SunPower Corp (SWPRA) *contact for tearsheet*
SunPower Corporation is an integrated solar products and services company that designs, manufactures and markets high-performance solar electric power technologies.
Differentiated products such as a relatively high conversion efficiency and better aesthetics should help SunPower gain new customers and contracts faster than peers. The highest efficiency solar cells in the industry means that SunPower’s cells need less space to generate the same amount of electricity. This makes their products an ideal choice for home and business installations, where space constraints and aesthetics are important considerations.
The solar industry has enjoyed rapid growth of over 40 percent during the last five years. Going forward, demand for solar electric power systems will be driven by increasing energy consumption in emerging countries, rising oil prices, environmental concerns and growing interest in solar power as a viable energy source.
The biggest risk is the level uncertainty that naturally comes with fast-growing, immature industries. With so much money pouring into research for alternative energy, a superior technology could emerge that SunPower will be unable to compete with. Another risk is that the company would not be economically viability without government subsidies that are by no means indefinite.
SunPower plans to continue its rapid growth by improving the efficiency and reducing the cost of its solar systems so that the cost of solar electricity can compete with retail electric rates and become a major energy source. The company also hopes to expand production to increase sales. This would allow profitability significantly expand since fixed costs would be a lower percentage of sales.
Quick Hits
Friday, March 20, 2009
SPWRA
Daily Insight
A report from the Labor Department that showed continuing jobless claims soared to a new record didn’t help things as it reminds the market we still have tough labor-market conditions to deal with. This though does not signal the latest moves by the Fed are a failure as we’re talking about jobless claims data for the week ended March 7.
In terms of market activity, energy and material shares were the big winners as investors have inflation on the mind due to the Fed’s print-money mentality – these are areas in which one can hedge against this risk and that is where money was going yesterday. The dollar has gotten smacked since the Fed’s announcement and that means dollar-denominated oil goes higher – up another 5.5% to $50.78 per barrel.
Utilities also saw some life, possibly because interest rates fell big on Wednesday and this is the traditional area with which to search for yield. Financials and health-care shares were the worst performing groups.
Market Activity for March 19, 2009
Jobless Claims
The Labor Department reported U.S. initial jobless claims remained high but did fall 12,000 to 646,000 for the week ended March 14. This is the week that corresponds with the March employment survey week (the week in which the initial estimate for the March jobs report is calculated). It’s good to see the figure fall, but the level of claims suggests we’re in for another 600K-plus decline in payrolls for the month.
The four-week average of claims, a less volatile figure, did rise – up 3,750 to 654,750, the highest reading since October 1982. We will point out for new readers, while the level of claims is high, when you adjust for employment growth we would have to see jobless claims hit one million to truly compare with the 1982 labor market contraction.
The more important news within the report seems to be the continuing claims data, which hit another new record. For the week ended March 7 (there’s a one-week lag between initial and continuing), continuing claims jumped 185,000 to 5.473 million. The insured unemployment rate (the rate of joblessness for those eligible for benefits and a figure than tracks the direction of the overall unemployment rate) rose to 4.1% (the highest since June 1983) from 3.9% in the week prior. This very likely shows the overall unemployment rate will jump to 8.3%-8.5% when the March jobs data is released – it was 8.1% in February.
Philadelphia Fed
The Federal Reserve Bank of Philadelphia showed their business conditions index rose to -35.0 in March from the -41.3 in February, which was the lowest reading since the 1990-91 recession. The March reading was better-than-expected, but the index remains at a very depressed level and a couple of the important sub-indices within the report suggest factory activity actually worsened this month.
The new orders index plunged to -40.7 from -30.3 in February – the lowest reading since the 1980 recession.
The employment index fell to -52.0 from -45.8. That’s the lowest employment reading for the Philly Fed since the index began in 1968. This corroborates what the other manufacturing surveys are showing, and the jobless claims data as well.
I really wish we’d engage in a pro-growth attack at this economic contraction – I’m thoroughly tired of reporting on this stuff and am looking for a more optimistic tone but have to call it as I see it. Businesses need to have some confidence about the future, and I’m not talking about a belief that the economy will receive a 12-18 month pop from all of this spending and Fed stimulus – I’m talking about lower “permanent” tax rates that drive confidence regarding the long-term prospects for economic and after-tax profit and income growth.
In addition, we need much less government intrusion and an inviting message to global capital. (Certainly, the current administration entered in the midst of a significant downturn -- and the Bush team made their share of mistakes the final year in office -- but by picking up the ball and running hard left is proving quite damaging and does take its toll on confidence).
I suspect we will see business spending bounce back several months out, and these manufacturing indices, such as Philly Fed, will be the first indicators of this event. Nevertheless, firms are not stupid; the decision makers understand that the spending on the fiscal side of things means Congress will very soon be displaying the ‘higher taxes” placard. They also know with all the Fed is doing means the chances that inflation will rise to unwelcome levels is heightened – and this will affect the cost side of the business ledger.
As result, we will likely not see the pop in business spending we would otherwise enjoy when we come out of this contraction and the bounce we do see may not prove all that long-lived as businesses remain cautious. We really need to see the direction of policy change course in order to think otherwise. We will eventually get it right again – you’ve got to believe that --, but vilifying the holders of capital and the business community is not a winning strategy.
Have a great weekend!
Brent Vondera, Senior Analyst
Thursday, March 19, 2009
FDX, GE, GEF
S&P 500: -10.31 (-1.30%)
FedEx (FDX) +4.76%
FedEx reported fiscal third quarter results that were well short of expectations and announced additional cost reduction actions in response to severity and expected duration of the recession.
Express and freight segments were hardest hit by shrinking demand, with revenue off 18 percent and 21 percent, respectively. Ground shipping was the bright spot during the quarter. Volumes increased 2 percent, which can be attributed to FedEx wining DHL clients (DHL recently exited U.S.) and to ground’s cannibalization of more expensive express shipping.
FedEx said the continued deterioration in global economic conditions was behind the poor results, as shipment volumes declined and a more competitive pricing environment emerged. The company also said revenue was negatively impacted by reduced fuel surcharges and lower shipment weights. In response to the downturn, FedEx said it will reduce network capacity at FedEx Express and FedEx Freight, further reduce personnel and work hours, and expand pay reduction actions to include non-U.S. employees.
FedEx issued downside guidance for its fiscal fourth quarter. The outlook assumes continued weak global macroeconomic conditions and stable fuel prices. FedEx is generally considered a bet on the U.S. economy and the global economy, and the company is going to benefit as soon as there’s a rebound.
General Electric (GE) -1.84%
GE management spent six hours today reviewing GE Capital’s balance sheet and reiterating the fact that the finance unit will not need outside funding and will turn a profit in 2009. Assuming unemployment averages 8.4 percent this year and the U.S. economy shrinks by 2 percent, GE expects GE Capital to make a profit between $2 billion and $2.5 billion. Under the worse-case-scenario used by the Fed to test banks, GE predicts net income from its finance unit would break even in 2009.
Investors have become somewhat single-minded in their focus on GE Capital as they fear the unit’s $637 billion balance sheet (as of 12/31/08) is full of souring assets like commercial real estate loans and securities that make the unit and its parent vulnerable to future losses. The presentation today resembled that of a bank’s earnings presentation, providing a higher level of disclosure than GE Capital has before.
Despite GE Capital’s extra transparency, there still wasn’t any new information that would change my view that the shares are undervalued.
Greif Inc (GEF) +4.17% *tearsheet attached*
Greif (which rhymes with “life”) engages in the manufacture and sale of industrial packaging products as well as containerboard and corrugated products worldwide. The company operates in three business segments: Industrial Packaging (81 percent of revenues, 76 percent of operating income), Paper Packaging (18 percent, 19 percent) and Timber (0.5 percent, 5 percent).
Grief is the global leader in industrial packaging products and services with 30 percent of market share and leading market positions in steel drums, fibre drums, closures and water bottles. Greif derives its competitive advantage from its comprehensive product portfolio and unmatched geographic diversity. This provides their customers with a “one-stop-shop” and addresses substitution considerations, which is particularly important in an industry with little product differentiation.
Greif also benefits from a diverse customer base – no single customer represents more than 3 percent of revenues and their top ten customers do not exceed 20 percent of revenues – shields Greif from a downturn in one of their end markets that include chemicals, food, petroleum, agricultural and pharmaceutical industries.
Demand for Greif’s products is sensitive to the general economic climate, so it no surprise to see production volume teeter off. Higher energy and raw material costs also pose a threat to profitability. The company recently accelerated its very successful cost-cutting program that was implemented in 2003, and expects to generate an additional $100 million in free cash flow in 2009.
Greif has a history of rewarding its investors and has returned 20 percent of operating cash flow to shareholders since 2002. The company has been growing their generous dividend at a 40 percent rate in the last five years, and all indications imply that trend will continue.
Quick Hits
- The Bear Necessities
- Trivial Pursuit
- U.S. House Passes 90 Percent Tax on Employee Bonuses
- Naked Short Sales Hint Fraud in Bringing Down Lehman
Peter Lazaroff, Junior Analyst
Fixed Income Recap
In their announcement today the FOMC (Federal Open Market Committee) left the target rate for overnight loans between banks (Fed Funds) unchanged at a range between 0% and .25%. This was completely expected, however, the comments on expanding open market operations came as a bit of a surprise.
The $500 billion agency MBS buying program announced in January, is being expanded by $750 billion to a total of $1.25 trillion to be purchased by the end of the year. There is roughly $4.4 billion in agency MBS outstanding ($2.6 billion in Fannie and $1.8 billion in Freddie), which puts Fed buying commitments at 28% of the current market. Scary!! The street was essentially split on this before today’s events. Half of the market thought they would stand pat at $500 billion and the other half thought an increase of $100-$300 billion would be substantial enough to really get the ball rolling with respect to bringing mortgage rates down. The agency debt purchasing program was also increased by $100 billion, to $200 billion, and also extended to the end of the year.
The idea of the Fed buying Treasuries has been floating around as a serious possibility for about a month now. Today the Fed committed to purchasing $300 billion in longer dated Treasuries in the next six months. The bulk of the buying will take place in the 2- to 10-year sector of the nominal curve, although purchases will take place along all parts of both the nominal and TIPS curve.
The last big piece of news that came with the FOMC announcement is the expansion of the TALF (Term Asset-Backed Securities Loan Facility). There was a loose cap on the program of $1 trillion, which is now likely to expand, but more importantly, the kinds of securities eligible as collateral under the program is set to expand. The plan is likely to still include small business loans, credit card loans and car loans, but be expanded to include the poorer performing issues.
The 30-year Treasury rallied eight points immediately after the Fed announcement, but after traders digested more of the Fed’s statement, primarily that they will be concentrating more on the middle part of the curve, the gains were cut to only five points for the day. The two-year finished up 13/32, and the ten-year was higher by four points. These are tremendous one day movements in rates. Yields on the two- and ten-year dropped 22 basis points and 48 basis points respectively. The benchmark curve flattened by 26 basis points on the day. A basis point represents .01%.
MBS
MBS reacted well to the news, but not great. Mortgages underperformed Treasuries significantly today, widening 10 to 15 basis points depending on the coupon; however yields still dropped 40 basis points across most coupons. I would expect the market to lag the news, similarly to when the Fed first announced a buying program and it took weeks before the market tightened in. The market had some of the program expansion priced in, but I would expect some further tightening to occur.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Wednesday, March 18, 2009
EXPD
S&P 500: +16.23 (+2.09%)
Expeditors International of Washington (EXPD) *contact for tearsheet*
Expeditors International of Washington Inc. is a global logistics company that derives revenue from air freight (36 percent), ocean freight (25 percent) and customs brokerage and import services (39 percent).
The global logistics services industry is a strong and growing industry, with a large number of companies competing in one or more segments of the industry. Expeditors, however, is one of the few firms with a global network that offers a full complement of logistics services.
The air and ocean segments act as a freight consolidator, purchasing cargo space from planes/ships and reselling it to customers at lower rates than customers could receive directly. They also act as agent by preparing documentation, procuring insurance, arranging packing and crating and providing consultation.
Expeditors does not own any aircrafts or ships themselves, which alleviates business risks their competitors face such as large capital outlays, increased fixed operating costs, problems of fully utilizing planes/ships and competition with airlines/freighters.
The company’s customs brokerage and import services assist importers in clearing shipments through customs by preparing documentation, calculating and providing payment of duties and arranging government inspections. Other services include temporary warehousing, inland transportation, inventory management and cargo insurance and distribution.
Expeditors’ low-cost business model drives the company’s ability to generate strong returns on invested capital (ROIC) – over 30 percent during the last five years – and steadily grow revenues at a double-digit pace. Expeditors’ balance sheet has no long term debt and nearly $750 million in cash, which is much more than required for operations. Unusually high cash levels and a low dividend payout ratio (22 percent) suggest the company will continue raising their dividend at a double-digit clip.
The valuations of many logistics companies already reflect worries about the economy, and any strengthening in the U.S. economy could drive improved sentiment. In the near term, customers are likely to continue to use lower-priced delivery methods and ship less due to rising cost of transportation. Longer term, demand for international shipping will be driven by export activity out of Asia and developing economies throughout the world.
Quick Hits
- IBM Said to Be in Talks to Buy Sun Microsystems
- GE to Shed Light on Its Properties
- The Next Great Wall (fitting story in light of the Coke/China news today)
Peter Lazaroff, Junior Analyst
Daily Insight
Personally, the rally over the past few days seems to be driven more by growing expectations mark-to-market will be modified. Each day we get more comments on the issue and the latest talk out of FASB has many believing we’ll break the link between this accounting rule (put in place in November 2007) and regulatory bank capital. This would be a huge development and the market is trading ahead of an official statement. Although these days more than ever, you can’t go too much on words – they have to follow it up with action or stocks will fall even quicker than they’ve risen of late.
What’s really nice is to see how broad-based the rallies have been, and even more so yesterday as you can see all sectors advanced. Hopefully, we’ll stage an assault on the 825-830 range (S&P 500) and erase the latest move down (a month-long 24% slide until this latest rally stopped it cold) – one step at a time though.
