Afternoon Review

Hansen Natural Corp. (HANS) +7.32%
Hansen reported impressive earnings that came in ahead of expectations and, even more importantly, the Monster energy drink brand continued to take market share from competitors.

Despite weaker consumer spending trends, the company increased revenues more than 3 percent year over year, primarily as a result of higher prices. Gross margin expanded more than 3 percentage points, as greater volume of the firm’s new energy shooter drinks provided a more favorable product mix.

Hansen has performed very well in this economic climate because energy drink consumers don’t have good substitutes – most people drink these products because they don’t like coffee. Sales have also been helped by the fact consumers can not make comparable energy drinks at home the way that a coffee drinker could easily make their own cup. Also helping Hansen is their younger consumer base, which is less adverse to the economic climate and likely to spend more discretionary income.


Dell (DELL) +3.90%
Dell had a positive earnings report in which cost discipline saved an otherwise difficult quarter.

PC revenues declined 22 percent on a 12 percent decline in units. Gross margin performance was likely the most important factor for investors this quarter. Cost and pricing discipline allowed Dell to post gross margins of 18.1%, which should be viewed positively in this environment.

Dell’s unit declines coupled with Hewlett-Packard’s poor numbers last week, supports the fear that demand conditions continue to deteriorate in the PC and enterprise segments. The next several quarters should be remarkably challenging for Dell, but there is growing sentiment that the shares can’t fall much lower without a significant deterioration of market share.


General Electric (GE) -6.48%
GE is finally cutting its annual dividend in a move to preserve cash and protect the company’s top credit rating. GE’s stock price has reflected the assumption that the company would have to cut its dividend for quite some time. Now yielding 4.5 percent, GE shares may offer even more upside potential than before since the company will have an extra $9 billion annually to invest in future growth of their business.


Quick Hits

• Debtors’ Prison: Companies Made a Fashionable Mistake
• Citi Gets Third Rescue as U.S. Plans to Raise Stake
• February was another record month for corporate bond offerings
• Golden Parachute
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks began the trading day higher on Thursday, even after the release of a horrible durable goods report and another very weak jobless claims reading (both prior to the bell), but began to sink as the morning session came to a close and then fell to negative territory in the final hour.


The market appeared to give the Obama budget – some of which we touched on yesterday – a thumbs down but I’m not sure it’s fair to blame yesterday’s activity on the fact that the relationship between the federal government and the private sector is in the process of being altered. This has been a major reason the market is down 25% since Election Day– per yesterday’s session, we’ve known the agenda for a while so it’s not like what was announced was much of a surprise. We’re going to see government spending as a percentage of GDP move from the 18%-20% range of the past quarter century to something closer to 30%, and this will have an effect on longer-term growth rates simply because the private sector allocates resources in a much more efficient manner than government, period.

Financials and telecoms were the only winners yesterday – telecoms have been on a nice little run of late. In terms of financials, it’s a rarity these days to see the overall market decline on a day the banks gain ground, but the broad market was weighed down by the drubbing health-care stocks took – the budget was not kind to this sector as a push to universal health care, a proposal to lower Medicare Advantage payments to managed-care firms and requiring drug-makers raise rebates (you want to crush drug discovery, this is the way to do it) pushed the group lower.


Market Activity for February 26, 2009

Well, let’s get to the economic data.

Initial Jobless Claims

The Labor Department reported initial jobless claims for the week ended February 21 rose 36,000 to 667,000 -- the expectation was for a decline. Claims just keep rising and we’re approaching the all-time high hit in 1982. However, while one shouldn’t downplay this event, when adjusting for payroll position growth claims would have to hit one million to match that 1982 level. There are 135 million payroll positions today compared to 88 million in 1982.

The four-week average of claims – a less volatile figure -- jumped 19,000 to 639,000.


Continuing claims rose 114,000 to 5.112 million in the week ended February 14. The insured unemployment rate – which tracks the overall jobless rate – rose 0.1 to 3.8%.

I think it’s pretty clear payrolls will show another huge 600,000 loss for February when the data is released next Friday. The unemployment rate may hit 8.0%, currently it is 7.6%. I’ve got to believe the degree of monthly job losses will ease a couple of months out as firms may have gone too far in job cutting, scared by the combination of the credit freeze last quarter followed by policy that has not exactly offered a boost to confidence.


Durable Goods Orders

The Commerce Department announced durable goods orders dropped 5.2%, following an almost equally large 4.6% decline in December. A decline in transportation orders of 13.5% led the decline as defense aircraft and auto bookings dropped.

Excluding transportation, durables orders fell 2.5%, following a big 5.5% decline for December that was revised down to show double the damage of the initial estimate. There were no silver linings in the data. Primary metals orders fell 4.6%, industrial machinery was down 2.0%, computer orders fell 5.0%, electrical equipment was down 6.1%, autos were down 6.4%.

The component of the report we watch most closely (as longer-term readers are aware) is nondefense capital goods ex-aircraft, this the proxy for business equipment spending. This figure dropped 5.4% last month and 5.8% in December – down 34.3% at an annual rate the last three months. This as well as anything explains the level of caution with which businesses are operating. This gets the business equipment side of GDP off to a horrible start for the first quarter.

New Home Sales

Wow! The Commerce Department reported new home sales declined 10.2% in January to 309,000 units at an annual rate from an upwardly revised reading of 344,000 for December – first reported at 331,000.


The supply of new homes fell 3.1% in January – the 21st straight month of decline – to 342,000 to the lowest level since April 2003. The population was 19 million lower back in 2003; I think this shows how the supply glut has been completely erased, new home prices are down 26% from the peak.


It will take some economic confidence, however, for this to flow through in sales. The supply of homes relative to sales rose to 13.3 months’ worth.


By region, sales in the Northeast rose 12.5%, but the Midwest and South fell roughly 6% and the West saw new home sales plunge 28%, for the month! This depressed activity in the West is quite different from existing home sales data as we’ve seen activity rebound to a decent degree for existing.

New home sales are down 65.8% at an annual rate over the past three months and have yet to show any sign of bottom, but we’ve got to be close.

Have a great weekend!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks fell for the seventh session in eight after the President’s address to Congress showed contempt for business (sorry, don’t know another way to put it) and clearly believes the government should play a greater economic, permanent, role.

Dividend cuts from a number of insurance names, as they get hammered by mark-to-market and a falling stock market and thus have to put additional money aside to support annuity guarantees, kept financials down even as Fed Chairman Bernanke reiterated bank nationalization is not in the cards.

It appeared those comments from Bernanke, along with some clarity with regard to the Treasury’s “bank stress test” and future capital injections plan, is what helped stocks rally in the afternoon session. The S&P 500, for instance, jumped 3.5% after lunch until it all fell apart again in the final 30 minutes of trading.

Industrial shares led the market lower, the index that tracks these shares fell 2.86%, with health-care and basic material stocks not far behind. Worries the economy will take quite a while to bounce back put pressure on material and diversified manufacturing shares. The sole winner was telcom, which added 1.01%.


Market Activity for February 25, 2009

Crude

Crude oil rose to a three-week high, jumping 6.36% yesterday, after the weekly Energy Department report showed gasoline inventories fell 3.32 million barrels to 215.3 million last week. Motor fuel consumption averaged nine million barrels per day over the past four weeks, up 1.7% from the same period last year. The price of crude is up 25% since February. While half of this move is due to the March contract expiring on the 20th (the April contract traded higher than that expiring March contract) the rest is due to gasoline fundamentals.

Refineries have also reduced production, which is normal for this time of year as they retool to shift from heating oil to more gasoline production.

Oil supplies went in the other direction (although as you can see the supply of gasoline can drive the price of crude) as supplies at Cushing, Oklahoma (where traded West-Texas Intermediate crude is delivered) rose 34.5 million barrels to the highest level since April 2004.

Oil trades in contango right now, meaning you can buy the front month contract and sell later month contracts at a higher price. This means oil is being delivered to Cushing for storage. The opposite of contango is backwardation, the situation in which the front month trades higher than months forward.


Mortgage Applications

The Mortgage Banker’s Association reported that mortgage applications fell in the week ended February 20 as the 30-year fixed mortgage rate moved above 5.00%. We’ve talked about how activity bounces when that rate moves into the 4% handle and vice versa when it moves back above 5%, and this seems to be the case.

The outlier to this view is the rebound that occurred in the week ended January 30 even as the 30-year mortgage rate hit 5.29%, but this may have been because the prior week’s decline was so large. Therefore, the bounce was a function of coming off of that low level. A rate below 5.00% is still the target and if we can get below that level for an extended period we may begin to see some sales and refi activity that helps to absorb supply and lower servicing costs.

Purchases fell 2.6% last week and refinancings dropped 19.1% after a big 64.3% jump in the prior week.


Existing Home Sales

The National Association of Realtors (NAR) reported that existing home sales fell 5.3% in January (that was weaker-than-expected and the increase in December was revised lower) to 4.49 million units at an annual rate. Multi-family activity led the decline as sales for this segment slid 10.2%. Single-family existing home sales fell 4.7% last month.


In terms of region, sales in the Northeast fell 14.7%, the Midwest and South both declined 5.7% and the West was flat (the West region has endured the largest foreclosure activity and thus the largest price decline – sales seem to have found a bottom for now as a result).

On supply, the number of existing homes on the market continues to come lower – which is a good thing for when sales do bounce back, supply (relative to the sales pace -- the month’s worth of supply figure) will come lower quickly. The issue right now is the job market and general lack of confidence. We get those two things turned around and this housing correction will have run its course rather quickly.



On that last point, this is why we’ve argued the way to go is to focus on economic growth and let the housing market correct as it will. Policy makers keep talking in terms of doing the opposite (focusing on housing and allowing hope for a rebound to spur economic activity), which will only prolong the housing correction as the consequences of their actions have adverse effects. We cannot turn jobs around on a dime, but by focusing on incentives (lowering tax rates on capital, labor income and profits -- and thus raising after-tax returns on these activities) we can stop the bleeding and allow the growth in economic activity take care of the rest. That’s when confidence turns and that’s when we’re back in business.

Unfortunately, the administration is out with next year’s budget and they are wasting no time raising taxes. It’s not that this is a surprise, but the fact that they are moving, even if incrementally, so quickly on this front is very concerning to me. In this budget proposal, there will be limits on deductions for those in the top two income tax brackets and higher tax rates on hedge funds.

We’ll then see the current income tax rates rise across the board as they revert back to the pre-2003 levels; the capital gains and dividends rate will revert as well (end of 2010). And you watch, the middle class will be hit hard as well – not just from the perspective of lower economic growth and stock market activity as higher tax rates are destructive to after-tax returns, but more directly via their paychecks. Anyone who believes that payroll taxes (FICA) will not be increased is not in tune with the agenda, in my humble opinion.

Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
Treasuries were down across the board today as the long end of the curve underperformed shorter Treasuries. The two-year traded down one-eighth of a point while the ten-year was lower by about 1.25 points in price as the benchmark curve steepened by 5 basis points. A basis point represents .01%.

MBS
Mortgages outperformed comparable Treasuries on Wednesday, tightening 7 basis points to remain at the bottom of the range we have established. I would expect FNCL 5’s, 30-year Fannie Mae 5% MBS, to maintain a spread over Treasuries of about 145 to 160 basis points for the next couple weeks.

Municipals
Highly rated municipal bonds have tightened in considerably and many cities, counties and states in all parts of the country are taking advantage of the opportunities at these lower rates. I would expect AA- rated or better munis to tighten more from here.

From an investor’s perspective shorter munis still look attractive on a relative basis, assuming the investor is in the top tax bracket for tax exempt issues. For investors who can take additional liquidity risk in smaller blocks, odd-lot munis look especially attractive.


Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

Afternoon Review

Stress Test Details Unveiled
The market obviously welcomes any details they can get their hands on regarding the government’s plans for the financial system. It is not a surprise that the market took off this afternoon when these details were released. The good people in Washington also provided us with some FAQs. Gosh golly, how did they know we would have questions?

Bernanke’s comments today also seemed to lift sentiment for financials.


AT&T (T) +1.98%
AT&T rallied on a U.S. Supreme Court ruling in the company’s favor, which makes it tougher to sue companies for antitrust violations. Bloomberg reported the justices unanimously rejected a claim that an AT&T subsidiary engaged in a “price squeeze” aimed at driving out competition in the market for digital subscriber line (DSL) service.

Also boosting shares was an analyst upgrade at JPMorgan, citing the growing number of iPhone customers spurring sales growth. The report estimates that iPhone customers will boost AT&T’s the average monthly bill 1.2 percent this year by paying extra for plans that support the phone’s web-surfing features.

Last quarter, AT&T posted subscriber gains that exceeded estimates as consumers scooped up web-capable phones and projected that their decision to subsidize the iPhone (which cut into profit margins) would begin to pay off in the upcoming quarters. This analyst report supports AT&T’s projections.


Positive prospects for PC sales
Reports that Microsoft’s Windows 7 may ship as early as September, sent PC makers Dell and Hewlett-Packard higher on hopes the release may spur sales of PCs amid the global recession.

Intel (INTC) also moved higher, despite reports that global chip sales will decline in 2009, as the company could benefit from higher PC and netbook sales. Unlike Vista, Windows 7 is also designed to run on the increasingly popular netbooks that run on Intel’s lower-priced Atom chips.

There has been a large concern that these cheaper chips would erode profits, but Intel said today at Goldman Sachs Technology and Internet Conference their margins in netbooks are better than cheap notebooks.


Principal Financial Group (PFG) -6.68%
Labor federation Change to Win has made a direct request to Geithner that Principal’s $2 billion TARP application be denied due to its lobbying activities, specifically regarding it’s opposition to Employee Free Choice Act.

Principal later in the day released this statement, denying any stance on the Employee Free Choice Act.



Quick Hits

• Bank Nationalization is Done Deal, Let’s Move On
• Signs of Life
• Obama in Canada Finds World’s Best Financial System
  
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks recovered all of Monday’s losses (and then some for the broad market, mid and small cap indices, not so for the Dow) after FDIC Chair Bair stated large U.S. banks have enough capital and Fed Chairman Bernanke provided some clarity and thus assuaged concerns over bank nationalization.

The Chairman came through yesterday in his best performance I’ve seen. In his testimony to Congress, Bernanke smoothed things over (after the administration along with Senator Dodd scared the heck out of the market again via its lack of clarity) by explaining that additional capital injections and more government control over banks would only occur if absolutely necessary. That helped things out enormously in yesterday’s trading; thank you Mr. Ben.

Regarding the administration, it’s like they’re afraid to say anything terribly concrete for fear a policy will fail and they’ll have to take responsibility – this is a major issue for stocks right now; we cannot afford additional uncertainty.

Financials led the rally; the index that tracks these shares jumped nearly 12%. Consumer discretionary and energy shares also outperformed.


It’s tough to get excited though as the political environment is costly right now. We have higher tax rates on the horizon (and I can’t even believe the President’s comment last night that he’ll raise corporate tax rates), way too much government involvement and much more regulation coming down the road.

There are reasons stocks now trade at these low levels. Yes, one is earnings are weak. Yet another factor is massive selling pressure due to de-leveraging. But there should be little doubt that valuations also reflect the fact that after-tax return expectations have been diminished and a coming regulatory burden that always crimps growth. We do not need more regulation we need enforcement, along with sound monetary policy that does not encourage excess credit expansion. Higher tax rates are the worst thing we can do right now, they must be driven lower.

In the end, nearly the entire universe of stocks offer great return potential over the next decade – even if the next couple of years will be tough; the more the government does, the longer the rebound will take. Beyond that, assuming we snap back and do not go the way of Western Europe, which is one of the questions the market is dealing with, the potential in stocks is huge.

The really sad thing about all of this is that U.S. firms are streamlined, energy prices are very low, stock multiples are compressed (S&P 500 trades at the lowest P/E since 1986 on a 10-year average earnings basis) and there are mounds of cash on the sidelines. If we could just get policy that drives incentives and offers some economic confidence we could really be on to something. Of course, there is no magic bullet, only time can correct for the credit excesses fostered by mistaken monetary policy and government involvement in the housing market (Congressional demands to offer easy credit to poor credit-score borrowers). But bold action with regard to after-tax returns on capital, incomes and profits would be a huge jolt to the American spirit – this is what’s missing. We’ll find that groove again. For now though, ebullience is absent.

Market Activity for February 24, 2009

Home Prices

The S&P Case/Shiller home price index continues to show rapid deterioration, the year-over-year decline sped up to 18.5% for December from 18.2% in November – setting a new record.

The table below speaks for itself, so not much reason to expound on its figures. All in all, I don’t like this indicator as it only follows the 20 largest metro areas, about half of the index involves the cities in which speculation was most rampant. Housing market traders would set up consortiums, and spec houses using no money down (because they didn’t have to) and simply walked away when prices began to fall. Hence, foreclosure rates are hitting this index harder than any other.


Another look is the Federal Housing and Finance Agency’s (FHFA) home price index, which offers a very broad look at the housing market. Its results for December were out yesterday too, showing prices actually rose 0.1%. This marks the first monthly increase since February 2008 and only the second since April 2007.

Unfortunately, it’s too early to get jazzed just yet as price increases in the West region is what drove the number into positive territory. Prices have been so wrecked in the West that some sort of increase was bound to occur. The Northeast, Mid Atlantic and Southeast continue to show robust declines. This index has home prices down 9.5% over the past 12 months.

Consumer Confidence

The Conference Board’s consumer confidence survey dropped to a stunning reading (even in this environment) of 25.0 in February from 37.4 last month – this is a record low. The expectations index got slammed, coming in at 27.5 after posting 42.5 in January. The survey was taken after the announcement of the stimulus plan.


Consumers’ assessment of the labor market conditions is dirt – no surprise there. The percentage of those judging jobs as “plentiful” fell to 4.4% in February from 7.1% in January, while those viewing jobs as “hard to get” rose to 47.8% from 41.1%. Thus the net “plentiful” less “hard to get” index fell to -43.4% last month from -34.0% in January. (That January reading improved a bit, giving some people hope, but this latest look will crush that feeling, if last Thursday’s jobless claims data hadn’t already.)

The market will have its eye on mortgage applications and existing home sales data for January today. Existing home sales rose 6.5% last month, so we’ll be looking to build on that and get some kind of trend going. Fixed mortgage rates are very low, but a positive trend is probably a ways out still simply because the weak labor market will delay a rebound in sales. We shall see.

Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review

United Natural Foods (UNFI) +20.16%
United Natural Foods soared as earnings exceeded expectations on lower fuel costs, expense control and the continuing integration of Millbrook Specialty business.

For the quarter that ended Jan. 31, United Natural managed to increase sales by 2 percent. This is very impressive given the trade-down trend the more expensive organic/natural foods are facing.

Lower costs stemming from new distribution centers as well as the Millbrook Specialty business helped boost gross margins by 50 basis points. The Specialty business has unique products that serve niche markets and affluent customers, which might explain why it has held up in this weak consumer environment. The Millbrook’s integration appears to be going smoothly and margins in this segment should continue to improve. United Natural’s improved network of distribution centers will also contribute to margin expansion in the future.

The company lowered revenue guidance and widened earnings guidance to reflect lower sales growth and greater uncertainty surrounding the impact of the recent peanut recall. The company also lowered its capital expenditure guidance for fiscal 2009.


H.J. Heinz Company (HNZ) +5.63%
Heinz reported quarterly earnings rose 12 percent on increased pricing, currency hedges and a lower effective tax rate.

Revenues declined 7.5 percent because of the stronger dollar, but sales increased 3.9 percent excluding currency fluctuations as price increases more than offset weaker volume.

The company indicated that the trade-down trend hurt sales results, but the company has been offering different size packages with different price points to better compete against generic products. Also slowing sales were lower orders from retailers that are trying to work down inventory.

Heinz last year enacted price increases as commodity costs rose and they do not plan to roll those increases back, noting the increases weren’t enough to cover the sharp spike in most commodities.

The takeaway from the report today is that Heinz’s business remains fundamentally sound, which is evident in its strong cash flow and balanced portfolio of leading brands.


Quick Hits

• Bernanke Says U.S. Will Acquire Bank Ownership Stakes Only as Losses Occur
• U.S. Bailout, Stimulus Pledges Total $11.6 Trillion (Table)
• Dividends Falling Means S&P 500 Is Still Expensive
• NYSE May Relax $1 Share Price Requirement to Prevent Delistings
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks took another good old-fashioned street beating as policymakers scare the heck out of capital – it’s running for the hills, maybe Galt’s Gulch if not careful, and they seem oblivious to the fact that it’s their fault. JP Morgan’s Jamie Dimon put it straight when on the decision to slash the dividend payout stated he is preparing for a worsening economic situation due to a more costly political environment. That pretty much sums it up.

The Dow Industrial Average closed at its lowest level since May 1997 and the broad S&P 500 at its lowest point since April of that year.

Stocks engaged in a brief rally during the initial hour of trading, apparently on news the government would inject more capital into banks. However, possibly after traders had a chance to think about it sentiment did a 180 – oh, talk of raising tax rates didn’t help either; good job!

The administration delivers a new plan each week, and absent of detail to boot. Then we have Senator Dodd popping off, making statements that increase market confusion. It’s hard to see how they could screw up anymore. More on the capital injection and policy response thing below.

Basic material, information technology, industrial and energy stocks led the broad market’s decline as expectations of an economic rebound occurring anytime over the next six months deteriorated, at least for now. A gloomy forecast for the PC market from Morgan Stanley certainly didn’t help things, especially for tech names.


Market Activity for February 23, 2009


Please Stop

Well, here we go again. Policymakers chose to engage in essentially more of the same by proposing a plan to pump additional capital into banks, and the current preferred shares they own via former injections would convert to common shares – this conversion will help capital adequacy as what is known as tangible common equity (TCE) will improve financial health since that health is based in part on common share-based capital. Problem is this is just another step toward nationalization – and if some form of nationalization is not swift (take the troubled institutions over, clean them up, and summarily send them back out to the private sector) such action only exacerbates the capital strike.

But assuming, on the surface, that more capital injections from the government is a good thing, what happens when current “toxic” assets continue to fall in price, or assets acquired by writing new loans are dragged down by distressed pricing as mark-to-market accounting demands? You’ll get more capital injections and thus greater government control over banks -- that can’t be good, only need to look at Fannie and Freddie for that one. (Regulators say major banks have capital ratios that exceed requirements, but as we’ve seen all we need is a couple of quarters of distressed-pricing write-downs and suddenly more capital is needed. The more capital that comes from the government, the longer private capital will sit on the sidelines.)

Public-sector injections can make things even worse in two ways (the freeze it puts on private capital is the result):

One, does anyone really believe Washington can manage the banking system? This of course is a rhetorical question – to ask is to answer --, as we all know politicians are not at all capable of this task. You think things are highly politicized now, just wait.

Two, what happens to the thousands of banks that have not needed government assistance? What is the fall-out from the appearance that government funded institutions are stronger. Does money run from those that did not engage in poor decisions to those that did as the perception is your money is safer at the government-backed bank?

These are the types of consequences that result from government action and we’re seeing Washington involved on such a grand scale right now that no one can contemplate the magnitude of consequences that will bring about their own problems.

We have argued for mark-to-market accounting to be abolished. For one thing, pro-cyclical accounting rules are extremely damaging. In good times, banks can hold less capital and in bad times they are forced to build more – either way you look at it such behavior is destructive.

The second reason to abolish this 15-month accounting regime (and more appropriate to today’s discussion) is because the longer we wait it means that government engages in a plethora of programs that have huge economic costs – not just from a perspective of money but simply because the market is at the whim of Washington; in which case, capital freezes (as the rules are changed weekly), essentially going on strike.

Eliminating mark-to-market is not an elixir that heals all, but it stops the self-affliction, with the former accounting standard in place I am convinced we would not have been this damaged – the credit chaos would not have occurred (not to the extent with which it did last quarter) and thus economic deterioration and job losses would not have been so substantial.

I believe when the history is written readers two decades hence will be bewildered why we chose to engage in various highfalutin ideas when abolishing mark-to-market was staring us right in the face.

The other thing readers of history will be astonished by is how we let the Federal Reserve off the hook for so long – without their mistakes earlier in the decade, none of the damage from credit expansion, with little standard, would have occurred. I do believe though that it won’t be too long – five years or so – in which setting major constraints on the Fed’s monetary policy decisions will be a consensus view. The Fed has been responsible for the largest economic distortions since its inception in 1913. Certainly Congress plays its role in causing havoc, but substantial policy mistakes from the FOMC are the origin of the major crises over the past 96 years.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries were mixed today as the long end of the curve outperformed shorter Treasuries. The two-year was unchanged while the ten-year traded higher by 1/8 of a point as the benchmark curve flattened by 2 basis points. A basis point represents .01%.

The Federal Reserve Bank of New York is now $134.8 billion into their $500 billion dollar MBS buying plan to keep mortgage rates low. The Fed announced last week that it purchased $19.9 billion in agency MBS during the seven day period ending last Wednesday, bringing the weekly average to $19.25 billion.

Mortgage spreads over Treasuries have normalized in the past week into the 145-160 basis points range. With all the demand from the Fed it’s hard to imagine MBS widening anytime soon. If demand for U.S. Treasury debt doesn’t keep up with issuance as it continues to grow in order to fund the ever growing deficit, I would expect MBS to tighten, keeping yields on MBS fairly constant. The government remains dead-set on keeping mortgage rates low and its ability to create artificial demand in order to do so is being felt in the market now.

Links

Hillary Clinton, Treasury Sales Rep

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

Afternoon Review

Capital adequacy ratios
Until now, the most popular ratio in determining a bank’s capital adequacy was the amount of Tier 1 capital it had as a percentage of total assets. Tier 1 capital is used to measure a bank’s ability absorb losses without a bank being required to cease trading.

Today, attention has been refocused on banks’ tangible common equity, or TCE. TCE is a bank’s assets minus all its liabilities and, most importantly, all of its preferred shares and intangible assets like goodwill, brand names and patents. In short, tangible common equity shows what common shareholders would get if the company was liquidated.

Banks’ TCE ratios had historically been between 3 percent and 5 percent before the credit crisis. Today, Citigroup’s TCE ratio is 1.5 percent, Bank of America’s ratio is 2.83 percent and J.P. Morgan’s ratio is 3.8 percent.

Companies have some discretion as to what their TCE ratios are, but those with a TCE below 3 percent of assets should consider raising more capital. Because these companies would have difficulty raising capital in a stock sale, some (like Citigroup and AIG) are asking the government for assistance.

The government’s injections so far have been through buying preferred shares, which increase a bank’s Tier 1 capital but does not increase its TCE ratio. To help bolster banks’ TCE, it sounds like the government plans to convert some of its preferred shares into common shares.

What is troubling about this “reclassification” of balance sheet items is that the government is, in effect, changing the accounting rules. This leads me to wonder, why not just adjust the fair-value, or mark-to-market, accounting rule? While I understand the merits of fair-value accounting, it seems to me that there must be a better valuation methodology that is less volatile.


Garmin (GRMN) +7.32%
Garmin, maker of GPS devices, reported earnings that missed analyst expectations and opted not to give 2009 guidance until the “outlook for the year becomes clearer.”

Revenues fell 13.9 percent year-over-year and operating margins slipped 200 basis points compared to the third quarter and 310 basis points from the prior year.

Garmin’s Outdoor/Fitness segment had revenue increase 5 percent in the quarter, but Automotive/Mobile revenue plunged 17 percent, Aviation revenue was down 5 percent and the Marine segment turned in flat revenue for the quarter.

Still, the stock managed to rally today on reduced inventory. Garmin said it reduced its inventory by $274 million in the quarter, up from expectations of a drop of about $150 million in inventory levels by the end of the year.


UnitedHealth Group (UNH) -14.87%
Health insurers took a beating after Humana Inc. said the 2010 preliminary rates for the U.S Medicare Advantage program would have a “significant adverse impact” on premiums and benefits for plan members.

Bloomberg reports, that Humana, UnitedHealth Group and other insurers with U.S. Medicare-backed health plans for the elderly and disabled would get a rate increase of 0.5 percent in 2010, far less than premium growth projected by analysts that ranged as high as 2 to 4 percent growth.


Quick Hits

• Can’t pay or won’t pay?
• Obama’s stimulus package forgets your net worth
  

Peter Lazaroff, Junior Analyst

Daily Insight

Fears about the health of our nation’s largest financial firms sent U.S. on a wild ride lower on Friday. Talk of nationalizing troubled banks pushed the S&P 500 near its November 2008 lows, but markets jumped after the White House insisted nationalization was not in the cards. Of course, it’s hard to believe statements like these since the government has made similar comments in the past, only to change their stance later.


Market Activity for February 20, 2009

Economic data
The Consumer Price Index (CPI) rose 0.3%, showing the cost of living in the U.S. rose in January for the first time in six months. The CPI year-over-year rate remained unchanged for the first time since 1955, according to Bloomberg.

The core rate, which excludes food and energy items, advanced 0.2% last month and was up 1.7% on a year-over-year basis. Both measures came in slightly above expectations. These increases were largely due to higher prices for autos, clothing and medical care.


Bank nationalization
After Citigroup’s shares fell below $2 to an 18-year low, reports surfaced over the weekend that Citigroup is in talks to have the government take a larger stake in the company by converting a substantial portion of its preferred shares into common stock. The government holds $52 billion of preferred shares in Citigroup, five times the bank’s market value as of Friday.

Multiple reports say that the government could wind up holding as much as 40% of Citigroup’s common stock, which would dilute the stakes current Citigroup shareholders. The positive for U.S. taxpayers is that such a move would not cost them any additional money. Citigroup is also encouraging Government of Singapore Investment Corp, Abu Dhabi Investment Authority and Kuwait Investment Authority to convert their preferred stakes into common stock, which will only further dilute current shareholders’ stake more.

The idea behind Citigroup’s strategy is that converting preferred shares to common stock will bolster the company’s tangible common equity (or TCE) ratios – one of several gauges of a bank’s financial strength. Until this point, banks and regulators have referred to the Tier 1 capital ratio to determine a bank’s ability to absorb future losses. I will talk about these ratios in more detail in today’s Afternoon Review, which you can access by visiting our blog at http://www.acropoblog.com/ (the Afternoon Review is usually posted around 4PM CST).


Looking ahead

Futures are up this morning, which may be a sign that investors would embrace a temporary nationalization. The news of government’s potentially increased stake in Citigroup overshadowed the Obama administration’s announcement that they will seek to cut the deficit in half by 2013, through tax increases and spending restraint. The idea of raising taxes during a period of economic weakness makes a lot of people cringe, but it is likely the market has already priced in the expiration of the Bush tax cuts in 2010.

This is a big week for economic data, and Brent will be back tomorrow to guide you through it all.


Have a great day!

Peter Lazaroff, Junior Analyst