the investor to have cash for expenses or for reinvestment during the life of the bond. Most Treasury, corporate, agency and municipal debt is structured in this way.

Another common structure is the callable structure. One form of callable bond is very similar to the bullet structure except for a provision that gives the issuer the ability to pay back the principal before the bond matures. A callable bond will have a higher yield to maturity than a comparable bullet because of the added risk of the call structure. Issuers will often call bonds if rates have fallen and they are able to reissue the debt again at lower interest cost. Consequently, investors receive their principal back at a time when rates are low and reinvestment looks unattractive compared to before. Mortgage backed securities are partially called every month when the bonds pay principal from regularly scheduled mortgage payments and prepays resulting from the home being sold or refinancing. This leaves the investor with both interest income and principal to reinvest or spend.

Zero coupon bonds are issued at a discount, but mature at par, generating return for the investor without any interest payments. Although reinvestment risk isn’t as much of a concern with zero coupon bonds, delaying all of the return until maturity is also a risk. Zeros may be appealing for investors with no need for cash flow before maturity.

Another form of structure is credit structure. Some bonds are split up into sections called “tranches”, with each tranche having different exposure to credit risk. This form of structure is common among non-agency mortgage backed securities where defaults within the mortgage pool can be allocated to lower quality tranches first, in order to protect the higher quality tranches. Each tranche trades separately from the others, but their returns are often linked.

There is no best structure. The market prices the risks associated with each form of structure so investors must consider value along with their own needs for cash flow when choosing a structure. Diversification of structure, like other forms of risk, is important to any fixed income portfolio.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

Tuesday, February 17, 2009

Afternoon Review

Cerner (CERN) -0.07%
I seemed to have missed Cerner’s earnings report last week. The company reported earnings that came in above estimates due to benefits from a large currency gain and lower tax rate.

However, despite the fact that revenues and bookings were at the bottom end of guidance, the results were solid in the midst of the really difficult backdrop. The current financial liquidity issues continue to affect hospitals’ access to the credit markets. This, in turn, is forcing some of Cerner’s clients to delay or cut back the scope of healthcare IT projects. Nonetheless, the company’s backlog and new engagements have been resilient.

Cerner is outperforming its peers, and should ultimately stand to benefit from the stimulus package, although magnitude and timing is highly uncertain. The stimulus package could have a negative effect in the near-term, however, as hospitals adopt a wait-and-see approach in light of expected government help. Cerner’s widened guidance seems to reflect this fact.


Wal-Mart Stores (WMT) +3.68%
Wal-Mart said fourth-quarter net income declined 7.4 percent, which was better than estimated, and projected first-quarter earnings in line with expectations.

Settlement costs from wage-lawsuits cut into profits. Wal-Mart is the biggest private employer in the U.S. with more than 1.4 million U.S. workers and over 2 million worldwide.

The stronger dollar hurt international sales, which slid 8.4 percent. In the past, Wal-Mart benefited from as stronger U.S. dollar since most of their internationally manufactured goods revenue were sold in the U.S. However, this backdoor dollar play is fading with the company’s focus on expanding international sales (especially in Brazil, China and Mexico) to fuel future earnings growth.

Same-store sales in the U.S. rose 2.8 percent, which shows that Wal-Mart is benefiting from the slumping sales at other retailers as consumers trade down and seek bargains.

At this point, the retail store industry is a bit of a mixed bag. It is no secret that weak consumer confidence has curbed spending habits, making winners out of stores with lower exposure to discretionary items and a higher focus on necessities. Wal-Mart’s grocery business, which generates over 40 percent of the company’s revenue, along with their growing health and wellness segment makes the company less susceptible to the conservative consumer.


Transocean Ltd (RIG) -7.15%
Transocean’s fourth-quarter results came in above expectations helped by higher day rates and the company announced plans to buyback $3 billion of shares.

Transocean’s rigs commanded an average rate of $251,500 a day during the final three months of 2008, up 12 percent from a year earlier. Rates for the company’s most-sophisticated deepwater vessels jumped 22 percent to an average of $423,600 a day.

Despite the 56 percent decline in oil futures during the fourth-quarter, demand for deepwater rigs remains strong. Deepwater ventures remain economically viable for energy companies because oil prices are expected to be higher five to ten years from now, which is the amount of time it takes to turn a subsea oil discovery into a producing field.

Transocean’s deepwater rigs, which account for about 40 percent of drilling revenues, are fully booked in 2009 and 90 percent booked in 2010 at high rates contracted during the commodity boom. Midwater and jackup fleets, however, will weigh on earnings in 2009 – and 2010 if oil prices don’t rebound – since they have fewer days under contract at the higher prices.

The deepwater market is positioned to expand substantially in coming years because of large deepwater discoveries, and Transocean has positioned itself as the prime beneficiary. The company’s $41 billion backlog (nearly three times its current market capitalization) and orders extending out to 2020 provide stability for the business and nice visibility into the future.


Genuine Parts Company (GPC) -4.49%
Genuine Parts’ fourth-quarter net income slipped 30 percent as weak consumer spending and a decline in industrial production hurt sales.

The results were disappointing since many expected the company to be insulated from the recession as consumers opt out of buying new cars and instead attend to vehicle maintenance concerns. The company’s boosted its dividend last month by 2.6 percent, which many took as a sign that business was good.

Genuine Parts did not give guidance, but CEO Thomas Gallagher said the company’s near-term outlook was more conservative than it might be in “more normal times.” He did, however, express optimism for each of the company’s four business lines longer term.


Teva Pharmaceutical Industries (TEVA) +4.02%
Teva reported fourth-quarter earnings that beat expectations and increased its dividend. Teva’s quarterly profit also got a boost from tax rate of just 6 percent – if they paid a normal tax rate of 11 percent, the company would have missed consensus estimates.

Net income came in higher than analysts’ anticipated, rising 11 percent on wider margins, particularly stemming from strong sales of flagship drug Copaxone (multiple sclerosis treatment).


Quick Hits

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks fell on Friday, led by financials (what else?), after Wells Fargo revised its latest earnings report, stating results were worse than first reported. Consumer discretionary shares also kept pressure on the broad market after the University of Michigan’s preliminary consumer sentiment index hit its lowest level since 1980 – we will receive the main consumer confidence reading, put together by the Conference Board, in a week.

Stocks fell another 4.8% last week, essentially all of that damage occurred on Monday after the much-hyped Geithner press conference (the green light to short banks again speech) offered zero with regard to new details. This marked the fifth week of decline out of the last six.

No major industry groups managed to gain ground last week, even basic material stocks – which have caught some fire of late – ended lower. It appears we’ll test the November 20 multi-year low as we’re just 3% from that mark regarding the Dow Industrial Average – although still 9% above that level from the S&P 500’s perspective.

The main issues right now are the state of the financial and consumer sectors and the intense uncertainty that results from government’s increased involvement.

On the first, we need to get mark-to-market removed (there you go I said it, even after telling myself not to bring it up) or banking industry woes will continue to be exacerbated. The consumer, despite the first rebound on retail sales in six months after the latest reading, is not going to come around in a sustained manner until the cash savings rate approaches 5% -- which is probably 4-6 months out at the current pace of increase.

On the second, investors need to know the rules of the game. The government can come out with something good, or they can continue to fumble the ball; no ones knows. In addition, they seem to keep getting in their own way – which is kind of the history of the Washington response.

For instance, they want private money to come in and help fund the “bad bank” idea (known as the Public-Private Investment Fund) yet are in favor of “cramdown.” Now, why would private money come in and buy mortgage-related securities when a bankruptcy judge will have the authority to change principal and terms of the loan? They won’t. This just increases the uncertainty issue.

Market Activity for February 13, 2009

The Group of Seven

The G-7 got together this weekend (maybe I should say the G-6 since it appeared Japan’s Finance Minister was bombed – he has now resigned) and the prevailing message coming out of the meeting was a warning against protectionism This topic dominated the talks due to Treasury Secretary Geithner fomenting the issue when he called China a currency manipulator. Without getting into a specific history, China has been pegged to the dollar since 1994 – outside of allowing the yuan to strengthen during the previous couple of years. This peg has served us all well, but when the Federal Reserve is going to drive the dollar into the dirt, the manufacturing industry is going to have problems with this policy. And this is the issue we here need to deal with. Instead of blaming others for their actions, we should first concentrate on sound monetary policy here at home. That is the first order of business when talking about currency valuations.

Back to topic, the G-7 has proven to be sort of like the UN in that we hear a lot of words, but they rarely deliver action. Words are certainly not action and the realities on the ground are such that we’re all moving toward protectionism. It appears the U.S. kept the “buy American materials” provision in the stimulus plan – despite the President’s statement that he’d remove it; French auto companies (largely state-owned) have stated they’ll close overseas plants before closing ones in France – instead of focusing on those that are the least efficient; the U.K. stimulus plan stipulates that banks commit lending to British businesses -- probably causing some issue with international-trade financing.

These issues don’t seem like much, but protectionism is growing under the surface – and we haven’t even mentioned Congressional attempts to block additional trade pacts. We must be very careful here this is dangerous stuff, it doesn’t take long for retaliation to set in and at that point the global economy is in big trouble. The U.S. needs to take the lead because the G-7 is not capable of unification. This means our Treasury Secretary must change his tone. He’s going to be the key Treasury-debt salesman (as a result of all of this “stimulus” spending) and the wrong comments will make this job much more difficult.

The good news is we’re talking about the G-7 and not the G-8. Russia has apparently gotten the boot as of late.

Stimulus Plan

Congress passed the stimulus bill this weekend. It will inject $800 billion over several years into everything from welfare payments, health-care benefits, infrastructure projects, more health-care benefits, and tax rebates and incentives. In terms of the tax segment in the legislation: On the incentives, higher business write-down allowances and bonus depreciation will help things on the capital spending front so long as government stops scaring the hell out of the business community. On the tax rebates, the plan is a joke as it trickles in $12-$14 dollar increments per pay period – and no that’s not a typo.

Proponents of such nonsense say it will make people feel like they’re getting a permanent tax cut – of course, actually providing such a thing would be a mistake apparently. There are actually economists that are saying this is a worthwhile experiment. I’d rather these people be brought up to speed as to what works, rather than the rest of us being bludgeoned each day via such nonsensical proposals. A quick read of Friedman’s Permanent Income Hypothesis may do the trick. As to tricking people into thinking a one-time $400 shot-in-the-arm (spread over 28 weeks) is permanent – well, good luck with that one.

Say what you want about the likelihood of efficacy regarding the stimulus plan, they are going about it all wrong.

First, you know where I come down. The most effective approach would be to slash tax rates across-the-board and eliminate mark-to-market. But that’s not going to happen.

The alternative should be to encourage China to engage in massive stimulus – maybe three times the amount of their already huge $600 billion plan, which is spread over two years. In return, we will say we’re happy with the current dollar/yuan exchange rate. (Look, if China took the yuan off the peg it’s not like those low-paying manufacturing jobs would come back to the U.S. They will go to the next place, like Thailand or Vietnam. And China will be worse off and have less funds to buy our expensive capital equipment.) It is counter-productive right not to call them a currency manipulator. Besides, who are we kidding? The world is run by fiat money; who isn’t a currency manipulator?

China has an incentive to do this as they need to tamp citizen uprising due to higher unemployment. For our benefit, we wouldn’t have to drive annual budget deficits to $1 trillion-plus and thus reduce the chances (maybe) of higher tax rates two years out.

But we don’t like to think outside the box all the time. We instead like to throw money at the problem because this gives politicians a way of saying they did something. And they’re doing something alright.

Could Be a Rough Session

Overseas bourses closed yesterday’s session lower on reports Japan’s economy shrank 12.7% at an annual rates last quarter – the biggest decline since 1974. This marks the third-straight quarter of contraction as exports activity is very depressed. Reportedly, exports slid 13.9% in the fourth quarter (45% annualized), the worst since WWII.

While down, international stocks held up pretty well considering that report out of Japan, down roughly 1% across the board. But today things are a bit worse as stock indices are down 2%-3% this morning.

Economy Watch

We’ll be watching for the New York-area manufacturing number for February this morning. Tomorrow the big data will be housing starts and building permits along with industrial production (all for January).

Have a great day!


Brent Vondera, Senior Analyst