Market Activity for March 17, 2009
Crude-Oil
Crude has made a move back to $50 per barrel, an upward trend over the past four sessions reversed what looked to be a move back below $40 just one week ago. Some of what’s been going over the past few days may be trading based on the expiration of the April contract. Oil futures are in contango, meaning future month contracts trade higher than the front month.
In addition, that strong rebound in February housing starts increased expectations the economy will come back to life sooner than previously anticipated, and this belief obviously drives oil demand expectations. Oil is trading on GDP expectations more than ever right now. (We’ll touch on the housing starts data below)
Traders will also be keeping a close eye on the weekly Energy Department report this morning. The expectation is for a build of 1.5 million barrels. If the supply numbers don’t draw down over the next couple of weeks crude may move higher. This sounds confusing as it should have the opposite affect, but many are viewing rising inventories as a sign OPEC members are cheating (not abiding by lower production quotas). This may cause the cartel to implement an aggressive reduction in production, which will send crude higher. I’m not convinced they’ll do so in this weak economic environment but I do believe there’s a better chance of crude heading higher over the next several months rather than the other direction.
The Economy
Producer Price Index
Overall producer prices (PPI) fell 0.1% for February – food prices fell 1.6% last month and energy rose 1.3%, boosted by an 8.7% rise in gasoline.
Over the past year, PPI is down 1.3%, but the core rate is up 4.0%.
The decline in food prices, along with a 4.5% drop in computer prices (great time to buy electronic goods) pushed the overall reading lower for the month.
However, we see evidence of prices remaining sticky in a number of categories. Those convinced that under-utilization rates in both labor and capital make it impossible for inflation to rise (yes, there are economists – many of whom reside in our Federal Reserve system -- who continue to grasp to this NAIRUist model even though the 1970s steamrolled the idea) should focus on the 3.6% rise in core PPI over the past three months. We’re starting at a pretty high base for this stage in the business cycle. If the Fed’s action, along with massive fiscal spending spark inflation it may be quite an event 12-18 months out.
Prices for consumer goods have increased the past two months (and the consumer goods core figure is up 4.1% past three months); light trucks haven’t shown a decline yet; capital goods prices are up for the third-straight month. Deflation fears are highly overblown and as the fiscal stimulus rolls out (I find it interesting how those “shovel-ready” jobs aren’t quite that ready, which is what a number of people warned about a month back) and the Fed continues to print money, we’ll find those still concerned about deflation are not quite in the game.
Housing Starts
The Commerce Department reported housing rebounded big in February, jumping 22% to 583,000 units (at an annual rate) from an upwardly revised 477,000 units in January -- previously reported at 466,000 units. Multi-family starts surged 82.3% last month; single-family starts rose just 1.1%.
A couple of things here.
One, January weather was pretty harsh in most parts of the country and thus this drove the housing starts figure to extremely depressed levels, making another new low in fact. So the February bounce back has to be seen as a function of that weather-related extreme weakness.
Two, most of the gain came from the multi-family segment (condos, apartments and townhouses) – jumping 82%. This is a very volatile segment of the report and should not be viewed as a trend.
I decided to add the longer-term chart below just to show how depressed housing starts have been. Despite the comments above that suggest we should not view this one month worth of data as a sign residential construction is on the rebound one has to believe that the level of residential activity has become so low that a bottoming has occurred. Certainly the drag this area has on GDP should diminish – which has already occurred simply because it makes up just 3% of GDP today, down from 6% in 2006.
The permits data looked good, up 11% for single-family units, and the three-month change is moving in the right direction relative to the 12-month change. Overall permits were held back (up only 3%) as multi-family permits to build fell 10.8%. But one thing at a time, we’ll take the increase in single-family for now. The increase in single-family permits may be signaling a bottom has been reached, but because of the weather-related rebound in housing starts we’ll have to wait for the March data before conviction can arrive.
FOMC Meeting and Statement
The market awaits the end of the Fed’s two-day meeting this afternoon, and most importantly the statement that ensues, to learn what they are thinking regarding their latest attempt at quantitative easing. Some believe the FOMC will follow the Bank of England down the path of government debt purchases, but we think this is unlikely just yet. Instead, they may concentrate specifically on mortgage rates and signal an increase in purchases of agency (Freddie, Fannie, Federal Home Loan) debt and mortgage-backed bonds.
The Bank of England is in the process of buying $150 billion in gilts (UK Treasuries) and if the U.S. Fed were to go at this on the same scale it means they’d push their balance sheet to 30% of GDP, or roughly double where it is today – and that’s on top of already doubling over the past several months! Read this as printing money on a massive scale and I don’t believe the Fed wants to put the U.S. dollar in the gallows just yet. They will engage in Treasury purchases only as a last resort.
While the dollar is strong right now, at least relative to its lows hit last summer (it’s gotten a boost from the safety trade, or the flood into the Treasury market), printing money on such a huge scale, in addition to $2.0 trillion in Treasury debt issuance this year, will very likely send it back to those lows over time. Not saying investors and traders will flee the greenback for the euro or pound, those economies have major issues too, which can mean only one thing – hard assets anyone?
We will have a better idea of the direction Bernanke and Co. will take at 1:15CT.
Have a great day!
Brent Vondera, Senior Analyst
Tuesday, March 17, 2009
Norfolk Southern Corp. (NSC)
S&P 500: +24.23 (+3.21%)
Norfolk Southern Corporation (NSC) *contact for tearsheet*
Norfolk Southern provides rail transportation service in the eastern U.S. Operating over 21,000 miles of road, Norfolk hauls shipments of coal (24 percent of revenues), intermodal traffic (20 percent), plus a diverse mix of automobile, agriculture, metals, chemical, and forest products (each 9 percent to 12 percent).
Coal is Norfolk’s most profitable segment, but their intermodal business is the fastest growing segment longer term. The company is committing a significant amount of capital to the intermodal franchise to position themselves to capture growth from freight moving away from highway transportation and to the railroads.
The case for this longer term trend is that fuel prices are not expected to remain at current low levels, highway congestion is getting worse and large shippers are trying to reduce their carbon footprint – railroads account for about 40 percent of the overall freight ton miles moved, but only consume 8 percent of the associated fuel.
Because coal demand represents one-fourth of Norfolk’s revenues, environmental regulation discouraging utilities from using coal is an obvious risk. Norfolk also has a significant automobile franchise, which is subject to the cyclical automobile market.
One of the biggest criticisms of railroads is their lower profitability. Despite the best pricing in decades, returns on invested capital (ROIC) are still fairly close to its cost of capital. This is largely due to high capital expenditures, which represent roughly 13 percent of Norfolk’s revenues annually. Profitability among railroad companies is also hurt by unionized employees. Even so, Norfolk stands out by generating around $1 billion in free cash flow annually, or 10 percent of revenue, making them on of the most profitable rails in North America.
The U.S. rail industry has an oligopoly-like structure – over 80 percent of revenues generated by the four largest railroads – meaning Norfolk enjoys overwhelming barriers to entry. Another positive is management’s commitment to returning value to shareholders via share repurchases and increasing dividend payments.
Quick Hits
- Bernanke May Need ‘Massive’ Asset Purchases to Counter Deeper Contraction
- Intel, Lockheed Tell Obama on Taxes, F-22: Not in This Economy
- Coca-Cola Flees Commercial Paper for Safety in Bonds
- Drug Firms Bet Big on High-Risk Deals
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks, as measured by the S&P 500, erased a 2.5% gain in a late-session move lower, ending a four-day streak that pushed the broad market nearly 12% above the 12-year low hit last Monday. Word was that an afternoon statement out of American Express regarding rising credit-card delinquency rates is what caused the sell-off. Possibly, a worse-than-expected industrial production reading also weighed on sentiment late in the day, although I think there were some glimmers of hope in that IP reading, which we’ll touch on below.
The S&P 500 had bounced 13% above its intra-day low of 666 – yeow! let’s stay away from that one – so we shouldn’t expect rallies of this nature to extent too long without a pullback. These pullbacks are good any way; we don’t want to get ahead of ourselves.
Over the next few days the market will be eagerly awaiting comments on mark-to-market accounting as FASB and the SEC are expected to at least modify the rule. We would suspect that a decision to suspend this accounting standard, with regard to assets that currently have no market, in favor of a cashflow-based accounting measure will engender an additional rally.
We also have a two-day FOMC meeting that begins today. We’ll see if our Fed will follow the Bank of England’s decision to buy government debt, or even issue their own. If they go down this road, it will pretty much cement the view that inflation is going to become an issue 12-18 months down the road – they will be printing money to engage in this policy. We shall see.
Utility, industrial and basic material shares led yesterday’s gainers. Financials, consumer discretionary and technology shares put pressure on the indices.
Market Activity for March 16, 2009
Small Business “Help”
Treasury Secretary Tim Geithner has begun urging banks “to go the extra mile” and offer small businesses loans, stated they (the banks) bear a “special responsibility” to assist in the recovery because of their role in the financial crisis.
Isn’t this the kind of thing that got us into trouble in the first place, a sort of social engineering pushed by government to provide credit to the areas in which they want it directed regardless of the consequences? Sounds a lot like the emphasis of the previous decade to offer low-cost housing loans regardless of the borrower’s ability to pay. If banks view it is beneficial to make loans to specific small businesses, they will do it, but they should not be forced by government officials to do so. Besides, at the same time they’ve got regulators demanding they raise capital, which means they won’t be making new loans.
It appears the administration understands the huge role small business plays in our economy; these are the largest U.S. job creators. However, they are going about it the wrong way. The government cannot demand, or direct, how resources are allocated -- nothing good ever comes of this. Rather, they should refrain from raising tax rates on income (600,000 small businesses will be affected by the administration’s own admission, via the increase in the top bracket) and slash the capital gains rate small businesses pay. This is how you offer help to small business and you allow the market to allocate resources. But then, government doesn’t grab more control this way now does it.
The Economy
Empire Manufacturing
The New York Federal Reserve Bank’s factory activity index, known as the Empire Manufacturing survey, came in weaker-than-expected falling to its lowest reading since the survey began in 2001 – not a lot of history here and this is not a great regional factory indicator either.
There is nothing in this report to suggest manufacturing activity has hit bottom, although below we’ll touch on how industrial production may be showing early signs of a rebound. The headline number on Empire is a general sentiment indicator, it is not a weighted average of the sub-indices like the nation-wide ISM survey. Put in ISM terms, according to RDQ Economics, we’re looking at 35.1, down from 40.2 in February.
On Thursday, we get a better regional manufacturing report in the Philly Fed survey – we’ll be looking to that report for evidence of a bottoming out process.
The sub-indices provide zero suggestion that New York factory activity will bounce in April. The shipments index plunged to -26.7 from -8.1 and new orders, as illustrated below, fell to -44.8 form -30.5 in February.
The employment index ticked up a bit, but remains extremely depressed.
Industrial Production
In a separate report, the Commerce Department stated industrial production declined meaningfully in February (the fourth-straight month of substantial contraction). The reading was slightly worse-than-expected. We noted yesterday that the market would likely have a tough time adding to last week’s rally on a bad reading from this figure – which may have been true to some extent -- but it looks like weather played havoc last month as a decline in utility activity accounted for half of the decline.
Auto production rebounded by 10.2% last month as holiday-related plant idling (which extends into January) came to a close. More importantly, consumer goods, construction supply and business equipment production all declined at the smallest levels in several months. The auto production bounce may prove to be a transitory event as auto sales remains subdued. However, the reduction in the rate of decline for the previously mentioned segments of the report should be viewed as a positive.
So with the possibility of warmer weather playing havoc and the easing with regard to degree of decline in the above mentioned areas, these may be an early sign things are bottoming. We’ll know over the next couple of months.
Have a great day and a great St. Pat’s!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasury prices are getting attacked on multiple fronts. The first being Bernanke’s comments over the weekend that he believes the recession will probably end this year, which is killing the flight to quality trade. Secondly, the market is questioning the Treasuries’ ability to tap foreign investors. This is being complicated by Washington accusing China of manipulating their currency (Secretary Geithner needs to be careful with regards to this). Lastly, comments from the FOMC are leading many to believe that the Fed may be content with 5% on the conventional 30-year fixed rate mortgage, instead of the previously rumored 4.5%. The Fed hasn’t released any formal target; I am just talking about broad speculation. The rate currently sits at 5.09% according to bankrate.com.
The two-year finished down 2/32, and the ten-year was lower by about a half of a point. The benchmark curve steepened by about 3 basis points on the day. A basis point represents .01%.
MBS
Agencies tightened to comparable Treasuries by 18 to 22 basis points today depending on the coupon, with higher coupons outperforming the rest. There was a very large Fed purchase operation that went off today, the bulk of which was $2.149 billion in the old FNMA five-year benchmark. Although this was an agency debenture purchase operation, not MBS, the news, coupled with the Fed’s anti-Treasury purchasing rhetoric really lit a fire under MBS today. Today’s movement essentially erased all of last week’s spread widening. It’s almost funny what a little government meddling can do to volatility.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Monday, March 16, 2009
ITW, GR, ACI, BTU
Illinois Tool Works (ITW) -3.27%
Illinois Tool Works fell after the company lowered its previous first quarter earnings guidance citing “significantly weaker” demand than expected. The company now sees profit of 8 cents to 16 cents a share from continuing operations instead of its Feb. 16 forecast of 26 cents a share to 42 cents a share. According to Bloomberg, the average analyst estimate was a profit of 31 cents a share.
Illinois Tool Works said it experienced a 21 percent drop in operating revenue for the three months ended Feb. 28, reflecting a 20 percent decrease in base revenue as well as a 7 percent fall-off in contributions from currency translations. The biggest revenue weakness in the three months ended Feb. 28 was construction products (down 32 percent) and industrial packaging (down 28 percent).
Standard & Poor’s cut the company’s long-term corporate credit and senior unsecured debt ratings from A+ from AA- because of “persisting weak demand in its key industrial markets.” S&P also lowered the short-term and commercial paper ratings one level.
Goodrich (GR) +5.22%
Goodrich, the world’s largest producer of aircraft landing gear was raised to “buy” at Goldman Sachs Group noting Goodrich’s aftermarket business, which “historical analysis shows that aftermarket-exposed companies have outperformed in this part of the cycle.”
We have favorable long-term view towards the aircraft parts maker. The company derives 36 percent of revenues coming from aftermarket business, which has much higher margins than original equipment. In the near-term, the aftermarket business is especially important for Goodrich since the aerospace cycle is in a downturn, as aging planes are repaired and not replaced.
In the longer term, Goodrich is a trusted supplier of integral parts for the newest Boeing and Airbus models, which have backlogs equal to over 6 years of sales. Not only should Goodrich see a spike in original equipment sales, but they will also have a strong position in the aftermarket business for new Boeing and Airbus planes.
Arch Coal (ACI) +1.63% and Peabody Energy (BTU) +4.58%
A Barron’s article lifted sentiment for coal stocks. The article predicted that Consol Energy (CNX), the third-largest U.S. coal producer, could triple by 2010 if the global economy improves.
Quick Hits
- Good Idea That Turned Bad
- As Growth Slows, Ex-Allies Square Off in a Tech Turf War
- Computer Makers Prepare to Stake Bigger Claim in Phones
- Diagnosing J&J’s Next Move
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks ended the week on a positive note Friday, bolstered by sectors that underperformed the broad market over this five-session rally. Heath-care, consumer staples and utility shares led the S&P 500 higher on Friday, while the areas that propelled the indices over the previous four days ended a bit lower – industrials, tech and energy.
For the week, the S&P 500 gained 10.71% after sliding 26% over the previous nine weeks. That roughly two-month slide put the broad market down 57% from the all-time high hit on October 9, 2007.
It took a year for the S&P 500 to fall 20% from that high, but everything changed in mid-September 2008 when Lehman and AIG went down and the downside accelerated at amazing speed – down 45% from the peak by mid-October 2008, down 52% by late November and finally down by 57% before last week’s rally. This has been the crusher with regard to confidence, lack thereof actually, on both the consumer and business side of things.
Let’s hope we’re onto something here. For sure though we have headwinds ahead of us as the actions taken by the Fed and Congress will very likely engender an inflationary event that will have to be dealt with. If we can extend upon this rally though, it will offer a very needed boost to confidence.
Market Activity for March 13, 2009
Summers’ Call
Fed Chairman Bernanke received most of the attention this weekend (as he made an appearance on 60 minutes – assuming people still watch the news magazine) but it was comments by Larry Summers on Thursday and his speech on Friday that should been given more emphasis by the press.
The head of President Obama’s economic team, and former Treasury Secretary under President Clinton, made a call to G20 members to increase their stimulus spending programs. However, Europe doesn’t seem interested in playing as they have seen for years the ineffectual, and indeed growth damaging aspects of doing so. Western Europe has been in the process of cutting tax rates and spending and while they are engaged in their own stimulus package they do not desire to up the ante.
Of course Western European economies have many obstacles to growth, way too much entitlement spending, productivity-killing work-hour regulations, and a birth-rate problem that makes sustaining their current social safety net impossible. So I’m not trying to say that Europe is in great shape, because they are not, but they made some good policy decisions over the past couple of years.
This is what makes the current U.S. policy so troubling. Instead of encouraging Western Europe to increase stimulus via the old Keynesian ways (more government spending that many times is not directed at areas that produce a productivity return to this spending but rather sap it) we should acknowledge the fact that the rest of the world is doing what we heretofore had been leading by example – cut tax rates at the margin in order to incentivize production and investment. I’ve never thought to be writing such things, but here we are doing exactly what we’ve been telling the world for two decades what not to do.
It is important to clarify and point out that I’ve been a proponent of the idea among some to strike a deal with China – we’ll stop calling them a currency manipulator if they triple their stimulus spending. In this regard China is different. They have a huge savings rate, too large in fact as this makes them overly dependent on export growth. Nonetheless, their savings rate allows them to massively increase spending. The fact that they are an emerging market also means that they need continued infrastructure improvements based on their population and growth rates and in this regard government fiscal spending makes much more sense for them than it does for the U.S. and Europe. For the U.S., we need to acknowledge the fact we’re a capital-intensive economy and thus policy should be directed at inviting capital, which is accomplished on the tax rates side of things.
But Summers has pleaded to the Europeans that they increase their deficit spending, let’s hope they continue to tell him no and that the way to go is to incentive the private sector. You know we have a problem when Chinese Premier Wen is lecturing us about making sure we remain a “credible” nation – as he stated on Thursday night. Obviously, these comments are largely just Chinese rhetoric. But look, foreign holders of our debt are going to have a legitimate worry over this debt issuance. They will eventually become unwilling to buy Treasuries at these interest rate levels and we better get things right or we’ll all deal with the consequences of a declining dollar and onerous interest rates.
On the Economic Front
The Commerce Department reported the trade deficit for January continued to narrow significantly. Surely there are those out there that relish this development, but it also means that things are not good from an economic perspective – it takes significant contraction in the in the U.S. in order for this to occur. (Although, the widening of the trade deficit did get a bit out of control 2005-2007, but this was due to massive monetary easing in the years just prior as this resulted in a credit expansion that was not sustainable.
In addition, Fed policy earlier in the decade meant foreign currency reserves rose to very high levels (via more dollars in the system) and this meant countries like Japan and China needed to buy large amounts of U.S. Treasuries (otherwise their domestic currencies would rise to levels that were not conducive to their export activity) and this also kept interest rates lower than they otherwise might have been, thus making debt more appealing. These are aspects of the credit expansion we all must understand or we’ll make the same mistakes in the future. We have to stop blaming the private sector for everything that has occurred and focus more blame on the Fed for it is their policy mistakes that are the ultimate origin of this situation.
Anyway getting to the data, the trade deficit narrowed to $36.0 billion in January from $39.9 billion in December – a compression that was more than expected. Imports fell 6.7% for the month and exports declined 5.7%.
The narrowing in the nominal trade gap was in some part due to declining oil prices, though most simply due to contraction in U.S. consumer and business activity.
The export data (U.S. exports to other nations) shows the degree to which global economic activity has weakened.
Asia NICs (newly industrialized countries) led the decline showing a 31.8% decline; China posted a 28.6% decline. Canada posted a 27.6% in goods purchased from the U.S. Exports to the European Union fell 17%. OPEC nations recorded the first decline of U.S. export purchases during this downturn, as exports to this region fell 14.1% in January.
The chart below is measures in negative numbers, just in case you can’t see the scale – thus when the figure is rising it illustrates a narrowing in the trade deficit.
In a separate report, the Labor Department reported import prices fell 0.2% in February, a smaller than expected decline. The year-over-year figure showed the decline in import prices accelerated, a plunge in petroleum prices has been the main contributor (imported petroleum prices actually rose last month but are down 52.4% over the past year) – excluding petro import prices are down just 1.9% for the past 12 months.
The month-over-month figure is likely signaling we’ve seen the worst of the import price deflation.
The fall in prices, whether it be import, producer or consumer, has been a function of the collapse in energy prices. If the dollar takes a turn down (a likely scenario when the safety trade comes off and actions by the Fed and fiscal spending put pressure on the greenback as well) import prices won’t take long to shoot up again.
Futures
Stock-index futures are higher this morning, so at least at the open it appears we’ll build upon last week’s rally. In terms of economic data we’ll get New York-area manufacturing activity, by way of the Empire Manufacturing reading for March, and industrial production for February. I think we’ll need to see a better-than-expected reading on that industrial production figure to hold onto gains throughout the day.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Thursday’s thirty-year sale completed a week of well received auctions in the Treasury market. The issue came in at 3.64%, and then rallied to 3.61% by market close. Bond prices move inversely to yields. This marked the third day in a row of auctioned bond outperformance.
Treasuries looked a little rich after rallying strong for a three day period that saw stocks (S&P 500) rally roughly 11%. It’s a general rule that Treasuries prices move inversely to stocks, although this is not always true. Today’s movements are just a correction in my mind.
The two-year finished up 2/32 after being down most of the day, while the ten-year was lower by about a quarter of a point. The benchmark curve steepened by 7.5 basis points on the day and stands unchanged for the week. A basis point represents .01%.
TIPS
Treasury Inflation Protected Securities were up roughly 2% for the week as they continue to be volatile. Today’s reality when it comes to inflation is concerning. Unprecedented fiscal stimulus, Fed Funds sitting at zero with virtually no chance of going up any time soon, a budget deficit from Washington with limited Treasury buyers besides the Fed, in addition to a bulging Fed balance sheet (TALF, MMIFF, Fed MBS purchases) that could reach 30% of U.S. GDP all point to a major inflation event.
We could be a year or two from feeling the effects of the current policy, but I don’t see how we don’t get one. Excuse me for getting a little technical but consider the following equation for monetary exchange.
MV=PQ
M (money) is what is increasing at a break neck speed due to the loose money policies I detailed above.
V (velocity) is the number of times a dollar is exchanged between parties during a period of time. This varies along with the business cycle.
P (price) Prices rise in an inflationary period and prices fall during a deflationary period.
Q (quantity of goods and services available) This number rises during economic booms and falls during recessions.
Money is raging right now, but with velocity being so low, no pressure is being put on the other side of the equation. When the economy begins to show a little life and velocity returns, the quantity of goods will struggle to keep pace, leaving prices as the only variable left to balance out the exchange of money.
This is what is meant by “too much money chasing too few goods”. The process of hiring people, bringing factories back on line, and rebuilding the systems essential to running a business take time and therefore lags money supply growth.
We believe TIPS are an essential part of a portfolio in an inflationary environment.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst