INTC

S&P 500: -16.92 (-2.03%)

Intel (INTC) -2.53%
Intel is set to launch its next chip for servers on Monday known as Nehalem. The 45nm Nehalem microprocessor units (MPUs) feature some of the most important innovations to Intel’s products since the introduction of the Pentium in 1993. New features result in about 2x higher performance over current server MPUs. A Credit Suisse note estimates that Intel is garnering $50-$100 in average-selling-price premiums and conversations with original equipment manufactures and chief information officers indicate extremely positive views on Nehalem.

There has been a lot of concern that Atom (6 percent of 2009 revenue) will cannibalize higher-margin products, marking a long term mix-shift and lower profitability. Nehalem could put some of these concerns to rest due to the potential growth in the server business (currently 18 percent of revenues), which has lofty gross margins near 75 percent.



Quick Hits

• Greenspan’s Amnesia
• Fund Firms Look to Offer a Toxic Taste
• Ending Excess
• Defense Companies: In the Line of Fire
  
  

Peter Lazaroff, Junior Analyst

1Q 2009 Participant Insights

The Q1 2009 Participant Insights have gone to print! This issue examines how a bear market affects participant investments and highlights some common mistakes investors make.

Click here to read this issue now.

Daily Insight

U.S. stocks continue to rally with another strong performance yesterday after better-than-expected earnings results out of Best Buy and the 7-year Treasury auction went very well, easing any concerns over a lack of demand after a UK auction failed on Wednesday.

Industrial and tech shares led yesterday’s rally as both sectors hugely outperformed, up 5.05% and 4.00%, respectively. Consumer discretionary shares also performed very well on that Best Buy news and material stocks continue to get a boost as the Fed’s action almost guarantees commodity prices are going higher.

The S&P 500 is now 23% above the nefarious March 9 low of 666 and it appears we’ve got momentum to move higher. The technicians say 840 is the next resistance, so if we can get above that level in the next couple of days we may have a shot at 900.

Yesterday’s rally occurred even as Treasury Secretary Geithner was on Capitol Hill yesterday exclaiming we cannot wait to set up a super regulator. His comments illustrate Washington continues to miss what has done such damage to the market. Without a doubt, the origin of the credit excesses is failed monetary policy and social engineering by Congress, which was followed by the natural human reactions to easy money.

But the reasons the stock market got crushed even beyond what occurred by mid-October (off the peak by 35% by mid-October) was the de-leveraging event, an overtly easy way to short stocks, lack of margin requirements in the credit default swaps (CDS) market and an accounting rule that has vaporized bank capital and allowed the shorts to game the system. (As Andy Kessler explained brilliantly in yesterday’s WSJ Opinion page, all the shorts had to do was bid up CDS prices, which increased the likelihood, or the perception at least, that CDO derivatives would default. As a result, banks had to mark these assets down across the board and watch their regulatory capital erode, at which point banks’ share prices plummeted and the short position became hugely profitable.

There’s nothing you can do about de-leveraging, it’s what needed to occur, but something can be done about the unnecessary ease of shorting the market and the increased ability to game the system that zero margin requirement in the CDS arena and mark-to-market accounting delivered We don’t need a monolithic regulator – as Geithner proposes, a machine that largely burdens the private sector. We need mark-to-market modified, reinstatement of the uptick rule and a clearinghouse (with margin requirements) for the CDS market. You do these things, refrain from micromanaging the private sector, and this market rally has a shot at some level of sustainability. Unfortunately, the agenda appears to be a move toward micromanagement and gives the perception that the administration is more interested in a power grab and feeding the current populist frenzy.

Market Activity for March 26, 2009

Fourth-Quarter Gross Domestic Product (final revision)

The Commerce Department reported the final revision to Q4 GDP was revised to -6.3% (in real terms at an annual rate) from the previous revision of -6.2% (the figure was first reported at -3.8% in the initial estimate back in January).

The big change from that initial estimate of -3.8% all the way down to -6.3% was due to the fact that the inventory estimate was very wrong. Inventories were estimated to have increased in that initial estimate by $6.2 billion when in reality stockpiles fell $25.8 billion. (The initial estimate has to make a lot of assumption because much of the quarter’s data is not out when the first look at GDP is released.)


The decline in economic activity last quarter was the most severe since the 1981-82 recession. Residential investment (housing construction) fell 22.8%; business fixed investment fell 21.7%; personal consumption (the largest component) slid 4.3% -- a huge decline for this segment. All of these figures are in real terms at an annual rate.

The decline in personal consumption follows a 3.8% drop in the third-quarter, marking only the third time we’ve seen back-to-back declines in consumer activity in the post-WWII era.


The current quarter is not shaping up much better. The personal consumption segment is shaping up to post a much better reading, and may actually be positive; however, business spending and inventory liquidation is going to weigh heavily on the figure and we’ll likely see another decline in GDP of at least 4.5%-5.0%. Nevertheless, the inventory dynamic (the huge degree at which stockpiles have been liquidated) should offer a boost to the second-quarter GDP reading – enough so to make it positive, but it’s a very early guess right now. And still, we cannot expect the consumer to offer much help for a while as the job-market picture remains bleak.

Corporate Profits

The corporate profits measure within the GDP report, known as NIPA (National Income and Products Account) showed economic profits fell 16.5% last quarter – this is not an annualized number – and has declined 21.5% over the past year. This decline was driven by the 59.3% plunge in financial-sector profits. Nonfinancial profits fell 10.7%. (These are called economic profits because they are adjusted for capital consumption and inventory changes.)


Initial Jobless Claims

The Labor Department reported initial jobless claims rose 8,000 to 652,000 in the week ended March 21. The four-week average was essentially unchanged, falling 1,000 to 649,000.


Continuing Claims jumped another 122,000 to 5.56 million for the week ended March 14 (that date is not a typo, continuing claims lag initial by a week).

The insured unemployment rate rose again, increasing to 4.2% (the highest level since the spring of 1983) from 4.1% in the prior week. This rate tracks the national unemployment rate and has risen from 3.8% in February. Because this latest continuing claims data (and the insured unemployment rate is attached to continuing claims) is for the week with which the March jobs report will use to calculate the first look at monthly payroll activity, it suggests the unemployment rate may rise to 8.5% from 8.1% last month.


The jobless claims figure is one of the best coincident (real-time) readings we have. We will need to see this figure reverse course (along with the ISM figure – another accurate real-time indicator) as a signal the economy is rebounding.


Have a great weekend!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
The two-year finished the day up 3/64, and the ten-year was higher by 25/64. The benchmark curve was unchanged on the day and remains at +182 bps. A basis point represents .01%.

Today’s $23.9 billion seven-year note auction was better received compared to yesterday’s. The bid/cover ratio on the auction was 2.52. The bid/cover ratio is the dollar amount of bids received over the dollar amount of Treasuries actually sold at the auction. A higher bid/cover ratio signifies higher demand.

MBS
Agency MBS were mixed today, with higher coupons outperforming. Fannie Mae 4.5% 30-years were unchanged on a spread basis, while up in coupon 5% and 5.5% 30-years were tighter to Treasuries by 9 bps and 10 bps each.

TIPS
Today the on-the-run ten-year rallied 1.05% and the TIPS ETF (TIP) was up 1.12%.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

WMT, WAG, CERN, INTC, SPWRA

S&P 500: +18.98 (+2.33%)


Wal-Mart Stores (WMT) +2.09% and Walgreen (WAG) -1.01%
This Bloomberg story helped lift Wal-Mart while sending Walgreen lower. Expanding its prescription program beyond Caterpillar is definitely a positive step for Wal-Mart in its attempt to grab market share in the prescription industry. The article seems to imply that Walgreen has nothing comparable to the program that Wal-Mart is expanding beyond its partnership with Caterpillar, which is not really true. Walgreen has started to grow a network of pharmacies, in-store clinics and company health centers that it markets to corporate and government employers nationwide.

Walgreen is a leader in what is generally viewed as a lucrative industry. As I mentioned earlier this week, Walgreen’s prescription sales are significantly outpacing the rest of the industry. Although nobody can match Wal-Mart’s scale, Walgreen’s success is derived from convenience and customer experience. Walgreen has used its free-standing stores in prime locations as the backbone of their growth strategy for over the past decade – people will fill prescriptions where it is most convenient. While Wal-Mart has pharmacies in its stores all across the country, it is a much bigger hassle to deal with the vastness of the store and its operations.

Don’t get me wrong, Wal-Mart is a powerhouse whose economies of scale pose a threat for all industries in which they operate. My point is that the industry has always been highly competitive and each player brings a different value proposition to consumers.


Cerner (CERN) -3.86%
The Wall Street Journal ran this article today examining the costs to U.S. hospitals that are adopting electronic records. The information in the article is nothing new, so it may be more appropriate to attribute today’s decline with the fact that investors are buying up shares of beaten-down companies – something Cerner is not.

Shares of Cerner, a leading supplier of health care IT solutions, have risen 14.8 percent YTD and over 40 percent since Nov. 20 on the expectations that Obama’s health care initiatives will increase business. Cerner should have an edge over competitors since Obama appointed Cerner board member Nancy-Ann DeParle to serve as director of the White House office for Health Reform.

Cerner’s software platform differentiates itself by providing information to all entities involved (patients, hospitals, pharmacies, laboratories, etc), whereas competing products provide information to some of the entities involved. This could prove to be a big advantage as well since Obama is calling for increased transparency within the health care industry.


SunPower Corp (SPWRA) +10.98%
China introduced a subsidy to promote the use of alternative energy, sending SunPower and other solar companies soaring. Solar energy companies have seen renewed enthusiasm as project financing begins to improve in the U.S. and as the Chinese government reiterates its support for the industry.

The U.S. Energy Department has made more than $2.6 billion available to states through its Energy Efficiency and Conservation Block Grant program, part of the federal stimulus package.


Intel (INTC) +5.89%
Bloomberg reports that chipmakers advanced after a benchmark for dynamic random access memory chips jumped 14 percent and Goldman Sachs Group said the price surge will be “likely sustainable” because of a shortage of supply.

Intel also filed to offer $1 billion in stock for acquisitions.


Quick Hits

• The Curious Case of Warren Buffet
• If Corporations Don’t Buy Stocks, Who Will?
• General Electric: Losing Its Magic Touch
• Botox Earnings Put Crooked E in Stock Market P/E
  

Peter Lazaroff, Junior Analyst

The Curious Case of Warren Buffet

By: David Ott

The world’s most famous investor, Warren Buffet, is a riddle wrapped in an enigma.

The Snowball: Warren Buffet and the Business of Life by Alice Schroeder details Buffet’s improbable rise from Midwest obscurity to the world’s most successful investor.

Although his investment prowess is well known, it is less widely known that Buffet is an odd person.

He has many quirks (like reading trade magazines at dinner parties), but the most obvious example is the decades-long, open relationship with Astrid Menks. His singular, obsessive focus on money and investing ultimately drove his wife Suzie away to California even though they remained married.

Buffet set Suzie up with a house in San Francisco, and, in return, Suzie set Buffet up with Astrid. Initially, Astrid simply the made the meals and did the house cleaning, but ultimately becomes one leg of a love triangle. As Buffet once said, “If you knew the people involved, you’d see that it suited all of us quite well.”

Far more interesting than the details about his personal life, though, is the trajectory of his business career. As a young boy, Buffet read a book about becoming a millionaire by age 35. He started many small businesses like delivering newspapers and worked at Sears. Unlike most kids who take on small jobs, Buffet graduated from college with savings of $83,000 in today’s dollars.

Several years later in graduate school at Columbia, Buffet finds his mentor in one of his professors, Benjamin Graham. In addition to teaching, Graham authored several investment classics and owned a money management firm where applied his techniques.

While Graham’s basic tenants are deceptively simple, they are not easy to execute. The first concept is that buying a stock isn’t simply taking ownership of a stock certificate; it is taking a partial ownership in a business. Therefore, when making an investment, it is critical to analyze the business before the security.

When analyzing the business, Graham tries to estimate the ‘intrinsic value’ of the company using basic fundamental analysis of the financial statements. While some of his specific methods are no longer useful, the basic concepts are completely intact.

Most importantly, investors must purchase a stock when the market price is trading well below the estimated intrinsic value. Graham refers to the discount between the estimate of intrinsic value and the market price is his ‘margin of safety’ reflecting the inherent uncertainty about the estimated intrinsic value.

Although initially unable to get work at Graham’s firm right out of graduate school, Buffet ultimately was able to land a position a few years later. In all, he spent eight years working for Graham in New York putting his formal education to work in the market.

When Graham decided to retired, Buffet went back to Omaha to set up his own shop. While working for Graham, Buffet built his nest-egg to $1.3 million in today’s dollars; he was 26.

Despite his recent criticism of the industry, Buffet essentially became a hedge fund manager by establishing private partnerships for the purposes of investment where he was the general partner and his clients were limited partners.

Unlike today’s hedge fund managers who typically assess a two percent management fee and earn 20 percent of the profits, Buffet earned a whopping 50 percent of the profits in excess of four percent (known as a hurdle rate).

However, he did not earn a management fee, and, most importantly, he would be personably responsible for 25 percent of the losses – something unimaginable today.

By the time he as in his early 40’s, Buffet was earning millions per year in through this compensation structure and nearly all of the money remained in the partnership while his lifestyle remained unchanged.

Even though his performance is often compared with the S&P 500, Buffet favored small companies on the ‘pink-sheets’ where prices were quoted weekly on the written page instead of on an exchange. He sought control of companies, installed himself on the board of directors and would often vote to distribute cash that wasn’t critical to operations.

Unlike Graham who staunchly believed in diversification, Buffet found much of his success in concentrated positions. At times, the partnership had well more than half of the money invested in a single company without the knowledge of his limited partners.

In the early 1970s, Buffet unwound the partnerships since he couldn’t find investments that he thought were worth buying. He did hold on to the now famous textile business, Berkshire Hathaway, and a few other odds and ends.

During the next three decades, Buffet transformed Berkshire into one of the world’s largest conglomerates through the acquisition of public and private companies. Although the most important segment of Berkshire is insurance, he bought all kinds of businesses from See’s Candy to Net Jets. He also famously invests in common stocks like Moody’s, American Express and Coca-Cola (despite having been a Pepsi drinker).

Some of the most interesting sections of the book are his investment mistakes. The purchase of Salomon Brothers stock (in large part because he liked the CEO at the time, John Gutfreund) may have paid off modestly as an investment, but it was a burden that cost Buffet an enormous amount of time, energy, and, to some degree, reputation.

Since the difficulties are as illuminating as the successes, it was nice to see Schroeder include them in the book, although it is obvious that Schroeder’s close relationship with Buffet highly influenced the hugely positive tone of the book. For example, the controversial appearance of his step-granddaughter in a documentary about the super-wealthy was relegated to the Appendix along with some unsettled lawsuits.

Despite the obviously friendly biographer and the sometimes grueling level of detail (especially before he is born), The Snowball is well worth the read since the subject is fascinating.

---
Recommendation: Buy

The Snowball: Warren Buffet and the Business of Life
By: Alice Schroeder

Bantam Dell, a Division of Random House, Inc. New York, New York 2008

ISBN: 978-0-553-50509-3

Daily Insight

U.S. stocks endured a wild ride, fluctuating 4.3% between peak and trough, but closed the session on the plus side.

Stocks began the session up strong after the release of better-than-expected economic data prior to the open, but reversed course after yesterday’s UK government bond auction failed, meaning they didn’t get enough bids, and the latest U.S. Treasury auction (of 5-year notes) was met by higher yields. (Although concern over a lack of bids for US Treasuries was over-blown as the bid-to-cover ratio for the 5s was strong at 2.02.) That UK bond market action may have increased doubts that fiscal policies will be able revive global growth; although, the concern didn’t last as a sharp rally in the final hour pushed stocks into the black.

That late-session rally has the technicians jazzed this morning – stock-index futures are up strong thus far in pre-market.

Financials led the rally, gaining another 4.6%. All but two major sectors closed higher, the two laggards being utilities and telecoms.


Market Activity for March 25, 2009

Don’t Get Dollar Policy Wrong (although it sure looks like they will)

Getting back to the Treasury auction for a moment. When we say the concern regarding a lack of demand for Treasuries is over-blown, this is not to say that the Fed and Treasury have wiggle room to be careless here. They mustn’t do too much damage to the US dollar or they will eventually find a real shortfall in bids.

And speaking of the greenback, Treasury Secretary Geithner made a very amateur mistake yesterday when commenting on the Chinese argument to basically bring back IMF special drawing rights (SDRs) – essentially an international currency. Geithner stated the administration was open to the idea, which was a huge mistake and you could see it in trading as the Dollar Index plunged in about two minutes time. Thankfully, according to press reports, former Treasury official Roger Altman was there and gave Geithner another shot at clarifying his remarks. He was then able to make the correct remark and the dollar rebounded in quick order, but failed to get back to where it opened.

Geithner is speaking again today; hopefully he gets his statements right, whether he truly believes them or not. The Treasury Secretary is making it pretty clear he’s a globalist, not to be confused with a free-trader who believes in American sovereignty. And when this sovereignty comes to our currency, policymakers better damn-well make sure the greenback remains the global currency reserve because none of us are going to like it if we move to an international currency. Going down this road will drive the dollar lower and result in more international economic authority, which develops into other troubles.

This is one reason the direction of policy is so upsetting. We must keep the greenback the most cherished currency in the world and the only way to accomplish that is via sound monetary policy and low tax rates on capital, period.

Mortgage Applications

The Mortgage Bankers Association reported that their mortgage applications index jumped last week, marking the third-straight week of increase. The overall index rose 32.2% for the week ended March 20, fueled by a 41.5% surge in refinancing activity. Purchases rose 4.2%.

That magic sub-5.00% fixed mortgage rate continues to do the trick, falling to 4.63% last week (you wont’ see this rate right now as fees are added in, but it’s definitely below the 5% level that people were waiting for to refi. The trend in refinancing activity should add marginal support to consumer activity as household debt servicing will decline.


Durable Goods Orders

The Commerce Department reported durable goods order rose 3.4% in February, blowing away estimates that anticipated a 2.5% decline. The increase was driven by strong machinery and electronics orders. A decent pick up in transportation orders also helped.

Excluding transportation, which is an exceptionally volatile aspect of the report and thus this look helps to smooth the data, jumped 3.9% (the expectation was for a decline of 2.0%). This followed a huge downward revision for January, coming in at -5.9% vs. the -2.5% initially estimated.

The best news within the report was a rebound in the non-defense capital goods ex-aircraft segment (a proxy for business-equipment spending) – the segment had shown significant deterioration since September. The figure jumped 6.6% in February, fueled by those strong machinery and computer & electronics orders – up 13.5% and 5.6%, respectively.

We really need this segment to trend higher as this will provide the biggest boost to the manufacturing sector and show business confidence is on the rise. Further, many people are watching the ISM (national factory activity report) for evidence that the economy has bottomed. ISM is one of the most accurate coincident economic indicators and when it begins to rise into the 40s (it’s been stuck in the 30s since October) this will give the market an added boost – equity traders undoubtedly are keeping a close eye on ISM.

This report is good news but we shouldn’t get ahead of ourselves just yet. The January figures were revised down in a big way and this February rebound does not make up for that large decline in the previous month, not to mention the substantial declines of the previous few months. The three-month rates of change remain heavily negative – down 30.1% for the overall number, 33.7% ex-trans and 37.5% on the business-equipment figure (45.2% below the fourth-quarter average at an annual rates).

Nevertheless, you have to start somewhere and this is a nice reversal, now it must trend higher for a couple of months – that’s the signal to look for.


New Home Sales

The Commerce Department also reported new homes sales rose 4.7% in February to 337,000 units at an annual rate from an upwardly revised 322,000 units in January (previously reported at 309,000). This marks the first monthly increase in new home sales since July.

By region, the South saw the biggest sales increase, up 9.7% and sales in the West rose 6.6%. The Midwest and Northeast saw sales decline 9.1% and 3.3%, respectively.

The supply of new homes fell 2.9% in February (this is inventory not adjusted to the sales rate and marks the 22nd straight month of decline) to 330,000. This is the lowest level of new homes available for sale since 2002 and illustrates the market has worked brilliantly (and harshly) in reducing the excesses from the housing bubble.

The inventory-tot-sales ratio inched lower to 12.2 months’ worth from 12.9 months’ in January. The median price of a new home has dropped 18.1% from the year-ago level to $200,900.


As with the durable goods numbers we need to see a build upon this nice improvement over the next couple of months. New home sales are down 42.5% at an annual rate over the past three-months compared to a 41.1% decline over the past 12 months. As a result, it’s tough to make a statistical argument we’ve hit an inflection point, yet this is a heck of a lot better than another month of decline. Cautios optimism would be the operative word.

One wants to believe, at these ultra-low levels, the housing market has bottomed. The Fed’s decision to buy more than $1 trillion in mortgage-backed securities should drive mortgage rates even lower, and while what the Fed is doing disturbs me regarding the longer term, this should give housing a boost in the short term. Still, the contracting labor market will weigh on sales and this will likely curtail the bounce the Fed is attempting to foment.


Have a great day!

Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
Treasuries marched lower throughout the day on poor participation in today’s $34 billion five year auction. The two-year finished the day down 1/64, and the ten-year was lower by 23/32. The benchmark curve was steeper by 3.8 basis points on the day and remains at +182 bps. A basis point represents .01%.

Treasuries opened lower this morning; feeling pressure from a failed forty-year U.K. government bond auction. By failed I simply mean there was a not enough demand for the entire amount the government wanted to sell. It was the first failed GILT (U.K. Treasury bonds) auction since 1995.

Today’s U.S. Treasury auction was described as poor, but in fact $70.4 billion of bids were submitted when the Treasury only wanted to sell $35.6 billion. Not too bad really!! $1.63 billion was bid at the U.K. auction; less than the $1.75 billion offered.

What is easing? Why is it damaging?
The Fed is running quite a complicated operation these days. Wait… the government issues debt and then buys it right back? How does that change anything?

In this process, referred to as Quantitative Easing, The Treasury issues debt to fund Government activities that aren’t already funded by tax revenue and the Fed goes into the open market and purchases the debt. This is sometimes looked at as a zero-sum transaction, but in fact it is far from it.

The Treasury, whose secretary is a member of the President’s cabinet, is fundamentally part of the government. The Federal Reserve, although created by an act of congress in 1913, is responsible for regulating the money supply and financial system as an independent institution. The degree of their actual independence is very crucial to their success or failure

The Fed can adjust short-term interest rates outright through its fed funds target rate in order to alter spending and saving behavior. If interest rates are high, people are rewarded more for saving, and borrowing becomes more costly so businesses slow down expansion. If interest rates are low people are paid less to save and businesses expand more because borrowing is cheap. Therefore, in general high interest rates lead to less spending and low interest rates lead to increased spending. We are currently in an environment where the Fed Funds rate is essentially zero (.15% as I write), but the economy is still contracting. If the goal is to continue to increase spending, but interest rates can’t be lowered any further, Quantitative Easing is the last resort.

The term “pumping money” is often used to illustrate the process of the Fed taking instruments of saving (Treasuries) out of circulation in exchange for money. The theory is that spending will increase because additional demand from the Fed will drive bond prices higher (yields lower) and increase the amount of money in circulation. “Printing money” is another term being used to illustrate the Fed actually creating money in order to pay for the securities. This may sound impossible but is one of the many negative attributes of fiat money.

How can this be a bad thing? If everyone simply had an extra $100 dollars in their pockets wouldn’t we just be better off? Not quite. In the same way that in the long run the government cannot spend what it does not take, either in taxes now or in the future, easy money policies must also be reversed.

It’s the reversal process that is damaging. Raising interest rates and taking money out of circulation causes spending to slow. If the Fed doesn’t operate independently enough there can be many political pressures to maintain an easy money policy for longer than an adequately independent Fed would prefer. In the end, the reversal is inevitable, and the longer the money supply is left to balloon, the greater the negative impact of this reversal will be.

From 2001 through the first half of 2004 we saw a Fed that was very loose for an extended period of time. As a result inflation manifested itself in the form of higher energy prices and a housing bubble that we are all very aware of by now. It may be easy to look back and see that the Fed was influenced too heavily by Washington, who pleaded for lower rates and easier credit policies to make the privilege of owning a home a Constitutional Right, but today’s policies aimed at correcting our current dilemma echo those of just years ago.

I believe the Fed is currently doing the right thing. My fear though is that Congressional and Presidential influence may keep the Fed from putting the brakes on at the appropriate time, resulting in a severe, and potentially damaging, inflationary environment.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

Lots to read...

S&P 500: +7.76 (+0.96%)
The market traded in a wide range today and ultimately finishing higher, as positive economic readings offset a disappointing auction of Treasuries. We were without big news regarding our Approved List companies, but that can't keep me from posting…

Quick Hits

• Dear AIG, I Quit! (Resignation letter from executive VP of financial products)
• But…But…My Bubble Was Smaller Than Theirs! (One blogger’s response)
• American Banks: Sharing the Pain
• Printing Money: Quantitative Easing v. Credit Easing
• Citi’s Upside-Down Family Tree (Use zoom to see details)

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks gave back at bit of Monday’s powerful rally as traders took some profits, a very typical reaction when the market is in a trading range – and we’ll remain range-bound for an extended period in my view. The latest manufacturing data was somewhat supportive, as the Richmond Fed showed the rate of decline in factory activity slowed, bouncing from near record lows – that’s what we’re looking for now, an easing in the deterioration of activity. However, this is not one of the more focused upon regional factory surveys so it didn’t offset the profit-taking.

Financial shares led the market lower – the sector had bounced 50% off of its March 6 low so traders took some money off the table. Comments from Bernanke and Geithner, speaking of the need for a “super financial regulator” – and amazingly they propose placing this responsibility with the same institutions that failed in their regulatory duties over the past several years, certainly didn’t help the financials. Utility shares were the second-worst performing sector after additional legislation was introduced to tax fossil-fuel power plants.


Despite the pull-back yesterday we think the rally has legs to it. The policy that is being rolled out (whether it be via the Fed, Treasury or Congress) is going to drive economic activity higher in the short term, and the equity markets will reflect this. Further, we are likely to get some modification to mark-to-market accounting and reinstatement of the uptick rule -- the market is currently anticipating these moves.

The issue, 18-24 months out, is that current policy will lead to additional problems; all we’re doing is shifting credit excesses from the private sector to the government. This will have an adverse affect on the dollar, inflation and thus interest rates (although with patience a great opportunity will present itself regarding the fixed income side of investing).

Market Activity for March 24, 2009


Economic Releases

FHFA Home Price Index

The Federal Housing and Finance Agency (FHFA) released its home price index for January, showing home prices rose 1.7%. The rise was fueled by price increases in the Northeast, Atlantic Coast and Southeast regions, up 2.0%, 3.9% and 3.6%, respectively (this survey gets very region specific by breaking out into nine areas, most housing surveys just measure the typical four). The only decline in home prices occurred in their Pacific region, the area that has shown the most damage during this period of housing-market contraction.

Based on the existing home sales data we received on Monday, I’m not sure this FHFA data got much attention – since this data is for January and the existing home sales for February showed single-family home prices were flat last month and down 6% since December. Nevertheless, the FHFA index offers a broad-based look at the housing market (basically the only segment it misses is high-end homes) and thus at the least should be viewed as a mild positive.

Richmond Fed

In a separate report, the Richmond Federal Reserve Bank released it latest index on manufacturing activity in the region, which showed the rate of deterioration eased substantially. While the survey remains deep in negative territory, the figure bounced to -20 in March from -51. The record low was hit in December when the survey printed -55 – although we’ll note Richmond doesn’t have a long history, going back only to 1993 so record lows don’t mean all that much.


As mentioned above, this is not one of the more important regional factory surveys -- Chicago and Philly are the one’s to look to for much better guidance regarding the direction of overall manufacturing activity. Nevertheless, we’ll take the improvement in Richmond as slight evidence factory activity has bottomed. We’ll need to see this flow through via Chicago, Philly and ISM to put some conviction behind this belief.

The Coming Denial

We’ve talked about, for some time now, how expectations regarding deflation risks are wildly over-blown. To the contrary, massive liquidity injections by global central banks along with trillions governments will spend on the fiscal side (stimulus packages) are highly inflation – particularly since production has been subdued over the past couple of quarters. We have also spent time touching on how, as inflation rises, Bernanke and Co. will do their best to explain that this is nothing more than a transitory event – they certainly won’t want to shut down what may be a nascent housing rebound a year down the road by raising interest rates (tightening policy), as is the typical way of dealing with higher rates of inflation. The fact that the Fed is not at all independent from the legislative branch right now only reinforces this view as politicians will pressure the Fed to keep policy very accommodative to housing activity ahead of the 2010 House elections).

As an early sign of what’s coming, yesterday morning we see saw UK inflation hit 3.2% on a year-over-year basis. This alone is not a worrisome level but it definitely signals we’re not in a deflationary environment and shows inflation is embedded – if it were not, this level would not be possible considering the rate of economic deterioration at present. So, we’re starting at a high base for this point in the business cycle and when commodity prices truly rise, via all of this “stimulus,” overall inflation rates may quickly soar. The Bank of England (the UK’s version of our Fed) is in the process of explaining that this inflation is a short-term event and prices will hardly rise at all by 2011. These are the early signs of denial.

Central bankers refuse to believe, not just because it will be politically impossible to address high levels of inflation over the next 12-24 months but because their models are flawed, prices can rise to harmful levels with the current slack in resources. That is, the labor market is currently under-utilized and thus the old Keynesian models (models that get central bankers in so much trouble) they precariously continue to clutch to do not allow them to accept that inflation can rise in this environment.

Problem is inflation is largely a monetary phenomenon, too much money chasing too few goods, and we have the classic set up of this environment arising over the next year to two – remember, production has been in decline for a while. It is likely production will remain weaker than it otherwise would be as the economy rebounds because businesses will remain cautious due to increased government involvement and the likelihood, if not certainty, tax rates will rise across-the-board as a result. Thus we will get that scenario of too much money chasing too few goods and much higher than acceptable levels of inflation will result.

Get ready for the coming denial.

In the short term (next couple of years possibly), this means commodity-related stocks should outperform. Longer-term, this means central bankers will eventually have to deal with this inflation, causing another round of economic angst. But every situation brings opportunities and very attractive rates for the fixed income side of the portfolio will arise. But it will require plenty of patience before we get there.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
Treasuries traded wildly today on news from the Fed (more on that below). The two-year finished the day down 1/32, and the ten-year was lower by 13/32. The benchmark curve was steeper by 3 basis points on the day and remains at +179 bps. A basis point represents .01%.

Today’s two-year note auction went better than expected. The notes were sold at a yield of .949% with 53.1% of the auction being bid indirectly (foreign buyers). The news is full of reports of fear that foreign buyers will soon exit the Treasury market, leaving no one to buy our country’s debt. Auction results like these certainly lead me to think otherwise.

Federal Reserve Open Market Operations
Last week’s announcement of increased Fed buying over the next nine months was set to be the market driver this week. That of course was before Monday’s toxic asset plan announcement (I’m still calling it that). However, around 1:45 central the Fed announced that tomorrow it will start to purchase Treasury notes maturing between February 2016 and February 2019, which attracted the market’s attention yet again. I saw this as no real surprise because a target of the middle of this week was announced when the plan was unveiled last Thursday. Nonetheless the ten-year rallied from down 3/4 of a point to unchanged immediately on the news.

I’m a little confused why the Treasury would come right out and announce this so specifically. I understand the market must be informed of the general plan, but what’s the benefit in allowing everyone to front-run you on billions of dollars of trades. But then again, if you were spending someone else’s money would you care?

TIPS
Treasury Inflation Protected Securities weren’t mentioned in today’s announcement but still rallied. The on-the-run ten-year rallied .29% and the TIPS ETF (TIP) was up .57%.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

HRS

S&P 500: -16.55 (-2.01%)


Harris Corp (HRS) +0.50% *contact for tearsheet*
Harris was left out of yesterday’s big rally, as an analyst downgrade pushed shares 8.7 percent lower. Although Harris classified as an Information Technology company, it’s hard not to group them with defense companies since more than two-thirds of their revenue comes from U.S. defense spending.

Defense companies have been hit hard in recent weeks due to concerns of a U.S. defense budget squeeze. However, the market seems to be overlooking the stability of a U.S. defense budget slated to grow 4 percent over the next several years – a growth rate many industries can’t measure up to. More importantly, Harris is well-positioned in the intelligence and communications market, which is expected to receive priority funding from the government over weapons spending (tanks, planes, missiles, etc).

The biggest reason we like Harris, however, is their strong product portfolio has attracted potential suitors and raised the possibility the firm will taken over. Defense companies with a product portfolio more leveraged towards weapons may seek firms like Harris with strong presence in intelligence, surveillance and communications to replace revenue lost as a result of the new defense budget. Harris’ cash generation abilities and low debt levels only make them seem that much more attractive from a takeover perspective.

Even if they aren’t acquired in the near term, strong returns on invested capital (ROIC) and a health dividend (2.3 percent dividend being increased at a 31 percent annual rate) make us happy to own the stock.


Quick Hits

• Stress-Test Results, Earnings Set Up as Next Key Events
• Eat-What-You-Kill Bond Traders Rise From Wreckage
• Cranking Up The Outrage-O-Meter
• All Hail the New Bull Market!
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks soared yesterday on expectations the latest Treasury plan to remove troubled assets from banks’ balance sheets will prove efficacious and a much better-than-expected existing home sale number offered additional support to the bulls.

We think the euphoria over the Treasury plan, which we’ll touch on below, is a bit of an over-reaction as there are some unanswered questions along with what damage the latest bonus fiasco will have on private-sector willingness to team up with the government. Of course, participants will also have to execute, which is quite a big uncertainty in my mind.

The home sales data was very welcome; expectations were for another decline, yet sales rose substantially. This data definitely helped to fuel the gains, but even in this regard we are not out of the woods yet as the level of existing home sales remains below where they were in December.

Yesterday’s huge move has pushed the broad market 21% above the multi-year low hit on March 9. This is a similar move to the 21% advance in late-November/early-December, bouncing from that November 20 low.

We’re seeing some improvement regarding the short-term – massive liquidity injections via the Fed, nearly a trillion dollars in fiscal stimulus and plans to remove troubled assets along with a possible modification to mark-to-market accounting should result in some nice intermediate-term results. Still, we have long-term policy issues that are not being addressed. But hey, we’ll take what we can get for now; this rally may have some legs – the shorts without conviction are definitely scared right now. S&P 500 842 will be the next target and we could be moving to 900, although unlikely in straight shot.


Market Activity for March 23, 2009


The New New Treasury Plan

I was under the impression Mr.Geithner was going to make public comments on this plan; instead it appears the administration made a smart move and refrained from any more public addresses by the Treasury Secretary. They released the plan on the Treasury’s website.

The plan states the Public-Private Investment Program (PPIP) will use the Treasury, FDIC and Federal Reserve to provide financing for private investors to buy illiquid loans and securities held at banks. They will also expand the TALF (the Fed program originally tasked to specifically kick-start consumer loans) in a way that permits it to fund purchase of legacy securities. (the administration has dropped the term “toxic assets” and replaced that with a more euphemistic “legacy assets.”) The stated intention is to remove $500 billion to $1 trillion of legacy loans and securities from the balance sheets of banks and other financial institutions.

The FDIC will provide non-recourse financing of up to a maximum of six times the capital, or equity, provided – although the price on this financing is not defined; surely it will be dirt cheap. I’m confused over this part as there has been talk FDIC doesn’t exactly have a massive amount of excess funds – which means the Treasury will print up some more of those greenbacks to finance most of these transactions. The upside and downside is spit evenly between the government and the private investors, except in the case of a total loss whereby the FDIC will be on the hook since the loans are non-recourse in nature.



Here’s how the Treasury Department explains it, directly from their website:

Sample Investment Under the Legacy Loans Program
Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC. Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio. Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity. Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6. Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.

Ignoring the fact that the government finances a huge majority of this funding, the problem of a market clearing price remains. You’ve got to get the banks to sell these assets at a level either private investors are willing to bid or FDIC is willing to get the process started.

Banks understand many of these assets are worth much more than they are currently being valued. The private sector likely realizes this as well, but they will look to bid lower for these securities (even with these very attractive financing terms – whatever this happens to be) as many uncertainties remain – chief among them, will the government change the rules in the middle of the game? The main point missing here is whether or not there will be a reserve place on the auction. That is, the banks won’t just say they want to sell a loan, or asset, if there is complete uncertainty over where the bids will come in. There must be some reserve at which if bids are below this level, the bank takes the loan back.

Later in the day, Geithner expressed confidence that many private firms and investors will be eager to participate – maybe so; after all, the government will be putting up 93% of the funding ($78 bucks in their $84 example; a more appropriate name for this program would be the Very Public-Minimally Private Investment Program (VPMPIP). If so, then why didn’t he name a few participants? It seems to me investors will be leery to take government funds (and participate) based on the populist wave that Congress seems all too willing to foment. What happens if firms do participate and they make 30% returns a year from now, yet national unemployment stands at 10% by then – just a hypothetical. What do you think Congress’ reaction will be? Answer: serious legislative risk!

Attempting to quell this concern that they themselves have stirred up, National Economic Council Director Lawrence Summers stated investors in the PPIP won’t be subject to compensation limits – as the WSJ stated yesterday, that’s also what TARP recipients were told.

Existing Home Sales

The National Association of Realtors reported existing home sales unexpectedly rose in February as record foreclosures and a sub-5.00% 30-year fixed mortgage rate brought bargain hunters into the market.

Purchases of previously owned homes climbed 5.1% last month to an annual rate of 4.72 million from 4.49 million in January. While the level of activity remains very depressed, the increase is helpful nonetheless.

Multi-family units propelled the overall figure higher as this segment (condos, townhouses apartments) jumped 11.4% last month. Single-family units rose 4.4%.


We should see an uptrend present itself as foreclosures push prices lower (the median price of an existing home is now down 15% over the past year – most of this due to large declines in the West region) and the Federal Reserve will aggressively print money to buy mortgage-backed securities. As a result of this plan, the 30-year fixed rate should move toward the 4.50% range in the very short run – there is a risk the Fed’s program will not be as effective in bringing the rate to this level, it all depends on how the market reacts to its printing-press mentality.

Below is a chart of single-family sales (excluding multi-family). I like to present this figure as the data has a longer history (multi-family unit calculations did not begin until 1999, hence the overall number only goes back a decade).

We’re basically back to 1997 levels, as the chart shows. This should give one the feeling that much progress has been made in erasing excesses.


In fact, factoring in population growth and home affordability, which has hit an all-time high, you’ve got to believe the housing market has more than regressed to the mean. Problem is we have the labor market issue to deal with right now, which will delay a full-blown rebound.


The supply of single-family existing homes has ticked down, but we have much area to cover still. We’ll need to get down to 5.0-6.0 months’ worth of supply before we get too excited.


In term of calling a bottom for housing, it’s just too early. Existing sales remain below that seen in December and the weak employment picture will surely continue to weigh on the housing figures. Nevertheless, one should assume mortgage rates will fall meaningfully in the very short term and housing will get a boost as a result – yet the question of sustainability remains.

I have additional comments on the Treasury PPIP plan for those still interested.

Geithner gets an A for creativity but an F for logic. This is not an eighth grade creativity contest but a country and an economy that has plenty of challenges right now – millions of jobs and long-run growth prospects are on the line.

Look, the entire Treasury plan is based on the assumption that these toxic, er legacy, assets that are currently priced at distressed levels have a much higher intrinsic value – this is the explicit statement via the architecture of this plan. (Readers of this letter understand this is a view shared by us as well.)

So, since this is acknowledged, why go down this road of highfalutin, some may say grandiose, strategies instead of simply attacking the problem directly by de-linking the relationship between mark-to-market accounting and regulatory capital? Let the banks hold these assets in their “hold to maturity” accounts, call it a day and address the next problem.

Some may remember that I was in favor if the original TARP plan (devised back in September) as it seemed clear regulators would not change mark-to-market, but that was before the government was so terribly involved. Now, we roll out trillion-dollar programs as if this is not a substantial figure. Based on the degree to which the government is now involved, I fear additional plans.

As a country we really need to focus on the perils of increased government involvement and our citizenry would be well served to read Hayek’s Road to Serfdom. It would do our economy, and our future level of freedom, a lot of good. There comes a time when enough is enough.

Have a great day!

Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
Treasuries were pretty stable considering the rally in stocks. The two-year finished the day down 1/16, and the ten-year was lower by 5/16. The benchmark curve was unchanged on the day and remains at +176 bps. A basis point represents .01%.

Geithner’s Toxic Assets Plan
From today’s Treasury Department press release:

Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.

Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.

Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.

Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.

Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.

Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis — using asset managers approved and subject to oversight by the FDIC.

How does this differ from Paulson’s original TARP plan from last fall? In an interview with CNBC’s Erin Burnett the Treasury Secretary says Paulson’s plan “isn’t the best way to protect the taxpayer”. In the above example the taxpayer will be shouldering 92.8% of the risk while laying claim to only 50% of the upside. If the outrage against the original plan was that the government would be subsidizing profits for hedge funds and other investors with capital to put at risk, then I don’t see how this is different at all. In fact, it’s worse.

Critics of the original TARP claimed the plan left the door open for the Treasury to overpay for bad assets, leaving the taxpayer with losses from paying too much to free-up a bank’s balance sheet. Neither Geithner’s plan, nor his interview on CNBC provided any clarification on this. This lack of clarity is going to keep this plan from being truly successful.

Without any talk of reserve levels or “last look” stipulations the market will remain skeptical. Not to mention the possibility of special 90% bonus compensation for companies choosing to sell assets. Geithner was directly asked about this also, and replied, “We need to work with the Congress to try to make sure that there's enough clarity and consistency about the rules of the game going forward so that they're willing to come in and take this risk alongside the government again”. If Geithner doesn’t have a straight answer to this question by now, I question how much of this plan he’s actually thought through.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

WAG

S&P 500: +54.38 (+7.08%)

Stocks surged on details of the Treasury’s Public-Private Investment Program.

Walgreen Co. (WAG) +9.43%
Walgreen reported profit and sales that exceeded estimates as store traffic has held steady despite the weak consumer spending environment. Revenue increased 7 percent during the quarter, with same-store sales rising 1.3 percent, or 2.1 percent adjusting for calendar shifts (including the absence of the leap day in 2009).

Prescription sales climbed 7.8 percent year-over-year, accounting for 63 percent of sales in the quarter. Walgreen’s prescription sales are outpacing the rest of the industry – Walgreen’s number of prescriptions filled increased 4 percent compared with a 1 percent decline for the rest of the industry. Prescription sales help offset weaker front-end (non-pharmacy) results, which were pressured by promotional pricing to attract cash-strapped consumers.

Promotional pricing and a higher LIFO charge negatively impacted margins, but the biggest impact came from clearing out holiday merchandise that it bought well before the economic downturn steepened. On the bright side, the company reported a 40 percent increase in free cash flow due to “improved inventory control and slower new store openings.”

Reorganization costs cut profit by 6 cents a share, while the program saved 2 cents a share. The company is eliminating 1,000 jobs, or 9 percent of employees in corporate and field management, to help save $1 billion annually by the year ending August 2011.

The company is aggressively seeking small acquisitions to further broaden its footprint and strengthen its foundation during tough times.

Walgreen is a perfect example of what you want to see from companies during an economic downturn. The company has significantly slowed new store openings to focus on improving existing stores, remodeling stores and scrutinizing its merchandise to enhance consumer experience and convenience. Walgreen has also started a network of pharmacies, in-store clinics and company health centers that it is marketing to corporate and government employers nationwide.

We continue to believe Walgreen is positioned for strong growth once the economy recovers.


Quick Hits

• JPMorgan to Proceed With New Jets and Hangar
• Obama Uneasy About Tax on Bonuses
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks fell on Friday, curbing a second-straight week of gains, as a populist wave threatens to surge out of control. Without the leadership willing to make tough political choices to stop this surge of populism the markets are going to find it tough to expand upon the gains of the past couple of weeks.

Traders halted what was essentially a seven-session winning streak (there was a day in there in which the broad market declined but it was minor and easily made up the following day) erasing two-thirds of the weeks earlier gains in the final two sessions. Still, we added upon the prior week’s big 10.7% bounce, so let’s be thankful for that.

Health-care and consumer staples, traditional areas of safety during rough times (although not so during this downturn) were Friday’s only positive sectors.

Financials, energy and industrials took the brunt of the damage, falling much more than the overall market. Shares of GE accounted for a third of the industrials decline (as measured by the S&P 500 index that tracks these shares) after analysts downgraded the conglomerate’s profit estimate.


Market Activity for March 20, 2009


Populist Wave

You know, I was going to touch on this bonus sideshow on Friday, but decided against it. That was a mistake. This issue potentially has wide-ranging ramifications, and since we are without an economic release to talk about, now is the next best time to comment on what’s occurring.

There are a number of things to think about with regard to the imposition of a 90% tax on bonuses, which was passed by the House on Thursday. For now, this legislation would encompass those firms receiving at least $5 billion in taxpayer funds. (I use the derivation of the root word “receive” instead of “need” because many institutions were forced to take government money as a way not to expose those that truly needed it – so, and it’s important to get this right, they demand that the money is accepted and then impose onerous restrictions on compensation. Nice.)

Anyway, there are a few things to think about as we endeavor down this dangerous road of populism:

One, the AIG bonuses make up just 0.1% of the total government funds to the company. It seems to me the 435 (actually 433 right now) members of the House have better things to concentrate on considering all that we face.

Two, the market hears loud and clear what is going on. While for now they focus on those firms that hold taxpayer funds, the message is one that disparages one of the most important forms of incentive-based pay. The market understands this is a quite damaging path for the government to travel and I don’t think those who provide the capital to this economy are going to gain any confidence from this behavior, in fact it’s likely to erode further.

Three, and this is the really idiotic aspect of this whole game, the Treasury Department and the Fed are in the process of attempting to roll out a couple of programs they deem essential to getting the credit markets back to normal and need the private sector to accomplish the plan.

The Fed has just begun the TALF program – a funding facility aimed at kick starting consumer lending – and Treasury is trying to get their Public-Private Investment Fund (PPIF) off the ground. (This is the plan to get troubled assets off bank balance sheets, which has now changed to the Public-Private Investment Program, or PPIP, – why they felt the need to tweak the name is beyond me). We can argue about whether these are the best ways to combat current credit-market issues but the people in charge believe these to be vitally important so that’s all that matters for now.

You can pretty much forget about getting private sector help when Congress is going to continue down the road of changing the rules of the game on a weekly basis. The TALF just rolled out on Friday and it began with $4 billion in bids, if you will, from private-sector firms – the program is meant to provide $1 trillion in funding. At this pace they’ll achieve that goal sometime in year 2500.

In terms of the PPIP, forget about that as well. Who in the heck is going to participate in this program when they fear the government will run top talent off via confiscatory tax rates on incentive pay, or take away some of their profits? The administration will have to explicitly state that those who participate in this program will be immune from confiscatory tax rates on incentive-based pay. They will also have to state that tax rates on profits will not arbitrarily be increased when huge profits result, and large profits are possible simply because assets are trading at distressed prices as a result of thin markets and thus have a much higher intrinsic value – how’s that one going to go over in this environment?.

And if they do make participants in the PPIP immune from their “scorch the earth” policy , then we have the classic situation of the government picking winners and losers as always occurs when government involvement rolls out of control.

And that brings us to another point. The Fed came out with its “shock and awe” strategy on Wednesday, and that phrase is not an overstatement. Why did they make such extraordinary moves? They may have known last week that PPIF was dead. Think about that one.

I’ve known for some time giving this group the numbers they have been granted in Congress is a dangerous endeavor, but with each day that passes, even those of us who understand the majority’s agenda, have to be surprised by the degree with which they can do damage – these are my own personal comments, not the firm’s.

So today we get Geithner III, his third public statement on the administration’s plan to remove “toxic” assets from bank balance sheets. Apparently, the market expects a greater explanation this time, although his Op/Ed this morning on the subject does not offer great detail.

Stock-index futures are up big as traders anticipate a strong performance and explanation of just how they will entice banks to sell at a level in which private firms are willing to bid, along with the issues expressed above. Let’s hope the third time really is the charm. Funny thing is as it appears we’ll be getting a statement from regulators very soon regarding the modification of mark-to-market accounting (for assets in which there currently is no market), and its impact on regulatory capital, we may not even need the PPIP.


Have a great day!



Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
The market has certainly calmed down since the Fed’s announcement Wednesday afternoon. Thursday’s trading was relatively calm and rates rose a bit as traders took profits from the mid-week fury.

Spring is officially here, so desks will be a little short handed as spring break runs its course. The two-year finished the day unchanged, and the ten-year was lower by 13/32 today on very light trading. The benchmark curve steepened by 3 basis points on the day, but still stands 19 basis points flatter for the week. A basis point represents .01%.

MBS
MBS has stayed even with Treasuries since the Fed announcement, but activity has picked up in the mortgage refinance area on speculation that thirty-year fixed mortgage rates are heading to 4.5%. The main hindrance to rates going right to 4.5% in a hurry is that mortgage shops aren’t staffed to handle the demand. When they get too busy to keep up, banks choose not to be as competitive on rates and they stay a little higher. There is nothing stopping rates from going lower, but it may be more of a steady downward trend than some would expect.

TIPS
Treasury Inflation Protected Securities had great week as a result of the FOMC announcement. The benchmark ten-year was up 4% for the week on anticipation of Fed purchases and future inflation resulting from our central banks very easy money policy. The TIPS ETF (TIP) was up 3.44% for the week. Here is someone’s take on the state of our monetary regulator and what it may mean for the future.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst