The S&P 500 finished higher for the second consecutive month as the market embraced the notion that the economy is transitioning from extreme duress to merely bad. Nearly all asset classes posted gains in April, the exception being commodities, with the biggest gains coming from small cap, emerging markets, and REITs.
Changes to the fair-value accounting standards as well as better-than-expected earnings reports helped deter the market’s attention away from a 6.1 percent decline in first-quarter GDP, stress tests on the nation’s 19 largest commercial banks, Chrysler’s bankruptcy, and the swine flu breakout.
All sectors in the S&P 500 finished the month higher. Defensive sectors such as utilities, telecom and consumer staples lagged as investors favored early-cycle industries. Beaten down sectors including financials, consumer discretionary, and industrials were the best performering sectors in the S&P 500 this month.
Financials soared after the U.S. government claimed the vast majority of banks are adequately capitalized, signaling to investors that the banking system crisis is on the mend – although this may be more hope than reality. Technology shares continued to climb steadily, with several bellwethers declaring demand has bottomed and they will return to growth as buyers restock inventories. The tech-heavy NASDAQ is up 9.26 percent year-to-date.
REITs were the best performing asset class in April, as these debt-laden trusts began slashing dividends and issuing new equity to shore up their balance sheets. The changes to fair-value accounting rules may also have lifted sentiment since lenders are provided with regulatory capital relief, which in turn frees up more capital and makes it easier for REITs to get financing.
The Fed’s efforts to lower Treasury yields were derailed by fears that their $300 billion in purchases would not be enough to dampen the $4 trillion in new supply expected to come in 2009-10. The Street anticipated the Fed to increase their buying target at the April 29 FOMC meeting, but were greatly disappointed when the Fed didn’t budge.
The yield on the ten-year rose 46.5 basis points in April to its highest level since November 2008.
Peter Lazaroff, Junior Analyst
Friday, May 1, 2009
Daily Insight
U.S. stocks held positive territory for much of the session on Thursday, but the broad market eventually succumbed to an economic report that sapped the prior day’s euphoria regarding the consumer and the announcement Chrysler will file for Chapter 11. The NASDAQ Composite did manage to close higher.
The latest personal income report showed consumer spending fell in March, which deflated Wednesday’s premature excitement that consumer activity was on a sustained path higher. This, combined with investors mulling the additional pressure the Chrysler bankruptcy filing would put on the economy, turned out to be too much of a drag for stocks to build upon the prior session’s gains. (This is not to say that bankruptcy isn’t the correct course for Chrysler because it is, but the event will put marginal pressure on growth, particularly within the manufacturing sector.
And speaking of manufacturing, the latest regional factory survey showed very nice improvement, by far the best news we’ve seen out of the sector over the past two quarters. Alas, it was not enough to keep stocks above the flat line. The Senate also rejected mortgage “cramdown” legislation, which is good news for home-financing channels over the longer term. (This legislation was an attempt to violate contract law and a progression down this path would have had tremendously dangerous consequences – big news that it was blocked) These two events probably kept stocks from falling further.
Energy stocks led the five major industry groups that lost ground on the day. The S&P 500 index that tracks these shares dropped 2.08% after Exxon Mobil reported a 55% decline in quarterly operating profit – although Exxon earnings are still plenty to keep funding development and exploration projects; it’s undoubtedly one of the best managed firms out there. Basic material shares led the other five major industry groups that posted gains; the index that tracks these shares jumped 3.01%.
Market Activity for April 30, 2009
Political Malfeasance
Chrysler is headed for bankruptcy court as enough private bond holders chose to reject the Treasury Department’s offer, yes the Treasury Department’s offer, that would have reduced the claim by private investors and given it to a political constituent, the UAW. (This is not unlike the proposed deal at GM that would give the government a majority stake, yet leave the private-sector bondholders – both private investors and the gov’t own $27 billion in GM debt each -- just 10% of the restructured firm; the UAW would receive 40%) President Obama castigated the private investors (mutual funds, hedge funds, pension funds, retail investors) for refusing “to make sacrifices while everyone else was.”
The reality is, just maybe they simply chose to take the chance that their claim would be worth more to them (and their investors) in liquidation than via the Treasury’s skewed plan. After all, many large investors had purchased credit-default swaps as protection in the event of bankruptcy – shall they have given that insurance up to partake in this ridiculous offer?. Oh, and since a UAW health-care trust fund would end up owning 55% of the restructured company one can bet the chances their investment would be worth more in liquidation is dramatically higher.
Mr. Obama has it all wrong as he attempts to take from one group to give to another and vilifies the private investors for acting in their own self interest. In his disdain for the private sector, he forgets that the government doesn’t make all the decisions, not yet at least. There is still a freedom to choose and investment managers chose that the deal the Treasury was offering to Chrysler’s creditors was a bad one. It’s no more complicated than that. Besides, all who pay taxes will be “sacrificing” in short order to pay the bills the federal government is ringing up.
Jobless Claims
The Labor Department reported that initial jobless claims fell 14,000 to 631,000 in the week ended April 25 (better-than-expected) from an upwardly revised 645,000 in the week prior. The four-week average of initial claims fell 10,750 to 637,250.
Continuing claims jumped 133,000 to 6.271 million (much worse-than-expected) – this marks the 13th straight week in which the reading has made a record high.
The insured unemployment rate, which is tied to the continuing claims report and closely tracks the direction of the overall jobless rate, rose again, hitting 4.7% -- the highest level since December 1982 when the overall unemployment rate hit 10.8%.
Bottom line is it does appear initial claims have peaked – although it’s tough to say as that Good Friday holiday played havoc with the number. If initial claims ease again next week we’ll have conviction in stating the worst has been seen. In addition though, the Chrysler bankruptcy will very likely mess with the reading (as plants are closed) and it’s just really tough right now to confidently say we’re trending lower from here.
Ultimately, we’ll need to see the four-week average trend into the 500K handle. While this is still a very elevated position from a historical perspective, it will offer a clear sign the worst is over for the labor market.
Continuing claims are hitting new records, which illustrates the fragility of labor market conditions. That said, this reading is not the leading indicator that initial claims is, it’s more of a lagging figure as is the overall unemployment rate. Continuing, just as the unemployment rate, will continue to remain elevated even as the economic rebound truly takes hold; however, we need to see continuing claims at least cease to make new highs.
Personal Income and Spending
The Commerce Department announced that personal incomes fell 0.3% in March (the fifth decline in the past six months) and is up just 0.3% now from a year-over-year perspective. Every private sector income component declined again, which does not bode well for a sustained upswing in consumer activity.
Total compensation fell for the fifth-straight month, down 0.3% in March and down 0.5% from the year-ago period. Wage and salaries fell 0.5% last month and are down 1.2% year-over-year. Rental income, dividend income, interest income and proprietor’s income were also lower and three of these four are down from the year-ago period – rental income is still up big thanks to massive monthly increases late last year.
Government transfer payments remain the only component of personal income that is on the rise, boosted by a large 7.1% jump in unemployment insurance last month. For the year, government transfer payments are up 12.3%.
On the spending side, expenditures fell 0.2% in March after an upwardly revised 0.4% increase for February. Assuming the data is not significantly revised when this month’s data is released next month, the personal consumption estimate within the GDP report on Wednesday looks to be pretty accurate, up 2.2% for the quarter.
The personal savings rate rose again, hitting 4.2% of disposable (after-tax) income, after a blip down in the previous reading.
A sustained rebound in consumer activity is unlikely as consumers will feel the continued need to augment their cash-savings due to the hit their two main savings vehicles (homes and stocks) have taken – maybe somewhere around the 6% level is where we see consumer activity trend higher; my former number was 5% but I’m thinking that is a poor assumption.
In addition, as stated above, we’ll need to see initial jobless claims signal the worst of the labor market conditions have been reached by trending down to the 500K handle. When this occurs the possibility of sustained help via the consumer with regard to GDP growth will become much more likely. Even then, the trend higher in personal consumption will remain somewhat tepid due to low income growth.
The inflation gauge that is tied to this report, the PCE Deflator, came in slightly lower than expected, up 0.6% year-over-year (0.7% was expected).
The core rate, which excludes food and energy, rose 0.2% for the month (higher than the 0.1% increase expected) and 1.8% on a year-over-year basis (right in line with expectations). While this rate remains very tame, it is up 2.4% over the last three months at an annual rate – kind of a high level for this stage in the business cycle.
Chicago PMI
The Chicago Purchasing Managers Index (the most watched regional factory survey) jumped to 40.1 in April from the nearly 30-year low of 31.4 hit in March. This is the highest level we’ve seen since the economic world changed in September -- 50 is the dividing line between expansion and contraction.
This increase is great news and is the best indication the manufacturing sector has seen the bottom. While the improvement illustrates a slower pace of contraction rather than a rebound to expansion, hitting 40 was a big step to take.
Nearly all of the sub-indices showed nice improvement.
Production added 5.4 points.
New orders shot up 11.2 points.
Order backlog jumped 15.6 from an extreme depth.
Employment improved a bit.
Unfortunately, the inventory gauge declined. This doesn’t give the impression that firms are too terribly optimistic about sales growth over the next few months, but let’s not dwell on it as the rest of the report gives us one of the most positive signs we’ve seen yet in this recession.
The issue right now is the extent to which continued auto-sector woes weigh on this index – Chicago PMI is the regional factory index most affected by auto activity. This is why it will be increasing important to watch the other regional surveys as clues the economy is rebounding. It will also be essential for the ISM (nationwide manufacturing survey) to trend into the 40s (currently stuck in the mid 30s) and remain there – we get that number this morning. The regional factory surveys we’ve seen over the past couple of weeks have sent the signal ISM will hit the 40s. Will it remain there and trend to expansion mode? That’s the question, and auto bankruptcy (while a necessary condition for U.S. auto makers to get things right) increases the difficulty of answering this question.
Have a great weekend!
Brent Vondera, Senior Analyst
The latest personal income report showed consumer spending fell in March, which deflated Wednesday’s premature excitement that consumer activity was on a sustained path higher. This, combined with investors mulling the additional pressure the Chrysler bankruptcy filing would put on the economy, turned out to be too much of a drag for stocks to build upon the prior session’s gains. (This is not to say that bankruptcy isn’t the correct course for Chrysler because it is, but the event will put marginal pressure on growth, particularly within the manufacturing sector.
And speaking of manufacturing, the latest regional factory survey showed very nice improvement, by far the best news we’ve seen out of the sector over the past two quarters. Alas, it was not enough to keep stocks above the flat line. The Senate also rejected mortgage “cramdown” legislation, which is good news for home-financing channels over the longer term. (This legislation was an attempt to violate contract law and a progression down this path would have had tremendously dangerous consequences – big news that it was blocked) These two events probably kept stocks from falling further.
Energy stocks led the five major industry groups that lost ground on the day. The S&P 500 index that tracks these shares dropped 2.08% after Exxon Mobil reported a 55% decline in quarterly operating profit – although Exxon earnings are still plenty to keep funding development and exploration projects; it’s undoubtedly one of the best managed firms out there. Basic material shares led the other five major industry groups that posted gains; the index that tracks these shares jumped 3.01%.
Market Activity for April 30, 2009
Political Malfeasance
Chrysler is headed for bankruptcy court as enough private bond holders chose to reject the Treasury Department’s offer, yes the Treasury Department’s offer, that would have reduced the claim by private investors and given it to a political constituent, the UAW. (This is not unlike the proposed deal at GM that would give the government a majority stake, yet leave the private-sector bondholders – both private investors and the gov’t own $27 billion in GM debt each -- just 10% of the restructured firm; the UAW would receive 40%) President Obama castigated the private investors (mutual funds, hedge funds, pension funds, retail investors) for refusing “to make sacrifices while everyone else was.”
The reality is, just maybe they simply chose to take the chance that their claim would be worth more to them (and their investors) in liquidation than via the Treasury’s skewed plan. After all, many large investors had purchased credit-default swaps as protection in the event of bankruptcy – shall they have given that insurance up to partake in this ridiculous offer?. Oh, and since a UAW health-care trust fund would end up owning 55% of the restructured company one can bet the chances their investment would be worth more in liquidation is dramatically higher.
Mr. Obama has it all wrong as he attempts to take from one group to give to another and vilifies the private investors for acting in their own self interest. In his disdain for the private sector, he forgets that the government doesn’t make all the decisions, not yet at least. There is still a freedom to choose and investment managers chose that the deal the Treasury was offering to Chrysler’s creditors was a bad one. It’s no more complicated than that. Besides, all who pay taxes will be “sacrificing” in short order to pay the bills the federal government is ringing up.
Jobless Claims
The Labor Department reported that initial jobless claims fell 14,000 to 631,000 in the week ended April 25 (better-than-expected) from an upwardly revised 645,000 in the week prior. The four-week average of initial claims fell 10,750 to 637,250.
Continuing claims jumped 133,000 to 6.271 million (much worse-than-expected) – this marks the 13th straight week in which the reading has made a record high.
The insured unemployment rate, which is tied to the continuing claims report and closely tracks the direction of the overall jobless rate, rose again, hitting 4.7% -- the highest level since December 1982 when the overall unemployment rate hit 10.8%.
Bottom line is it does appear initial claims have peaked – although it’s tough to say as that Good Friday holiday played havoc with the number. If initial claims ease again next week we’ll have conviction in stating the worst has been seen. In addition though, the Chrysler bankruptcy will very likely mess with the reading (as plants are closed) and it’s just really tough right now to confidently say we’re trending lower from here.
Ultimately, we’ll need to see the four-week average trend into the 500K handle. While this is still a very elevated position from a historical perspective, it will offer a clear sign the worst is over for the labor market.
Continuing claims are hitting new records, which illustrates the fragility of labor market conditions. That said, this reading is not the leading indicator that initial claims is, it’s more of a lagging figure as is the overall unemployment rate. Continuing, just as the unemployment rate, will continue to remain elevated even as the economic rebound truly takes hold; however, we need to see continuing claims at least cease to make new highs.
Personal Income and Spending
The Commerce Department announced that personal incomes fell 0.3% in March (the fifth decline in the past six months) and is up just 0.3% now from a year-over-year perspective. Every private sector income component declined again, which does not bode well for a sustained upswing in consumer activity.
Total compensation fell for the fifth-straight month, down 0.3% in March and down 0.5% from the year-ago period. Wage and salaries fell 0.5% last month and are down 1.2% year-over-year. Rental income, dividend income, interest income and proprietor’s income were also lower and three of these four are down from the year-ago period – rental income is still up big thanks to massive monthly increases late last year.
Government transfer payments remain the only component of personal income that is on the rise, boosted by a large 7.1% jump in unemployment insurance last month. For the year, government transfer payments are up 12.3%.
On the spending side, expenditures fell 0.2% in March after an upwardly revised 0.4% increase for February. Assuming the data is not significantly revised when this month’s data is released next month, the personal consumption estimate within the GDP report on Wednesday looks to be pretty accurate, up 2.2% for the quarter.
The personal savings rate rose again, hitting 4.2% of disposable (after-tax) income, after a blip down in the previous reading.
A sustained rebound in consumer activity is unlikely as consumers will feel the continued need to augment their cash-savings due to the hit their two main savings vehicles (homes and stocks) have taken – maybe somewhere around the 6% level is where we see consumer activity trend higher; my former number was 5% but I’m thinking that is a poor assumption.
In addition, as stated above, we’ll need to see initial jobless claims signal the worst of the labor market conditions have been reached by trending down to the 500K handle. When this occurs the possibility of sustained help via the consumer with regard to GDP growth will become much more likely. Even then, the trend higher in personal consumption will remain somewhat tepid due to low income growth.
The inflation gauge that is tied to this report, the PCE Deflator, came in slightly lower than expected, up 0.6% year-over-year (0.7% was expected).
The core rate, which excludes food and energy, rose 0.2% for the month (higher than the 0.1% increase expected) and 1.8% on a year-over-year basis (right in line with expectations). While this rate remains very tame, it is up 2.4% over the last three months at an annual rate – kind of a high level for this stage in the business cycle.
Chicago PMI
The Chicago Purchasing Managers Index (the most watched regional factory survey) jumped to 40.1 in April from the nearly 30-year low of 31.4 hit in March. This is the highest level we’ve seen since the economic world changed in September -- 50 is the dividing line between expansion and contraction.
This increase is great news and is the best indication the manufacturing sector has seen the bottom. While the improvement illustrates a slower pace of contraction rather than a rebound to expansion, hitting 40 was a big step to take.
Nearly all of the sub-indices showed nice improvement.
Production added 5.4 points.
New orders shot up 11.2 points.
Order backlog jumped 15.6 from an extreme depth.
Employment improved a bit.
Unfortunately, the inventory gauge declined. This doesn’t give the impression that firms are too terribly optimistic about sales growth over the next few months, but let’s not dwell on it as the rest of the report gives us one of the most positive signs we’ve seen yet in this recession.
The issue right now is the extent to which continued auto-sector woes weigh on this index – Chicago PMI is the regional factory index most affected by auto activity. This is why it will be increasing important to watch the other regional surveys as clues the economy is rebounding. It will also be essential for the ISM (nationwide manufacturing survey) to trend into the 40s (currently stuck in the mid 30s) and remain there – we get that number this morning. The regional factory surveys we’ve seen over the past couple of weeks have sent the signal ISM will hit the 40s. Will it remain there and trend to expansion mode? That’s the question, and auto bankruptcy (while a necessary condition for U.S. auto makers to get things right) increases the difficulty of answering this question.
Have a great weekend!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries were mixed today as the long end underperformed for the eighth straight trading day mostly on concerns about supply. The two-year finished the day up 3/32, and the ten-year was lower by 3/32. The benchmark curve was steeper by 5 basis points on the day, and currently sits at +220 basis points. A basis point represents .01%.The Fed bought $3 billion in Treasuries ranging in maturity from 5/15/19 to 2/15/26 bringing cumulative purchases to $76.8 billion or about 25% of the way to their $300 billion target.
The Fed’s decision to leave its purchase agreements unchanged has left its mark on the market for government guaranteed debt. What remains to be seen is what the Fed is really targeting. Mortgage rates seem to be their biggest target so far, and they have dropped 50 basis points since the Fed decided to up their MBS purchases to $1.25 after their March meeting. My hope is that the Fed can be satisfied with mortgages at 4.6% and avoid being concerned with lowering government borrowing costs that are increasing because the supply of Treasuries grossly outweighs demand going forward.
Net Fed purchases of agency MBS during the past week was $23.1 billion. That makes over $400 billion since the program started. Prepayments have certainly picked up with mortgage rates at 4.62%, but we will likely see refinance activity increase from here in the months of May, June and July.
Have a great evening.
Cliff J. Reynolds Jr., Junior Analyst
Thursday, April 30, 2009
XOM, PG, ESRX
S&P 500: -0.89 (-0.10%)
Exxon Mobil (XOM) -2.56%
Exxon missed earnings estimates as a result of sharply lower oil and gas prices as well as lower refining profits. The results were pretty much on par with other oil majors that have reported to this point.
What’s encouraging is Exxon’s superior balance sheet allowed them to increase spending on capital and exploration projects by 5 percent year-over-year. In addition, the company plans to spend $5 billion on share buybacks in the second quarter, which is down from $7 billion in the first quarter but still far more than its competitors.
Procter & Gamble (PG) -1.94%
P&G’s revenue fell 8 percent year-over-year to $18.4 billion, just shy of consensus estimates. Foreign exchange impact weighed on revenue, but organic sales were up 6 percent reflecting a 6 percent net benefit from pricing and mix, which offset lower volume.
Operating margins improved 30 basis points for the quarter as lower SG&A expenses more than offset a commodity cost-driven decline in gross margin.
Consumer goods makers have been hurt as retailers trim inventories and consumers trade down to less-expensive store brands. P&G is more exposed to such private labels and cuts to discretionary spending than some of its rivals.
Express Scripts (ESRX) +5.82%
Express Scripts reported better-than-expected earnings and issued an in-line earnings outlook for the full year.
Quick Hits
- Catastrophic Quarter Is Averted as Job Cuts Help Profits Exceed Estimates
- U.S. Gas Fields Go From Bust to Boom
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks rallied on Wednesday as investor sentiment was sparked by a greater-than-expected rise in personal consumption (the largest segment of GDP) even as the overall economic reading showed the contraction over the past six months was the deepest since the 1957-58 recession. A massive inventory liquidation in the first quarter also gave the market hope the economy will expand in the current quarter as firms will be forced to increase production in order to rebuild stockpiles – I’m not sure about this one, we’ll need more data to confirm the view, but the inventory dynamic will surely boost GDP by the third quarter if not the second.
That 900 mark on the S&P 500 we’ve talked about is certainly in reach, the top end of this trading range is 935.
Financials led the rally, as the S&P 500 index that tracks these shares jumped 4.77%. Industrial, energy and material shares – the areas that jump on reflation hopes – also outperformed the overall market.
Nine of the 10 major industry groups ended higher, telecommunication shares being the sole loser.
Mid cap stocks, as measured by the S&P 400, gained 2.81% on the day and small caps, as measured by the Russell 2000, jumped 3.94% -- the other major small cap index, the S&P 600, added 3.66%.
Market Activity for April 29, 2009
Mortgage Applications
The Mortgage Bankers Association’s mortgage applications index fell 18.1% during the week ended April 24 as both purchases and refinancings fell even though fixed mortgage rates remain extremely low.
As you can see via the table below, refis (which make up close to 80% of all applications – and not evident in the table) dropped 21.9% last week. We’re not able to tell if some are waiting for an additional decline in rates or that simply most of the market has already refinanced by this point. No matter, we’ll get to a point in the not-too-distant future in which the index will have to rely on purchases again and with the labor market still very fragile we could go through a period in which this index endures a series of negative readings.
First-quarter GDP
The Commerce Department reported that first-quarter GDP came in at a worse-than-expected -6.1% (in real terms at an annual rate) and follows the 6.3% contraction in the fourth quarter. This marks the worst back-to-back quarterly contraction since the 1957-58 recession – easily surpassing (in terms of deterioration) the 1981-82 recession that endured back-to-back negative readings of -6.4% and -4.9% and the 1980 contraction that saw -7.8% followed by -0.7%.
However, the reading was met with optimism as the personal consumption component of GDP bounced back to rise 2.2% after big negative readings in the prior two quarters. This rise in consumer activity has people juiced that the gains are sustainable, but I think they’re are setting themselves up for a major disappointment. (I’ve got to say, it’s strange how the press and consensus seems to react to certain conditions. The financial press believed, on several occasions, during the period that ran 2004-2008 that the consumer was “tapped out,” even as the private sector components of the personal income data were growing at very healthy clips. Now, the consensus seems to believe consumer activity is back even though all private sector income readings are in decline. Government transfer payments is the only segment of the personal income data that is growing and this does not make for a sustained move in consumer activity. Then you have what’s occurring with regard to credit-card lines being cut and the decline in household wealth.)
Anyway, this personal consumption number for the first quarter is an estimate, as we have yet to receive the personal spending figure for March (we’ll get it today along with revisions to the February data), and I don’t think we can ignore the possibility of a downward revision. We knew, based on personal spending figures from January and February, that consumer activity had bounced from the previous six-straight months of decline, but it seems a bit high based on those results.
One wonders what the GDP number would have posted without this estimated rise in consumer activity, which added 1.50 percentage points to the overall figure. Gross private investment was just crushed, down 51.8% in the first quarter – fixed business investment was down 37.9% and residential construction posted its largest decline during this nearly three-year housing correction, down 38.0%.
The plunge in private fixed investment (plant and equipment) subtracted 6.04 percentage points from GDP and residential investment subtracted 1.36 percentage points. (If this were back in 2005 when housing made up 6.5% of GDP at the peak of the real estate boom it would have subtracted 2.47 points but since it has been reduced to just 3.4% of GDP, the subtraction was not as harsh. I bring this up just to give you some color, not trying to infer anything)
The change in real (inflation-adjusted) private-sector inventories was the other major drag on the figure. Inventories were estimated to have declined $103.7 billion last quarter, which is the biggest decline since records began in 1947. This component subtracted 2.79 percentage points from GDP.
The largest contributor to GDP was net exports as imports plunged at a faster rate than did exports – exports fell 30.1% and imports slid 34.1%, not exactly an inspiring development even as it added to growth.
What we’ll need is to foment confidence on the business side in order to get this economy rolling again. Yes, optimism regarding the consumer got a boost but, again, this area is going to remain weak overall as the two major savings vehicles (houses and stocks) have gotten hit hard and unemployment has hit its highest level in 26 years, and rising. Thus the consumer will feel the need to continue boosting cash savings and will remain cautious due to labor market conditions. This does not mean we won’t see pops in consumer actitvity, but I don’t see how a sustained rebound gets going until some of these drags on consumer confidence reverse course. It will just take some time.
Therefore, we’ll need to really lean on the business side to fuel growth. One thing that is very likely is the inventory dynamic will begin to catalyze growth a couple of quarters out – that is, inventory liquidation has been so substantial that the production needed to rebuild stockpiles will help GDP by the third quarter in our estimation. U.S. businesses are running as lean as they can and it won’t take much of an increase in demand to foster a production upswing. The slash-to-the-bone cost-cutting that’s occurred also bodes well for corporate profits a quarter or two out.
What is less clear is the direction of business-equipment spending. If firms believe the sapping of funds from the private sector, as the government pushes public-sector spending as a percentage of GDP from 20% to 30% over the next few years, will keep a lid on growth potential they may not spend as they generally do as the economy does bounce back. We will need the business community to have confidence in the future or they’ll hold off on activity, which would not be helpful as the consumer has a number of quarters yet to work through their issues.
The inflation gauge within the GDP report (the GDP Deflator) showed a surprising increase, jumping to 2.9% from 0.5% in the fourth quarter. However, this is a bad measure of inflation as it subtracts import prices. That is, this number will move in the opposite direction of energy prices, since we import 70% of our energy needs these days thanks to restrictions on domestic production. A more accurate gauge is the gross domestic purchases figure, which measures all prices paid by U.S. residents – it fell 1.0% last quarter.
As you all know, I expect inflation to kick up 12-18 months out, but this has not begun yet even though the jump in the GDP Deflator appears to signal so.
FOMC Decision and Statement
The FOMC (the Fed’s monetary policy decision-making committee) announced they would leave their fed funds target rate unchanged at a range of 0%-0.25% and economic conditions will likely warrant exceptionally low levels of fed funds rate for an extended period.
They also stated their plans to purchase Treasury and mortgage-backed securities would remain unchanged, but will continue to evaluate economic and financial market conditions and may shift the timing and overall amounts of these purchases as these conditions evolve.
(The bond market may be sending an early message to the Fed as they pushed Treasury prices lower, driving the yield on the 10-year note meaningfully above 3.00% for the first time since the FOMC initially announced to be contemplating Treasury and mortgage-backed purchases back n January. The Treasury will be issuing enormous levels of debt this year and next – and surely beyond – and if the market pushes yields substantially higher as a result you can be sure the Fed will move in quickly to state they are increasing purchases.) If the bond market begins to play with Bernanke, and pushes the 10-year Treasury yield even to a still historically low level of 3.50%, say, the following picture will really begin to roll:
Regarding the FOMC statements on the economy:
- Pace of contraction appears to have slowed
- Household spending has shown signs of stabilization but remains constrained by ongoing job losses, lower household wealth and tight credit
- Economic activity is likely to remain weak for some time
- Policy (fiscal and monetary) will contribute to the gradual resumption of economic growth and price stability
- In light of increasing economic slack inflation will remain subdued and could persist for a time that is below rates that are best to foster economic growth over the long term
(when they mention “slack” they refer to high levels of unemployment and low capacity utilization rates – exactly the kind Keynesian focus that gets them in trouble; they better pay close attention to commodity prices as a mechanism to guide policy instead of this Phillips Curve-type model because inflation very likely will get rolling well before the unemployment rate hits more normal levels)
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries were quiet for the first half of the day as the market waited for the FOMC to announce its rate decision. More on that below. The two-year finished the day unchanged, and the ten-year was lower by 3/4. The benchmark curve was steeper by 9 basis points on the day, and currently sits at +215 basis points. A basis point represents .01%.Rates rose today to levels not seen since November 25th of last year as the market was disappointed to hear that the Fed was going to stand pat on its MBS, Agency and Treasury buying commitments. The yield on the ten-year rose as high as 3.11% in afternoon trading, well through the support level of 3.05%.
The decision to not increase purchases most likely stems from the spread tightening between the ten-year and mortgage rates in the last three months. Thirty-year fixed mortgage rates currently sit at 4.62%, so although Treasury yields have inched higher, the desired effect is being felt. However, the Treasury’s concerns still remain. Borrowing costs are increasing, and with a record deficit to finance rates will only continue to increase if demand cannot keep pace with supply.
Have a great evening.
Cliff J. Reynolds Jr., Junior Analyst
Wednesday, April 29, 2009
CERN, TSS, GD
S&P 500: +18.48 (+2.16%)
Cerner (CERN) +10.71%
The reaction to Cerner’s earnings was another case in which investors feared the worst, but were relieved to see otherwise. Revenue fell short of estimates, which Cerner attributes to weakness in the economy, but the company expects a boost in the back half of the year.
Cerner sees some of the second-half boost coming from the $19 billion aimed at healthcare IT in the U.S. stimulus package – remember that Nancy-Ann DeParle, head of the newly created White House Office of Health Reform, was a Cerner board member and may have a bit of bias towards their products.
Cerner has a lot riding on the stimulus bill’s healthcare IT provision and, judging by Cerner’s current high valuation, investors have high expectations themselves.
Total Systems Services (TSS) -11.45%
Weak card issuing and transaction activity led to poor results from Total Systems and the company was unable to cut expenses fast enough to offset deteriorating transaction volume.
Even worse, hopes for a second-half rebound have faded as exchange rates weigh on results, pricing pressures hit the client base, sales pipeline activity slows, and card issuance and usage decline.
Washington Mutual’s deconversion during the first quarter led to a loss of roughly 20 million accounts as term fees only partially offset this loss. In addition, Total Systems is currently renegotiating with a large client where price concessions are expected in exchange for a long-term deal.
The company has managed itself well through a difficult period of sizable customer losses. We continue to view Total Systems as a leading provider of card processing services, but we expect ongoing business disruptions and price erosion in future quarters.
General Dynamics (GD) +5.39%
GD’s first-quarter results pleased investors as sales climbed across all segments for the defense contractor and the funded backlog grew 23 percent to $49.2 billion.
Exposure to the commercial aviation and business-jet industries caused the Aerospace segment to be GD’s only business to report a drop in operating profit. Over the past few years, GD’s growth has been fueled to a significant extent by Aerospace, but growth going forward will be driven increasingly by their defense segments.
Peter Lazaroff, Junior Analyst
Cerner (CERN) +10.71%
The reaction to Cerner’s earnings was another case in which investors feared the worst, but were relieved to see otherwise. Revenue fell short of estimates, which Cerner attributes to weakness in the economy, but the company expects a boost in the back half of the year.
Cerner sees some of the second-half boost coming from the $19 billion aimed at healthcare IT in the U.S. stimulus package – remember that Nancy-Ann DeParle, head of the newly created White House Office of Health Reform, was a Cerner board member and may have a bit of bias towards their products.
Cerner has a lot riding on the stimulus bill’s healthcare IT provision and, judging by Cerner’s current high valuation, investors have high expectations themselves.
Total Systems Services (TSS) -11.45%
Weak card issuing and transaction activity led to poor results from Total Systems and the company was unable to cut expenses fast enough to offset deteriorating transaction volume.
Even worse, hopes for a second-half rebound have faded as exchange rates weigh on results, pricing pressures hit the client base, sales pipeline activity slows, and card issuance and usage decline.
Washington Mutual’s deconversion during the first quarter led to a loss of roughly 20 million accounts as term fees only partially offset this loss. In addition, Total Systems is currently renegotiating with a large client where price concessions are expected in exchange for a long-term deal.
The company has managed itself well through a difficult period of sizable customer losses. We continue to view Total Systems as a leading provider of card processing services, but we expect ongoing business disruptions and price erosion in future quarters.
General Dynamics (GD) +5.39%
GD’s first-quarter results pleased investors as sales climbed across all segments for the defense contractor and the funded backlog grew 23 percent to $49.2 billion.
Exposure to the commercial aviation and business-jet industries caused the Aerospace segment to be GD’s only business to report a drop in operating profit. Over the past few years, GD’s growth has been fueled to a significant extent by Aerospace, but growth going forward will be driven increasingly by their defense segments.
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks swayed between gain and loss several times yesterday, but the major indices eventually succumbed to capital adequacy concerns and closed slightly lower. Concerns over a lack of capital within some areas of the banking system have returned after news broke that government stress tests on Citigroup and Bank of America may show the lenders need more cash to shore up the balance sheet.
(This morning the Federal Reserve is leaking comments that six of the 19 largest banks will require additional capital. It’s clear what’s going on here: the government will use these stress tests as a way to force banks to participate in selling “troubled” assets into the PPIP, banks have previously said they don’t want to sell because the intrinsic values are higher than the price they’ll get in this market. But PPIP is dead anyway because private firms that will be on the buy side are scared. When they make big profits by using huge levels of government leverage they know what will happen – Barney Frank will drag them up to Capitol Hill and lambaste these firms in front of the camera as if they are the devil – why would they want to put themselves in this position. And then they’ll have their pay restricted and very likely see profits stripped – this is indeed a nasty road we’ve ventured along.)
Anyway, yesterday’s market losses would have been worse if not for better-than-expected economic reports. As we mentioned yesterday, a move back above -10 on the Richmond Fed Index would offer good support to the market and that’s exactly what the index did, rising to -9. That manufacturing survey improved nicely and the market responded to the news by erasing early-session losses. A better-than-expected improvement in the consumer confidence index, even if it remains extremely depressed and the job outlook aspect of the survey hardly improved, helped stocks as well – we’ll touch on this more specifically below.
In the end though, between incessant reporting on swine flu and the capital adequacy concerns, the negatives caused the slight momentum to fizzle in the final hour of trading.
Mid and small capitalization stock indices did end the session higher.
Market Activity for April 28, 2009
S&P Case/Shiller Home Price Index
The Case/Shiller Index for February measured home prices fell 18.63% from the year-ago period regarding the 20 largest metro areas tracked by the figure. This is an improvement from the year-over-year decline of 19.00% registered for January and marks the first month in which the index hasn’t made a new year-over-year decline since January 2007.
The decline in home prices within these 20 cities was a bit milder than expected due to vast improvement in the rate of price decline within the West region – this region dominates the index, making up nearly 35% of the index. In fact, price declines eased in 16 of the 20 cities tracked – price declines accelerated in the East Coast locations and Cleveland.
The largest improvements occurred in L.A., San Diego, Seattle, San Francisco, and Tampa – places where some of the most speculation took place and thus have the highest foreclosure rates. The plunge in prices within these areas over the past year (San Diego down 22.9%, L.A. down 24%, San Fran down 31%) has brought in bargain hunters, which has begun to put a floor in on prices. (They are still declining, but at a much lower rate and that at least is something to celebrate) The lowest fixed mortgage rates since the 1940s are also helping.
The month-over-month decline in the overall index improved to -2.17% from -2.80% in January. L.A. home prices placed the largest drag on the index from a month-over-month perspective, even though the rate of decline in prices among homes in that area eased. L.A. makes up 15.1% of the index and since prices fell 2.03% it subtracted 0.31% from the index. New York placed the second-biggest drag on the index; it makes up 19.4% of the reading and thus the 1.57% month-over-month price decline subtracted 0.30% from the index.
Consumer Confidence
The Conference Board’s consumer confidence index bounced off of the Feb./Mar. all-times lows, hitting a better-than-expected 39.2. Still, much improvement is needed to get the gauge back to the pre-confidence-killing September levels (roughly 60 on this index) and that will be the level to watch with regard to the overall index. Nevertheless, the bounce off of the record lows is a helpful sign.
The other important indicator to watch within this survey is the net jobs “plentiful” less “hard to get” figure, which barely moved from -44.1 in March to -43.4 in April.
As we’ve talked about a couple of times, it is unlikely that consumer activity will bounce back with the force it usually does coming out of recession – the Fed’s easy money policies of the past several years led to debt levels that are simply too much to handle with the unemployment rate rising to the highest range we’ve seen in 26 years. Therefore, we’ll need to have some confidence return by way of the job market (especially since slashing tax rates in order to boost disposable incomes is antithetical to the agenda of the current political class) before consumer activity can even mildly increase in a sustained manner. As a result, we’ll need to see this jobs “plentiful” less “hard to get” figure show meaningful improvement before one can expect the largest segment of GDP (personal consumption) to begin to boost GDP growth again. Until this figure makes a move toward -20, it will be up to the business side of things and that inventory dynamic we keep touching on.
Richmond Fed Manufacturing Index
The Federal Reserve Bank of Richmond reported that their factory gauge continued to improve in April and has completely bounced back to pre-September levels – this is a really good sign. While the index continues to illustrate factory activity within the central Atlantic region remains in contraction mode, the progress made over the past two months is showing the sector’s worst is behind it. The improvement we’ve seen from the latest regional manufacturing surveys (New York, Philly, Dallas and now Richmond) have been encouraging and this one is the most so.
The Richmond index jumped to -9 in April from -20 in March, bouncing from the doldrums hit late last year/early this year. Evidence of diminished weakness was also evident in all of the sub-indices, although the employment index barely budged.
New order volumes
The order backlog index jumped 22 points.
The average workweek jumped 23 points from the -30 registered in March all the way back to -7 for April. If we can get these manufacturing workweek numbers back to positive territory it will offer very encouraging signs the worst within the labor market has been seen.
We still need the ISM manufacturing index (the nationwide look at the sector) to officially confirm a rebound has occurred, which means that index will have to bounce into the 40s – it’s been stuck in the mid-30s.
This morning we get the first look at Q1 GDP, which is expected to show the economy contracted at a 4.7% real annual rate. This will follow the -6.3% reading of the fourth quarter, marking the deepest contraction since the 1981-82 recession.
We’ll also get the FOMC’s (the Fed’s monetary policy decision-making committee) rate decision as their two-day meeting comes to a close this afternoon.
Obviously, the Fed will not be cutting rates, as their benchmark interest rate is already targeted in a range of 0%-0.25%. So, what the market will be listening for is their comments on quantitative easing (will they speed up their purchases of mortgage and Treasury securities, actually increase the amount planned to purchase, or leave their plans unchanged?) and the progress made within the economic data – albeit tepid – over the past couple of weeks. That is, will they put the focus on the improvements seen within the PMI figures (another term for the regional manufacturing surveys) or the labor market that has yet to show signs of improvement via the jobless claims figures?
Our feel is they touch on the positives, but put the focus on the labor-market conditions. They’ll state that the economy has found a bottom but signs of an actual rebound (there’s a distinction between stabilization at depressed levels and a pure rebound) have yet to be seen. They’ll probably stay away from increasing their quantitative easing plans. We’ll see how close these guesses are to the FOMC’s actual decisions by 1:15 CDT.
Have a great day!
Brent Vondera, Senior Analyst
(This morning the Federal Reserve is leaking comments that six of the 19 largest banks will require additional capital. It’s clear what’s going on here: the government will use these stress tests as a way to force banks to participate in selling “troubled” assets into the PPIP, banks have previously said they don’t want to sell because the intrinsic values are higher than the price they’ll get in this market. But PPIP is dead anyway because private firms that will be on the buy side are scared. When they make big profits by using huge levels of government leverage they know what will happen – Barney Frank will drag them up to Capitol Hill and lambaste these firms in front of the camera as if they are the devil – why would they want to put themselves in this position. And then they’ll have their pay restricted and very likely see profits stripped – this is indeed a nasty road we’ve ventured along.)
Anyway, yesterday’s market losses would have been worse if not for better-than-expected economic reports. As we mentioned yesterday, a move back above -10 on the Richmond Fed Index would offer good support to the market and that’s exactly what the index did, rising to -9. That manufacturing survey improved nicely and the market responded to the news by erasing early-session losses. A better-than-expected improvement in the consumer confidence index, even if it remains extremely depressed and the job outlook aspect of the survey hardly improved, helped stocks as well – we’ll touch on this more specifically below.
In the end though, between incessant reporting on swine flu and the capital adequacy concerns, the negatives caused the slight momentum to fizzle in the final hour of trading.
Mid and small capitalization stock indices did end the session higher.
Market Activity for April 28, 2009
S&P Case/Shiller Home Price Index
The Case/Shiller Index for February measured home prices fell 18.63% from the year-ago period regarding the 20 largest metro areas tracked by the figure. This is an improvement from the year-over-year decline of 19.00% registered for January and marks the first month in which the index hasn’t made a new year-over-year decline since January 2007.
The decline in home prices within these 20 cities was a bit milder than expected due to vast improvement in the rate of price decline within the West region – this region dominates the index, making up nearly 35% of the index. In fact, price declines eased in 16 of the 20 cities tracked – price declines accelerated in the East Coast locations and Cleveland.
The largest improvements occurred in L.A., San Diego, Seattle, San Francisco, and Tampa – places where some of the most speculation took place and thus have the highest foreclosure rates. The plunge in prices within these areas over the past year (San Diego down 22.9%, L.A. down 24%, San Fran down 31%) has brought in bargain hunters, which has begun to put a floor in on prices. (They are still declining, but at a much lower rate and that at least is something to celebrate) The lowest fixed mortgage rates since the 1940s are also helping.
The month-over-month decline in the overall index improved to -2.17% from -2.80% in January. L.A. home prices placed the largest drag on the index from a month-over-month perspective, even though the rate of decline in prices among homes in that area eased. L.A. makes up 15.1% of the index and since prices fell 2.03% it subtracted 0.31% from the index. New York placed the second-biggest drag on the index; it makes up 19.4% of the reading and thus the 1.57% month-over-month price decline subtracted 0.30% from the index.
Consumer Confidence
The Conference Board’s consumer confidence index bounced off of the Feb./Mar. all-times lows, hitting a better-than-expected 39.2. Still, much improvement is needed to get the gauge back to the pre-confidence-killing September levels (roughly 60 on this index) and that will be the level to watch with regard to the overall index. Nevertheless, the bounce off of the record lows is a helpful sign.
The other important indicator to watch within this survey is the net jobs “plentiful” less “hard to get” figure, which barely moved from -44.1 in March to -43.4 in April.
As we’ve talked about a couple of times, it is unlikely that consumer activity will bounce back with the force it usually does coming out of recession – the Fed’s easy money policies of the past several years led to debt levels that are simply too much to handle with the unemployment rate rising to the highest range we’ve seen in 26 years. Therefore, we’ll need to have some confidence return by way of the job market (especially since slashing tax rates in order to boost disposable incomes is antithetical to the agenda of the current political class) before consumer activity can even mildly increase in a sustained manner. As a result, we’ll need to see this jobs “plentiful” less “hard to get” figure show meaningful improvement before one can expect the largest segment of GDP (personal consumption) to begin to boost GDP growth again. Until this figure makes a move toward -20, it will be up to the business side of things and that inventory dynamic we keep touching on.
Richmond Fed Manufacturing Index
The Federal Reserve Bank of Richmond reported that their factory gauge continued to improve in April and has completely bounced back to pre-September levels – this is a really good sign. While the index continues to illustrate factory activity within the central Atlantic region remains in contraction mode, the progress made over the past two months is showing the sector’s worst is behind it. The improvement we’ve seen from the latest regional manufacturing surveys (New York, Philly, Dallas and now Richmond) have been encouraging and this one is the most so.
The Richmond index jumped to -9 in April from -20 in March, bouncing from the doldrums hit late last year/early this year. Evidence of diminished weakness was also evident in all of the sub-indices, although the employment index barely budged.
New order volumes
The order backlog index jumped 22 points.
The average workweek jumped 23 points from the -30 registered in March all the way back to -7 for April. If we can get these manufacturing workweek numbers back to positive territory it will offer very encouraging signs the worst within the labor market has been seen.
We still need the ISM manufacturing index (the nationwide look at the sector) to officially confirm a rebound has occurred, which means that index will have to bounce into the 40s – it’s been stuck in the mid-30s.
This morning we get the first look at Q1 GDP, which is expected to show the economy contracted at a 4.7% real annual rate. This will follow the -6.3% reading of the fourth quarter, marking the deepest contraction since the 1981-82 recession.
We’ll also get the FOMC’s (the Fed’s monetary policy decision-making committee) rate decision as their two-day meeting comes to a close this afternoon.
Obviously, the Fed will not be cutting rates, as their benchmark interest rate is already targeted in a range of 0%-0.25%. So, what the market will be listening for is their comments on quantitative easing (will they speed up their purchases of mortgage and Treasury securities, actually increase the amount planned to purchase, or leave their plans unchanged?) and the progress made within the economic data – albeit tepid – over the past couple of weeks. That is, will they put the focus on the improvements seen within the PMI figures (another term for the regional manufacturing surveys) or the labor market that has yet to show signs of improvement via the jobless claims figures?
Our feel is they touch on the positives, but put the focus on the labor-market conditions. They’ll state that the economy has found a bottom but signs of an actual rebound (there’s a distinction between stabilization at depressed levels and a pure rebound) have yet to be seen. They’ll probably stay away from increasing their quantitative easing plans. We’ll see how close these guesses are to the FOMC’s actual decisions by 1:15 CDT.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries were up in early trading but faltered on some better than expected economic data that brought stocks higher. The selloff worsened after a poor five-year Treasury auction brought yields even higher. The two-year finished down 2/32, and the ten-year was lower by 53/64. The benchmark curve was steeper by 3.5 basis points on the day, and currently sits at +206 basis points. A basis point represents .01%.Bids on $35 billion in 5-year Treasuries were plentiful but the rate still came in at 1.94%, higher than what was expected. The bid/cover ratio, a measure of demand for bond at auction, was 2.22, higher than the 4-auction average of 2.11.
Attention now turns to the Fed, who releases the comments from today’s FOMC meeting tomorrow at 1:15. They are expected to stand pat on Fed Funds (currently a range of 0-.25%), but the comments accompanying the decision will be closely watched. It has been six weeks now since the Fed announced its plan to buy $300 billion in US Treasuries to lower rates, but rates have returned to where they were before the Fed’s announcement. I would not be surprised if the Fed announces an increase in their Treasury purchases.
A Peek at Stress Test Results
Results of the stress tests were initially scheduled to be released on Monday, May 4th, but complete reports will probably be released sometime later that week. In the meantime, The Wall Street Journal reported this morning that regulators have told Citi and Bank of America that they may need to raise additional capital based on early results of the stress test that still haven’t been made public. Stress tests being performed by private analyst attempting to foreshadow capital needs as a result of the government’s program say BAC will need anywhere from $20-$70 billion in fresh equity. The $70 billion number comes from a stress test using an adverse situation with 12% unemployment, higher than the governments disclosed forecast of 10.3%.
The pros and cons of this program are being debated all over the street, but most agree that without transparency the tests themselves won’t get the job done. Even representatives at the banks who are working with regulators are having a hard time getting a handle on what the Fed is really searching for. Convoluted questions will lead to useless results in a “garbage in – garbage out” process such as this.
To make matters worse the government is nixing any chance of a private capital raise for a bank deemed in need of some by the stress tests. The Fed can continue to say that a negative result should not be perceived as a scarlet letter but the market has made up its mind in this regard. Raising capital in this environment would be highly difficult regardless of government involvement, but the fear of what comes with a government stake (pay restrictions, lending guidelines, board appointments, etc.) just makes it harder.
Have a great evening.
Cliff J. Reynolds Jr., Junior Analyst
Tuesday, April 28, 2009
EME, JEC, PFE, SPWRA, IBM
S&P 500: -2.35 (-0.27%)
EMCOR Group (EME) +6.67%
EMCOR reported a 25 percent rise in quarterly profit, helped by lower costs and gains from global operations. The company reaffirmed its “baseline” earnings, but noted that visibility remains limited and credit market uncertainty may continue to impact private sector capital spending.
The firm’s contract backlog (work waiting to be completed) declined to $3.67 billion from $4 billion at the end of 2008. The company attributed the decline to reduced contract awards in the hospitality/gaming sectors, particularly in Las Vegas, and in the commercial sector. This weakness was partially offset by growth in the transportation, industrial, institutional, and water and wastewater sectors.
EMCOR is positioned to benefit from projects stemming from the federal economic stimulus program, but they have not yet seen a significant amount of actual spending related to this program.
Jacobs Engineering Group (JEC) -11.33%
After the market closed yesterday, Jacobs reported a 10 percent increase in fiscal second-quarter profits, but significantly reduced its fiscal 2009 earnings guidance citing near-term “complexities and uncertainties” in their markets.
Quarterly revenues climbed higher on strong performance from Jacob’s field services division. Jacob’s said the public sector business remains strong, while the heavy process business is highly uncertain. Management frequently used the word “complex” to describe business conditions.
On the bright side, the backlog grew 2.5 percent year-over-year and is now worth about 1.25 times 2008 revenues. Jacobs expects to benefit from spending related to the U.S stimulus package, which sets aside $81 billion for infrastructure (with the biggest line item being for highway construction) and $61 billion to invest in energy.
Pfizer (PFE) -0.74%
Pfizer’s results were similar to other pharmaceuticals that have reported thus far: lower revenues due to a stronger U.S. dollar and increasing generic competition. More important to investors were updates to the Wyeth acquisition, which remains on track.
This past quarter showed solid execution on cost savings, which will be crucial during the next several years since earnings growth will be driven by cost reductions rather than top-line growth.
Pfizer has a poor history of large acquisitions that destroyed shareholder wealth. The company’s reliance on growth-by-acquisition instead of strong in-house research and smart licensing could eventually take its toll. Only time will tell if Pfizer can properly manage its massive pipeline, which is heavily-weighted towards early-phase drugs, to fuel future growth.
SunPower Corp (SPWRA) -5.95%
SunPower announced it plans to offer 9 million shares of Class A common stock and $175 million of senior convertible notes due 2014.
International Business Machines (IBM) +1.99%
IBM boosted its quarterly dividend 10 percent to 55 cents a share and said it plans to repurchase as much as $3 billion in shares.
Peter Lazaroff, Junior Analyst
EMCOR Group (EME) +6.67%
EMCOR reported a 25 percent rise in quarterly profit, helped by lower costs and gains from global operations. The company reaffirmed its “baseline” earnings, but noted that visibility remains limited and credit market uncertainty may continue to impact private sector capital spending.
The firm’s contract backlog (work waiting to be completed) declined to $3.67 billion from $4 billion at the end of 2008. The company attributed the decline to reduced contract awards in the hospitality/gaming sectors, particularly in Las Vegas, and in the commercial sector. This weakness was partially offset by growth in the transportation, industrial, institutional, and water and wastewater sectors.
EMCOR is positioned to benefit from projects stemming from the federal economic stimulus program, but they have not yet seen a significant amount of actual spending related to this program.
Jacobs Engineering Group (JEC) -11.33%
After the market closed yesterday, Jacobs reported a 10 percent increase in fiscal second-quarter profits, but significantly reduced its fiscal 2009 earnings guidance citing near-term “complexities and uncertainties” in their markets.
Quarterly revenues climbed higher on strong performance from Jacob’s field services division. Jacob’s said the public sector business remains strong, while the heavy process business is highly uncertain. Management frequently used the word “complex” to describe business conditions.
On the bright side, the backlog grew 2.5 percent year-over-year and is now worth about 1.25 times 2008 revenues. Jacobs expects to benefit from spending related to the U.S stimulus package, which sets aside $81 billion for infrastructure (with the biggest line item being for highway construction) and $61 billion to invest in energy.
Pfizer (PFE) -0.74%
Pfizer’s results were similar to other pharmaceuticals that have reported thus far: lower revenues due to a stronger U.S. dollar and increasing generic competition. More important to investors were updates to the Wyeth acquisition, which remains on track.
This past quarter showed solid execution on cost savings, which will be crucial during the next several years since earnings growth will be driven by cost reductions rather than top-line growth.
Pfizer has a poor history of large acquisitions that destroyed shareholder wealth. The company’s reliance on growth-by-acquisition instead of strong in-house research and smart licensing could eventually take its toll. Only time will tell if Pfizer can properly manage its massive pipeline, which is heavily-weighted towards early-phase drugs, to fuel future growth.
SunPower Corp (SPWRA) -5.95%
SunPower announced it plans to offer 9 million shares of Class A common stock and $175 million of senior convertible notes due 2014.
International Business Machines (IBM) +1.99%
IBM boosted its quarterly dividend 10 percent to 55 cents a share and said it plans to repurchase as much as $3 billion in shares.
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks made a run for positive territory about 90 minutes into the trading session but failed to hold up, succumbing to the onslaught of swine flu news – not to make light of the situation as it is early days but recycling the coverage every three minutes seems a slight bit excessive; it’s what sells. (I’m not even truly convinced the market’s losses were totally driven by talk of the epidemic. It seems that if investors were concerned about this becoming a pandemic the broad market would have lost more than 1%. At the top end of this range traders will use any bad news that has the potential to do damage as a reason to take some profits here.)
Stocks got off to a poor start, but rallied after the latest regional manufacturing survey showed factory activity in the Southwest U.S .meaningfully improved. The reading from the Dallas Federal Reserve Bank (which covers the Southwest) had April factory activity contracting at a milder pace than expected and respondents to the survey were relatively optimistic about business prospects six months out.
Financial and basic material shares were the hardest hit. Consumer discretionary shares were held down by consumer services stocks such as hotel and restaurants on the swine flu news. Transportation stocks took a pretty good beating also on fears of a contagion. But again, after a 46% jump in the trannies from the March low, traders were also waiting for a reason to take profits. Not surprisingly, health-care shares outperformed.
Market Activity for April 27, 2009
The Latest on Washington Motors
In the latest plan to offer GM assistance the U.S. Treasury would extend another $11.6 billion to the company (bringing gov’t injections to $27 billion), which the government would forgive half off in exchange for equity in a restructured GM. The U.S. government would be a majority shareholder (50.1% share) and thus have the full-blown authority to demand the type of car GM produces. Private bond holders, which also hold $27 billion of debt, would get a 10% equity ownership in the restructured company, as devised by this latest plan. So the private sector bondholders receive a 10% stake and the government receives a majority position – that’s nice.
This will not end well for the company. A traditional form of bankruptcy would be much more conducive to the company’s viability after the restructuring and keep us from traveling further down the treacherous path of intense government involvement. The deal, in its current form, won’t get done anyway as it is highly unlikely bondholders agree to these terms. Something tells me, however, the government is going to get their majority stake.
Dallas Fed Survey
This is another one of those regional factory activity surveys, but not one of the major readings such as Chicago PMI and Philly Fed – these two offer the best indication of where the manufacturing sector is headed, but we may want to pay closer attention to regions other than Chicago as it will be especially hard hit by the idling of auto plants over the subsequent two months. The less watched indexes, such as New York, Richmond and Dallas may therefore offer better clues over the next couple of months as they are not heavily weighted to the auto industry.
The Dallas Federal Reserve Bank stated their manufacturing activity index continues to improve nicely from the depths hit at the end of last year, even as it remains well in contraction mode. Still, we shouldn’t disregard that the 17-point improvement in April is substantial and probably offered some support to the market when released (as stated above stocks moved into positive territory shortly after the figure was announced).
The sub-indices of the report edged upward but because the readings remain well-below zero it shows the improvement reflects fewer companies seeing declines in these measures (new orders, capacity utilization, shipments etc.), rather than more firms reporting recoveries.
The best news within the report came via the six-month outlook. (This is the segment of the survey that measures respondents’ expectations of business activity six months out.) This reading rose to 5.0, the first positive print in 10 months.
Source: Federal Reserve Bank of Dallas
This Week’s Data
Things pick up on the data front beginning this morning with the S&P Case/Shiller Home Price Index and Richmond Fed Manufacturing Index. Case/Shiller is expected to show major price declines continued in February, estimates are for an 18.7% decline in home prices from the year-ago period for this measure of the largest 20 metro areas.
However, since this index measures the largest cities, it is weighted toward the West and thus many of the areas that have witnessed the highest foreclosure rates. As we’ve seen in other housing indices of late, bargain hunters have moved in to buy up distressed properties and this activity may ease the decline in prices and allow Case/Shiller to post a better-than-expected reading.
We’ll also get the Richmond Fed – another regional factory survey. It is likely to show manufacturing activity remained depressed this month for the region covered by the Federal Reserve Bank of Richmond, but it has shown nice improvement from the depths hit a couple of months back – pretty much as the other regionals have illustrated. If the reading can post a -10 or better, the market should respond to the move.
On Wednesday we get the first look at Q1 GDP, which is expected to show the economy contracted substantially again in the first quarter. The market expects a reading of -4.7% (that’s in real terms at an annual rate), which follows the large 6.3% contraction in the fourth quarter.
These readings are the worst GDP numbers we’ve seen since the 1981-82 recession. Indeed, everything changed in September. Prior to the Lehman collapse the economy remained resilient in the face of a nasty housing correction (that was almost two years in the making by September 2008) and an energy price spike that had the price of oil holding above $110 per barrel. When Lehman went down on September 15 the credit chaos that resulted caused business activity to either seize up as a direct result of the credit contraction or caused business managers to become terribly cautious in terms of those not directly affected. The consumer was then put down for the count as their two largest savings vehicles (homes and stocks) took a beating – the peak to trough 57% plunge in stock prices (and the stunning 42% nosedive September-November) crushed confidence.
We think the GDP figure will come in a bit worse than expectations, maybe not on this initial reading, but by time of the first revision – consumer activity won’t live up to estimates and the quarter endured substantial inventory liquidation. However, the inventory dynamic (the production necessary to rebuild very low inventory levels) will help to bring a positive GDP reading by the third quarter if we had to guess based on what is currently known.
On Thursday we get initial jobless claims, personal income and spending, and Chicago-area manufacturing.
Jobless claims are likely to remain very elevated, but beyond the next couple of weeks we’ll be watching for this figure to trend to the 500K handle – when this occurs it will mark a very clear sign that monthly jobs losses have eased.
Personal income for March should continue to show the only segment of the report that continues to grow is government transfer payments. This is a consumer-led recession (the first one of its kind since the 1980 recession) and as a result it will be tough for GDP growth to hit the levels we generally see as the economy bounces back before private sector income growth makes a comeback.
Personal spending will remain soft and will likely post a negative reading for March after showing increases in January and February following six-straight months of decline.
Chicago manufacturing, if the other regional factory surveys offer a good clue, will remain in deep contraction mode. The index is expected to rise to 35.0 from the nearly 29-year low of 31.4, but until this figure moves back to the 40s, it’s tough to find a silver lining. I was expecting these manufacturing numbers to begin to show signs of recovery by June, but now that GM is idling a number of plants a true recovery in factory activity will probably be pushed back.
Futures
Stock-index futures are lower this morning on news the stress tests run on Citigroup and Bank of America didn’t go well and both will need more capital. I thought we weren’t supposed to hear results until Monday March 4? So much for schedules.
Have a great day!
Brent Vondera, Senior Analyst
Stocks got off to a poor start, but rallied after the latest regional manufacturing survey showed factory activity in the Southwest U.S .meaningfully improved. The reading from the Dallas Federal Reserve Bank (which covers the Southwest) had April factory activity contracting at a milder pace than expected and respondents to the survey were relatively optimistic about business prospects six months out.
Financial and basic material shares were the hardest hit. Consumer discretionary shares were held down by consumer services stocks such as hotel and restaurants on the swine flu news. Transportation stocks took a pretty good beating also on fears of a contagion. But again, after a 46% jump in the trannies from the March low, traders were also waiting for a reason to take profits. Not surprisingly, health-care shares outperformed.
Market Activity for April 27, 2009
The Latest on Washington Motors
In the latest plan to offer GM assistance the U.S. Treasury would extend another $11.6 billion to the company (bringing gov’t injections to $27 billion), which the government would forgive half off in exchange for equity in a restructured GM. The U.S. government would be a majority shareholder (50.1% share) and thus have the full-blown authority to demand the type of car GM produces. Private bond holders, which also hold $27 billion of debt, would get a 10% equity ownership in the restructured company, as devised by this latest plan. So the private sector bondholders receive a 10% stake and the government receives a majority position – that’s nice.
This will not end well for the company. A traditional form of bankruptcy would be much more conducive to the company’s viability after the restructuring and keep us from traveling further down the treacherous path of intense government involvement. The deal, in its current form, won’t get done anyway as it is highly unlikely bondholders agree to these terms. Something tells me, however, the government is going to get their majority stake.
Dallas Fed Survey
This is another one of those regional factory activity surveys, but not one of the major readings such as Chicago PMI and Philly Fed – these two offer the best indication of where the manufacturing sector is headed, but we may want to pay closer attention to regions other than Chicago as it will be especially hard hit by the idling of auto plants over the subsequent two months. The less watched indexes, such as New York, Richmond and Dallas may therefore offer better clues over the next couple of months as they are not heavily weighted to the auto industry.
The Dallas Federal Reserve Bank stated their manufacturing activity index continues to improve nicely from the depths hit at the end of last year, even as it remains well in contraction mode. Still, we shouldn’t disregard that the 17-point improvement in April is substantial and probably offered some support to the market when released (as stated above stocks moved into positive territory shortly after the figure was announced).
The sub-indices of the report edged upward but because the readings remain well-below zero it shows the improvement reflects fewer companies seeing declines in these measures (new orders, capacity utilization, shipments etc.), rather than more firms reporting recoveries.
The best news within the report came via the six-month outlook. (This is the segment of the survey that measures respondents’ expectations of business activity six months out.) This reading rose to 5.0, the first positive print in 10 months.
Source: Federal Reserve Bank of Dallas
This Week’s Data
Things pick up on the data front beginning this morning with the S&P Case/Shiller Home Price Index and Richmond Fed Manufacturing Index. Case/Shiller is expected to show major price declines continued in February, estimates are for an 18.7% decline in home prices from the year-ago period for this measure of the largest 20 metro areas.
However, since this index measures the largest cities, it is weighted toward the West and thus many of the areas that have witnessed the highest foreclosure rates. As we’ve seen in other housing indices of late, bargain hunters have moved in to buy up distressed properties and this activity may ease the decline in prices and allow Case/Shiller to post a better-than-expected reading.
We’ll also get the Richmond Fed – another regional factory survey. It is likely to show manufacturing activity remained depressed this month for the region covered by the Federal Reserve Bank of Richmond, but it has shown nice improvement from the depths hit a couple of months back – pretty much as the other regionals have illustrated. If the reading can post a -10 or better, the market should respond to the move.
On Wednesday we get the first look at Q1 GDP, which is expected to show the economy contracted substantially again in the first quarter. The market expects a reading of -4.7% (that’s in real terms at an annual rate), which follows the large 6.3% contraction in the fourth quarter.
These readings are the worst GDP numbers we’ve seen since the 1981-82 recession. Indeed, everything changed in September. Prior to the Lehman collapse the economy remained resilient in the face of a nasty housing correction (that was almost two years in the making by September 2008) and an energy price spike that had the price of oil holding above $110 per barrel. When Lehman went down on September 15 the credit chaos that resulted caused business activity to either seize up as a direct result of the credit contraction or caused business managers to become terribly cautious in terms of those not directly affected. The consumer was then put down for the count as their two largest savings vehicles (homes and stocks) took a beating – the peak to trough 57% plunge in stock prices (and the stunning 42% nosedive September-November) crushed confidence.
We think the GDP figure will come in a bit worse than expectations, maybe not on this initial reading, but by time of the first revision – consumer activity won’t live up to estimates and the quarter endured substantial inventory liquidation. However, the inventory dynamic (the production necessary to rebuild very low inventory levels) will help to bring a positive GDP reading by the third quarter if we had to guess based on what is currently known.
On Thursday we get initial jobless claims, personal income and spending, and Chicago-area manufacturing.
Jobless claims are likely to remain very elevated, but beyond the next couple of weeks we’ll be watching for this figure to trend to the 500K handle – when this occurs it will mark a very clear sign that monthly jobs losses have eased.
Personal income for March should continue to show the only segment of the report that continues to grow is government transfer payments. This is a consumer-led recession (the first one of its kind since the 1980 recession) and as a result it will be tough for GDP growth to hit the levels we generally see as the economy bounces back before private sector income growth makes a comeback.
Personal spending will remain soft and will likely post a negative reading for March after showing increases in January and February following six-straight months of decline.
Chicago manufacturing, if the other regional factory surveys offer a good clue, will remain in deep contraction mode. The index is expected to rise to 35.0 from the nearly 29-year low of 31.4, but until this figure moves back to the 40s, it’s tough to find a silver lining. I was expecting these manufacturing numbers to begin to show signs of recovery by June, but now that GM is idling a number of plants a true recovery in factory activity will probably be pushed back.
Futures
Stock-index futures are lower this morning on news the stress tests run on Citigroup and Bank of America didn’t go well and both will need more capital. I thought we weren’t supposed to hear results until Monday March 4? So much for schedules.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries were up all day despite jostling in equities. Swine flu concerns over the weekend drove international money toward the safety of US government debt, ignoring what has the potential to be an ugly week due to increased Treasury supply. The two-year finished up 5/32, and the ten-year was higher by 22/32. The benchmark curve was unchanged on the day, and currently sits at +203 basis points. A basis point represents .01%.
The Treasury sold $40 billion in 2-year notes at a .949% yield with a bid/cover ratio of 2.72. Tuesday and Wednesday will bring another $61 billion in 5- and 7-year notes and analyst are expecting $200 billion in new supply next week as the Treasury does its monthly refunding. Today’s rally would have been substantially bigger if it were not for the looming supply. Poor performance in one of the auctions this week could send 10-year yields up past 3.05%, something the Fed does not want to see.
TED Spread Added to Table
The TED Spread, which is used as a proxy for liquidity in financial markets, is the difference between 3-month Libor and the yield on 3-month T-bills. The London Interbank Offered Rate (LIBOR) is the rate that banks charge for loans they make to other banks. As credit risks become more of a concern, banks charge more for these loans in order to be compensated for the increased risk of not being repaid. At the same time, as investors become more concerned with credit risk, they flee to the safety of Treasury bills, driving risk-free rates down. The result of 3-month Libor rising and yields on T-bills falling is an increase in the TED Spread.
The Treasury sold $40 billion in 2-year notes at a .949% yield with a bid/cover ratio of 2.72. Tuesday and Wednesday will bring another $61 billion in 5- and 7-year notes and analyst are expecting $200 billion in new supply next week as the Treasury does its monthly refunding. Today’s rally would have been substantially bigger if it were not for the looming supply. Poor performance in one of the auctions this week could send 10-year yields up past 3.05%, something the Fed does not want to see.
TED Spread Added to Table
The TED Spread, which is used as a proxy for liquidity in financial markets, is the difference between 3-month Libor and the yield on 3-month T-bills. The London Interbank Offered Rate (LIBOR) is the rate that banks charge for loans they make to other banks. As credit risks become more of a concern, banks charge more for these loans in order to be compensated for the increased risk of not being repaid. At the same time, as investors become more concerned with credit risk, they flee to the safety of Treasury bills, driving risk-free rates down. The result of 3-month Libor rising and yields on T-bills falling is an increase in the TED Spread.
The top half of the graph shows 3-month Libor (orange line) and 3-month bills (white line) individually, while the bottom part shows the TED spread.
The graph details the substantial change in the credit environment due to the Lehman bankruptcy last fall. Three-month Libor rose from just under 3% to 4.81%, signifying the reluctance of banks to lend to each other. T-bills saw a more abrupt change, dropping from 1.47% on 9/12 (the Friday before Monday 9/15) to .06% just two days after Lehman filed Chapter 11.
The TED Spread has recovered to more normal levels as credit markets begin to show signs of life, thanks to trillions in government purchases and guarantees that have brought liquidity back to the market. Although the current level of 95 bps is still double the long-term average, the fed has certainly made its presence felt.
Have a great evening.
Cliff J. Reynolds Jr., Junior Analyst
The graph details the substantial change in the credit environment due to the Lehman bankruptcy last fall. Three-month Libor rose from just under 3% to 4.81%, signifying the reluctance of banks to lend to each other. T-bills saw a more abrupt change, dropping from 1.47% on 9/12 (the Friday before Monday 9/15) to .06% just two days after Lehman filed Chapter 11.
The TED Spread has recovered to more normal levels as credit markets begin to show signs of life, thanks to trillions in government purchases and guarantees that have brought liquidity back to the market. Although the current level of 95 bps is still double the long-term average, the fed has certainly made its presence felt.
Have a great evening.
Cliff J. Reynolds Jr., Junior Analyst
Monday, April 27, 2009
Earnings on Deck: Big Oil
S&P 500: -8.72 (-1.01%)
Earnings on deck: Big Oil
Major oil companies Exxon Mobil, Chevron, BP, and Royal Dutch are set to report earnings this week (ConocoPhillips reported last week).
The major oil companies benefited from flight to safety in the second half of 2008, as investors placed a premium on the industry’s high earnings and dividend growth stability. But in 2009, this group has trailed the broader market as the impact of the credit crisis intensifies within the industry.
Industry pricing is notably lower than in the past few years due to rising stockpiles and easing demand in response to the global economic downturn. Budgets are being cut as a result, making it difficult to expand oil and gas production. Adding to the difficulties is rising nationalism, which increases the political risk and makes access to large energy resources more difficult and fiscal terms less attractive.
We are expecting lower oil prices to result in a substantial drop in income for the oil majors, and there is very little they can do about costs in the short-term. As we look specifically at Chevron and Exxon Mobil’s results later this week, we will be paying special attention to their capital expenditure outlook. This will likely determine their growth rate for the next several years.
Qualcomm (QCOM) +4.38%
Qualcomm announced the settlement of a technology patent infringement battle with Broadcom, which help offset the company’s wide earnings miss. Despite the poor quarterly results, Qualcomm raised its full-year sales forecast to reflect strong demand for 3G enabled products and services.
Qualcomm’s technology has grown more popular with the rise of third-generation (3G) phones that offer high-speed Web. Qualcomm surpassed Texas Instruments last year as the biggest maker of mobile-phone digital signal processors – the essential chips in handsets.
Quick Hits
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks rallied Friday after the latest data on new home sales and durable goods orders came in at better-than-expected levels. (That durables report showed a decline in orders, but only half as bad as expected.)
Stocks were also helped by cost-cutting news that has flowed through via the earnings reports. This is a topic we touched on a couple of days back, stating it won’t take much of a bounce in demand to fire up profit results again. At least for Friday, one never knows how sentiment can shift on a day-to-day basis, traders were looking a couple of quarters ahead, which is probably the length of time it will take before good earnings growth off of easy comparisons becomes evident.
Friday’s gains, however, were not enough to push the broad market to a seventh-straight week of gains – the S&P 500 ended the week lower by 0.39% after posting six weeks of improvement that drove the index 30.5% above the intra-day low of 666 that was hit on March 9.
Basic material (metals producers, chemical makers and paper companies) led the winners as the S&P 500 index that tracks these shares jumped 4.41%. Consumer discretionary, energy and tech shares also easily outperformed the market. Utilities and telecom shares were the only losers.
Market Activity for April 24, 2009
Stress Tests
Every time I type the words “stress test” I think of former VP Al Gore’s famous “lock box” phrase – don’t ask me why. Anyway, the Fed released the methodology behind bank stress tests on Friday – although I’m not sure what all the hype was about (CNBC had a running countdown to the release the entire morning) since the methods have been reported on for three weeks now.
The real farce of these tests -- and I shouldn’t be this cynical, but let’s be real – is how the Fed stated any banks deemed to need more capital “is not (my emphasis) a measure of current solvency or viability of the firm.” Well, good luck with that one. Say the Fed deems a bank has insufficient levels of capital under worst case assumptions –even if those assumptions never become reality – institutions can forget about raising capital from the private sector. That leaves…guess who?
New Homes Sales
The Commerce Department reported new home sales fell 0.6% in March to 356,000 units at an annual rate. This follows the strong 8.2% bounce in February off of the all-time low hit in January. While the March figure fell slightly, it should be viewed as a positive that it was close to unchanged from the February bounce.
New home sales last month were held up by higher activity in the West region. This is where the bulk of the foreclosures, or distressed properties as they are often termed, reside and just as the existing home sales data illustrated bargain hunting in depressed areas has put a floor in on the data, the new home data shows the same. This is certainly not a good sign regarding the prospects of a recovery in the housing market, but one step at a time, you’ve got to get the floor in first. Sales jumped 15% in the West last month, were flat in the South, fell 7.8% in the Midwest and plunged 32% in the Northeast.
The median price of a new home fell 3.5% to $201,400 and is down 12.2% from the year-ago period.
The supply of new homes has now moved below the 45-year average and once sales bounce the inventory-to-sales ratio will fall fast. But this will take a labor market recovery and we’re quite a while from that occurring.
Futures
Stock-index futures are significantly lower this morning on the swine flu news. It seems we’re getting a little carried away on this one, there are 36,000 flu-related deaths in the U.S in a typical year and this variation hasn’t killed anyone (in the U.S.) to this point – in fact there aren’t even many reported cases. People who seem to understand these viruses say it will probably fizzle out and return again in the winter months, at which point we are likely to have a vaccine – assuming biological scientists understand the strain.
One can’t gauge how the market is going to react to what will surely continue to be much press focus on this issue simply by the way futures are reacting on a Monday morning. However, when we get to the top end of these trading ranges it doesn’t take much to push us lower again. We’ll just have to wait to see if this is a trading-range trigger, or something else will prove to be the mechanism, but when the market rallies nearly 30% (even if it’s from a very low level) in seven weeks one has to expect some sort of pull back.
We also have the Treasury market trading range that may put pressure on stocks. Recall, last week we talked about how the Treasury market rallies when the 10-year hits 3.00% as traders understand the Fed is a buyer and see this level as a way to make quick and easy profits – does this take money out of equities as a result? We don’t know, but it may act as an adverse consequence of the Fed purchases.
Well, like clockwork Treasurys are rallying this morning, pushing the yield on the 10-year down to 2.94% -- it closed at 2.99% on Friday. (At the shorter end of the curve, the support seems to be at 1.00% on the 2-year Treasury, for instance. That maturity closed at 0.96% on Friday and is down to 0.92% this morning. Remember, the price of a bond and its yield are inversely related so when traders are buying and pushing the price higher, the yield falls, and vice versa.)
Of course all of this may be a result of the swine flu news, as investors flee back to the safety of the Treasury market, but we’ve seen the 10-year bounce off of this 3.00% level too many times now to ignore the trading range.
Have a great day!
Brent Vondera, Senior Analyst
Stocks were also helped by cost-cutting news that has flowed through via the earnings reports. This is a topic we touched on a couple of days back, stating it won’t take much of a bounce in demand to fire up profit results again. At least for Friday, one never knows how sentiment can shift on a day-to-day basis, traders were looking a couple of quarters ahead, which is probably the length of time it will take before good earnings growth off of easy comparisons becomes evident.
Friday’s gains, however, were not enough to push the broad market to a seventh-straight week of gains – the S&P 500 ended the week lower by 0.39% after posting six weeks of improvement that drove the index 30.5% above the intra-day low of 666 that was hit on March 9.
Basic material (metals producers, chemical makers and paper companies) led the winners as the S&P 500 index that tracks these shares jumped 4.41%. Consumer discretionary, energy and tech shares also easily outperformed the market. Utilities and telecom shares were the only losers.
Market Activity for April 24, 2009
Stress Tests
Every time I type the words “stress test” I think of former VP Al Gore’s famous “lock box” phrase – don’t ask me why. Anyway, the Fed released the methodology behind bank stress tests on Friday – although I’m not sure what all the hype was about (CNBC had a running countdown to the release the entire morning) since the methods have been reported on for three weeks now.
The real farce of these tests -- and I shouldn’t be this cynical, but let’s be real – is how the Fed stated any banks deemed to need more capital “is not (my emphasis) a measure of current solvency or viability of the firm.” Well, good luck with that one. Say the Fed deems a bank has insufficient levels of capital under worst case assumptions –even if those assumptions never become reality – institutions can forget about raising capital from the private sector. That leaves…guess who?
Durable Goods Orders
The Commerce Department reported that durable goods orders fell 0.8% in March after a downwardly revised 2.1% increase for February (previously estimated at a 3.4% increase). The decline in orders for March marks the seventh decrease over the past eight months. Excluding transportation orders, durables fell 0.6% last month, after a downwardly revised 2.0% increase for February (previously reported as a 3.9% increase). Orders are down 24.2% over the past three months at an annual rate, and while there is really no sign this data will bounce any time soon at least it’s a major improvement from the massive 50.4% decline of the previous quarter.
The most positive aspect of the report was the nondefense capital goods ex-aircraft component (the proxy for business spending), which rose for a second straight month. – up 1.5% in March and 4.3% in February. Now, these back-to-back readings follow a very large 12.2% decline in January so one can’t surmise that business spending has returned – more likely it’s a bounce from that plunge; this component is down 25.8% at an annual rate over the past three months. Still, it’s good to see back-to-back increases.
This business spending segment was boosted by a nice rise in electrical equipment. Machinery orders slipped 0.1% last month, but after a 7.1% increase in February it’s a moral victory the figure didn’t pull back further.
Shipments of durable goods fell for the seventh-straight month and is down 30% quarter-over-quarter at an annual rate. This is the figure the gross domestic product report picks up and thus will weigh heavily on Q1 GDP, again – we get the first look at the GDP reading on Wednesday.
The Commerce Department reported that durable goods orders fell 0.8% in March after a downwardly revised 2.1% increase for February (previously estimated at a 3.4% increase). The decline in orders for March marks the seventh decrease over the past eight months. Excluding transportation orders, durables fell 0.6% last month, after a downwardly revised 2.0% increase for February (previously reported as a 3.9% increase). Orders are down 24.2% over the past three months at an annual rate, and while there is really no sign this data will bounce any time soon at least it’s a major improvement from the massive 50.4% decline of the previous quarter.
The most positive aspect of the report was the nondefense capital goods ex-aircraft component (the proxy for business spending), which rose for a second straight month. – up 1.5% in March and 4.3% in February. Now, these back-to-back readings follow a very large 12.2% decline in January so one can’t surmise that business spending has returned – more likely it’s a bounce from that plunge; this component is down 25.8% at an annual rate over the past three months. Still, it’s good to see back-to-back increases.
This business spending segment was boosted by a nice rise in electrical equipment. Machinery orders slipped 0.1% last month, but after a 7.1% increase in February it’s a moral victory the figure didn’t pull back further.
Shipments of durable goods fell for the seventh-straight month and is down 30% quarter-over-quarter at an annual rate. This is the figure the gross domestic product report picks up and thus will weigh heavily on Q1 GDP, again – we get the first look at the GDP reading on Wednesday.
New Homes Sales
The Commerce Department reported new home sales fell 0.6% in March to 356,000 units at an annual rate. This follows the strong 8.2% bounce in February off of the all-time low hit in January. While the March figure fell slightly, it should be viewed as a positive that it was close to unchanged from the February bounce.
New home sales last month were held up by higher activity in the West region. This is where the bulk of the foreclosures, or distressed properties as they are often termed, reside and just as the existing home sales data illustrated bargain hunting in depressed areas has put a floor in on the data, the new home data shows the same. This is certainly not a good sign regarding the prospects of a recovery in the housing market, but one step at a time, you’ve got to get the floor in first. Sales jumped 15% in the West last month, were flat in the South, fell 7.8% in the Midwest and plunged 32% in the Northeast.
The median price of a new home fell 3.5% to $201,400 and is down 12.2% from the year-ago period.
The supply of new homes has now moved below the 45-year average and once sales bounce the inventory-to-sales ratio will fall fast. But this will take a labor market recovery and we’re quite a while from that occurring.
Futures
Stock-index futures are significantly lower this morning on the swine flu news. It seems we’re getting a little carried away on this one, there are 36,000 flu-related deaths in the U.S in a typical year and this variation hasn’t killed anyone (in the U.S.) to this point – in fact there aren’t even many reported cases. People who seem to understand these viruses say it will probably fizzle out and return again in the winter months, at which point we are likely to have a vaccine – assuming biological scientists understand the strain.
One can’t gauge how the market is going to react to what will surely continue to be much press focus on this issue simply by the way futures are reacting on a Monday morning. However, when we get to the top end of these trading ranges it doesn’t take much to push us lower again. We’ll just have to wait to see if this is a trading-range trigger, or something else will prove to be the mechanism, but when the market rallies nearly 30% (even if it’s from a very low level) in seven weeks one has to expect some sort of pull back.
We also have the Treasury market trading range that may put pressure on stocks. Recall, last week we talked about how the Treasury market rallies when the 10-year hits 3.00% as traders understand the Fed is a buyer and see this level as a way to make quick and easy profits – does this take money out of equities as a result? We don’t know, but it may act as an adverse consequence of the Fed purchases.
Well, like clockwork Treasurys are rallying this morning, pushing the yield on the 10-year down to 2.94% -- it closed at 2.99% on Friday. (At the shorter end of the curve, the support seems to be at 1.00% on the 2-year Treasury, for instance. That maturity closed at 0.96% on Friday and is down to 0.92% this morning. Remember, the price of a bond and its yield are inversely related so when traders are buying and pushing the price higher, the yield falls, and vice versa.)
Of course all of this may be a result of the swine flu news, as investors flee back to the safety of the Treasury market, but we’ve seen the 10-year bounce off of this 3.00% level too many times now to ignore the trading range.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries were down solidly all day on strength in equities that continued to get stronger as the day wore on outside of a brief selloff right after the stress test guidelines were released. The two-year finished down 3/64, and the ten-year was higher by 35/64. The benchmark curve was 4 basis points steeper on the day, and currently sits at +203 basis points. A basis point represents .01%.
We breached the 200 bps mark on the 2 to 10 spread today for the first time since March third as the long end of the curve continues to underperform at the top of this range in yields. The ten-year broke through 3% for a brief second just after 2pm central, but couldn’t hold on. The supply coming next week will test the 3.05% resistance, a level that has held in there well so far this year. Even if the auctions go well, I would expect a test of this level if we get any sort or rally in stocks.
Stress Test Guidelines Revealed
The Federal Reserve provided the market with some insight into the guidelines that are being used to stress test every bank holding company with more than $100 billion in assets. Here are a few bullet points on what was released today.
Banks are being asked to provide estimated losses on loans, investments and trading operations for 2009 and 2010 under two hypothetical economic environments.
- The baseline scenario projects real GDP growth of -2% in 2009 and +2.1% in 2010, unemployment of 8.4% and 8.8%, and home value declines of 14% and 4%.
- The adverse scenario projects real GDP growth of -3.3% in 2009 and +.5% in 2010, unemployment of 8.9% and 10.3% and home value declines of 22% and 7%.
- Under the above scenarios the Fed will concentrate on liquidity and capital ratios based on projections for losses provided by the banks being assessed.
- The Fed did not release any specifics on what a good test result might look like but did say that it will not be a simple pass/fail system. Although much of the market is expecting the banks to be divided into winners and losers.
Have a great evening.
Cliff J. Reynolds Jr., Junior Analyst
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