DELL, SO, MON, PG

S&P 500: +12.31 (+1.36%)


Dell (DELL) +0.78%
Dell reported less revenues and profit than last year, but the company still managed to beat analyst’s earnings expectations for the first quarter thanks to cost reductions.

CFO Brian Gladden said sales fell because of less demand from business customers and Dell’s decision to avoid price cuts. Dell said signals about the demand environment are mixed, but the company is preparing for what it believes will be a “powerful replacement cycle,” due to new products from Microsoft (MSFT) and Intel (INTC).

The company did not provide a specific financial outlook, but did announce it would slash another $1 billion in costs. That added to the $3 billion it had already pledged to cut annually within two years. Gladden sees the biggest opportunity for saving money in the cost of goods sold, including expenses from manufacturing and supplies.


Southern Company (SO) +0.42%
Southern Company announced it will manage and operate the U.S. Department on Energy’s new National Carbon Capture Center, which will develop and test advanced technologies to capture carbon dioxide from coal-based power plants. Arch Coal (ACI) and Peabody Energy (BTU) are among other partners.


Monsanto (MON) +3.99%
Earlier this week, Monsanto said earnings this fiscal year will be at the low end of its previous forecast because of stronger-than expected competition in its Roundup herbicide business.

The company is sacrificing Roundup sales volume to maintain prices amid increased competition from cheaper generic glyphosate herbicide from China. CEO Hugh Grant was surprised at how quickly and how much Chinese generic versions recently reached global markets. The generic version retails for about $20 a gallon, compared with $30 for Monsanto’s Roundup Grand.

The company expects growth in seeds to offset any decline in Roundup sales.

Procter & Gamble (PG) -1.24%
Yesterday, P&G said fiscal 2010 profit may rise as much as 4 percent as it introduces new products and doubles its distribution capacity in emerging markets.

The company raised some prices in some markets to cover fluctuating exchange rates, although it had to cut prices in categories such as fabric care and tissues to maintain its share.

On the topic of the balance sheet, the company’s primary use for cash will be to maintain its credit rating (Aa3 at Moody’s and AA- at S&P), but will also be used to expand its manufacturing capacity and to maintain the dividend. P&G will stop share repurchase program until the economy improves.


Quick Hits

• New Model Army?
• The Fed’s Balance Sheet
  

Peter Lazaroff, Junior Analyst

Fixed Income Recap

Treasuries rallied for the second day in a row leaving most of the curve unchanged for the week. The two-year finished up 5/64, and the ten-year was higher by 1 7/32. The benchmark curve flattened by 11 basis points, to end the week at +253.5 bps, flatter than we began the week believe it or not. A basis point represents .01%.

Mortgage rates as measured by the Fannie Mae 60-day Commitment Rate spiked 48 basis points yesterday to 5.21%. I normally quote the Mortgage Bankers Association Survey, which is only updated weekly. The Fannie Mae Commitment Rate is a rate commonly used in the mortgage origination industry, and is updated daily. Although it is not reflected in the graph the rate pulled back to 5.11% today.

It was certainly a wild week in rates but we really didn’t get anywhere. Mortgage rates are likely to stay above 5% after this week’s volatility, while the market waits to see if the Fed makes a move. The graph below shows the ten-year Treasury yield starting the week at 3.45%, and ending at 3.456%. If you took the week off you didn’t miss anything.

Next week is without an auction or a Fed purchase in the Treasury market, leaving traders with a few less worries.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Daily Insight

U.S. stocks, after struggling to find their direction during the morning session rallied in the afternoon. Energy shares led the upswing as oil prices look ready to take on the $70 per barrel handle; crude closed at $65.08 yesterday and is above $66 this morning. Financials were the next best performing sector as the Treasury market rallied, easing Wednesday’s concern over higher borrowing costs.

The market is in a gray area here, a state of confusion you might say, as the S&P 500 has traded in a tight range of 880 as the support and 925 as the resistance, just ahead of the 930 wall, over the past 20 sessions. I’m thinking very near term economic data is going to push us below that 880 level but it’s pretty clear that those who have not participated in this rally from the March 9 flagitious low of 666 are holding things up as they want in on the action.

Word that the Fed will boost their purchases of Treasury securities encouraged buying within the market place, full blown monetization of government debt is very likely but that’s another story. A $26 billion seven-year auction also went swimmingly, helping the Treasury market to rally and financials went along for the ride as the worry over a spike in rates eased, for now. One could say this is also why energy stocks jumped, the Fed’s actions will drive the dollar lower over time and that means higher commodity prices.

Treasury auctions are going to be more important than ever due to both fiscal and monetary policy decisions. A big test for this market will be the 10 and 30-year auctions scheduled for June 11 and 12, assuming Monday’s personal spending figure doesn’t blow a hole in the floor.

The day’s economic data was certainly no help; as we touched on yesterday, the market is holding up remarkably well considering what we’re seeing – more on the data below. Beyond the strong session for energy and financials all major industry groups, save consumer discretionary, closed to the plus side.


Market Activity for May 28, 2009


Jobless Claims

The Labor Department stated initial jobless claims fell 13,000 to 623,000 for the week ended May 23, beating the expectation by a bit, which was for a move to 627,000.
The four-week average fell 3,000 to 626,800.

Continuing claims made the 17th straight record high in the latest week, jumping another 110,000 to 6.788 million.

The insured unemployment rate, the jobless rate for those eligible for benefits, rose another tick to 5.1% -- the highest level since December 1982 when the post-WWII record unemployment rate of 10.8% was hit . This rate closely tracks the direction of the overall unemployment rate and you can expect it to blow past 9% when the May jobs report is released in a week.

This real-time data is illustrating there’s very little improvement within the labor market. We should not see a number like the 740,000 in payroll losses posted in January but a range of 530,000-600,000 appears to be in the cards for a couple of months still.

This level of losses cannot go on for much longer, although the auto-industry woes may make it a reality for longer than one would think possible, but it appears it may be a while before we move back to 300,000 in monthly job losses, which was the peak range for the last two recessions and the 2001 downturn.

Durable Goods Orders

The Commerce Department released their latest durable goods report, which showed orders rose 1.9% in April after a huge downward revision to the March data. The 1.9% bounce follows a 2.1% decline in orders for March (previously reported as a 0.8% decline). Durables were driven by a 2.7% increase in the vehicle and auto parts component and machinery orders – problem is we’d like to see something other than autos driving the reading because we know it’s not going to be of help over the next couple of months as auto plants will be idled.

Durable goods have endured the worst contraction in orders since the late 1940s.

Excluding transportation, orders rose 0.8% after a 2.7% decline in March – this number was revised down big time too, initially reported as a 0.6% decline.

The non-defense capital goods ex-aircraft component (a proxy for business spending) registered another large monthly decline, down 1.5%. On a three-month annualized basis, the decline has improved nicely, down 28.6% compared to the -44.2% last month that was affected by the massive 12.3% plunge in business spending orders during January. Needless to say, this rate of decline, while improved, shows businesses are still in a mode of heavy caution.

On a year-over-year basis, business spending is down 26.4%. This is the number to watch as we desperately need the business side of the economy to pull us out of this situation since the consumer will need additional time to get their bearings again. Unfortunately, the government has inserted itself as the economic driver. The consequence of this decision will be a crowding out of private sector activity as capital will be sapped via higher tax rates and debt purchases as result of the outsized deficit spending.

New Home Sales

The Commerce Department released new home sales for April, showing activity rose 0.3% to 352,000 units at an annual rate – the expectation was for sales to hit 360,000. This follows a 3% decline for March. New home sales are down 34% from the year-ago period. The record low of 329,000 units was hit in January, which was 76% below the peak hit in July 2005.

The lowest mortgage rates in 60 years and tax credits to first-time buyers have helped sales stabilize, albeit at the lowest levels since 1982.

The median price of a new home actually rose 3.7% last month, coming in at 209,700 – the figure is down 14.9% over the past year.

The number of new homes available for sale remains below the long-term average. This signals that the inventory to sales ratio will plunge once sales rebound in a significant way. The issue in the near term is the labor market, as we discussed yesterday; home sales don’t have much of a chance until job losses ease. Beyond that, sales will still have to fight headwinds as current fiscal and monetary policy will eventually drive interest rates higher.

On that inventory/sales figure, the supply of new homes relative to the rate of sales, the trend is moving in the right direction at least.

Delinquencies

In a separate housing market report, the Mortgage Bankers Association stated delinquencies as a percentage of all mortgage loans jumped again in the first quarter to 9.12%. This reading includes loans that are at least 30 days late. The delinquency rate among prime loans hit 6.06%; for subprime loans the rate hit 24.95%.

The percentage of seriously delinquent loans, those 90 days late, hit 7.24%, which means the foreclosure rate will rise – as of the first quarter that foreclosures made up 3.85% of all mortgage loans..

Today’s Data

This morning all eyes will be on Chicago PMI, a measure of factory activity in that region. Yes, we’ll get the first revision to Q1 GDP, which will get attention, but that Chicago reading will be the big one. The number made really good progress last month from a very low reading of 31.4 in March. The market will need to see progress continue, making its way to the mid 40s – a reading below 50 marks contraction but a solid move into the 40 handle will be enough to excite people.


Have a great weekend!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries rallied today after a number of issues plagued the market on Wednesday. The two-year finished up 1/32, and the ten-year was higher by a point. The benchmark curve flattened by 10 basis points, and currently sits at +265 bps. A basis point represents .01%.

The Treasury auctioned $26 billion in seven-year notes at a yield of 3.3%,

The Federal Reserve, who still denies having a specific target for certain interest rates such as residential mortgages, is definitely being forced to make a decision with rates moving higher. Thirty-year mortgage rates have dropped from 5.98% in November 2008, before the Fed announced the initial $500 billion in agency MBS purchases, to its current level of 4.81%. These record low levels are likely to rise due to the recent run-up in Treasury yields, but if we begin to see mortgage rates creep in to the 5%-5.15% area will that force the Fed to take action? If yes, then how?

The Fed’s MBS purchase commitments currently stand at 150% of 2009 supply and 25% of the market as a whole, how much more can they really buy? The Fed runs the serious risk of just inflating the recession away, through huge amounts of quantitative easing, only to have to trounce the next economic rebound to avoid hyperinflation. TALF has already been expanded to the point where the Fed is beginning to take some really questionable assets, on to their balance sheet, (subprime credit card loans and commercial real estate for example). When the Fed becomes such a major market participant, risk can’t be accurately measured by the private sector. Also not favorable for the long term.

Monetary policy, including quantitative easing, has a lagging effect. There is no doubt that the Fed has created a simulative rate environment, so the best course of action in my view would be to give it a chance to work. Even if it means no more 4.75% mortgages.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst

Daily Insight

U.S. stocks gave back most of Tuesday’s gains on news that the number of banks on the FDIC’s “problem list” climbed to the highest level in 15 years, concerns over government debt and comments from JP Morgan that credit-card defaults will continue to climb.

Banks are finding it difficult to build reserves fast enough to keep the ratio of reserves to non-performing assets static and that causes concern about loan activity and the degree of economic recovery. Frankly, based on the numbers we’re seeing on the delinquency front across a broad base of loans the stock market is taking the news remarkably well.

This is something we’ve talked about for a while, credit-card default rates -- along with commercial real estate losses that may not yet be halfway through the cycle – are going to cause trouble for some time. The very positively sloped yield curve (banks borrow near zero and lend much higher) will keep interest-income margins elevated, but I don’t see how it offsets these other major challenges.

As credit-card lines continue to be cut (exacerbated by legislation capping late fees and interest rates) it will put additional pressure on consumer activity. Consumer spending as a percentage of GDP will work its way from 72% of GDP back to the historic average of 65%, which will mean slower growth rates. If government policy were focused on spurring the business side of the economy, we’d be able to offset this drag a bit, but policies are doing nothing but scaring business and keeping managers cautious – not helpful.

And speaking of that positively sloped yield curve the spread between Treasury two and 10-year notes widened to a record on concern massive government debt issuance will overwhelm those Fed efforts to keep borrowing costs low. The degree of the slope generally portends the magnitude of the economic rebound (the more positive the better), but these are not normal times and if long-end interest rates spike because traders are worried about enormous levels of debt issuance rather than because the prospects of recovery has increased, you can forget about a meaningful recovery. The Treasury auctioned $35 billion of five-year notes and traders sent long-end yields much higher as a result.

The latest home sales data failed to offer a counterbalance to the aforementioned weights. Existing home sales did rise, as we’ll discuss below, but only from very depressed levels – there’s a difference between stabilizing at very low levels and a pure rebound.

Housing needs economic growth to rebound, not the other way around. Economists continually state a necessary condition for economic recovery is a housing rebound. This is backwards; until the labor market improves substantially you can’t have a significant bounce in housing and until the economy recovers you can’t have labor market improvement. The Fed can work on pushing mortgage rates down all they want, and it will certainly help - although not without longer-term ramifications – but when the economy continues to shed 500k-600k payroll positions a month there’s not much anyone can do. It just takes time.

Market Activity for May 27, 2009


Crude Oil

The price of crude for July delivery rose to a six-month high yesterday, now nicely ensconced above $60, closing at $63.13 per barrel. Signs of increasing demand out of Asia (China’s stimulus is beginning to take root and they are also surely stockpiling commodities for fear of future price spikes), word OPEC will cut production and speculation that the weekly energy report will show a drawdown in gasoline inventories all helped push the price higher. (We now know this morning the worry of an OPEC production cut was not necessary as the cartel has decided to leave production unchanged; crude prices have barely budged though, don just a nickel this morning)

One wonders how the consumer will react to higher gasoline prices this summer. The plunge in pump prices from last summer’s spike definitely helped cushion the blow of reduced incomes. If the retail price of gasoline holds below $2.50 per gallon (roughly $2.00 wholesale) it shouldn’t present a problem. However, if we push to $3.00 at the pump…well, that’s just one more obstacle.

Mortgage Applications

The Mortgage Bankers Association reported its mortgage applications index fell 14.2% during the week ended May 22, which followed a 2.3% increase for the previous week.

Refinancing activity, which currently makes up 70% of the index, slid 18.9% last week after a 4.5% uptick in the prior period. Purchases managed a 1.0% gain after falling 4.4% in the previous week. It appears the refinancing wave that took place in March and April has pretty much run its course. Either that or those who have not yet refied, and have the equity to do so, are waiting for a 4.5% fixed 30-year mortgage rate before pulling the trigger – not sure they’re going to get that number, but one never knows; if the Fed increases its mortgage-backed securities purchases it could happen. As the market has recently overwhelmed the Fed’s work in driving rates lower one can bet Bernanke & Co. will be increasing their Treasury and mortgage-backed purchases.

As discussed above, it will take some meaningful improvement in the labor markets to get home buying fired up again. The affordability index is at an all-time high – meaning it has never been a better time based on the combination of prices and mortgage rates – but the labor market is the prevailing factor; if potential home buyers loss their job, or the probability of this occurring is elevated – and it clearly is – they’ll hold off. As we move closer to the summer months it is becoming increasingly evident there really is nothing the Fed can do to spark home sales.

In the meantime, let’s hope their attempt does not cause additional problems 18-24 months down the road that then results in an economic double-dip – the chances of this occurring, another recession after, say, four quarters of GDP growth, are definitely elevated.

Existing Home Sales

The National Association of Realtors reported that existing home sales rose 2.9% in April, beating the expectation, to an annual rate of 4.68 million units. The data was driven by a 6.4% pop in multi-family units (condos and co-ops). Single-family sales rose 2.5% after falling 3.3% in March.

The median price for total existing homes slid 15.4% from the year-ago period, it currently sits at $170,200; the price for single-family units alone is down 14.9% compared to April 2008, currently at $169,800 – the peak of $230,900 was hit in July 2006.

Distressed properties (much of which involves foreclosures) made up 45% of all sales last month – only the most intense bargain hunting is occurring. First-time buyers accounted for 40% of sales, driven by tax-credits.

It appears we’ve hit bottom in the housing market, but one can’t say much beyond that. Existing home sales remain below the February reading. I focus on the Feb. number because that month was surrounded by ultra-low record readings of 4.5 million units (again, at an annual rate) for January and March – this latest data only appears to be an improvement based on those extremely depressed levels. Same is true when looking at only the single-family units.

By region, the Northeast and West posted sales gains of 11.8% and 11.1%, respectively. Sales in the Midwest and South were flat.

The supply figures continue to show there are a lot of properties to work off still. The single-family homes available for sale jumped a bit last month, rising to 3.34 million units from 3.06 million.

When matching supply against the current sales rate the glut continues at there are still 9.6 months’ worth of single-family existing homes on the market. Same is true when we add in multi-family units, as the total existing home inventory/sales ratio moved back up to 10.2 months’ worth.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

The two-year finished down 1/64, and the ten-year was lower by 1 12/32. The benchmark curve steepened by 12 basis points, and currently sits at +275 bps. A basis point represents .01%.

The recent selloff in Treasurys has pushed the yield curve to its steepest point on record, 1 basis point higher than the previous record set on October 13th 2003. Yield curve shape is based on a variety of factors, including liquidity differences between different Treasury issues and expectations for interest rates in the future. I will touch more on the reasons for the spike in longer-term rates below.

Treasurys were lower again today after $35 billion in 5-year notes came to market. The bid/cover ratio, the ratio of bids submitted to bonds sold, was 2.32, a sign of good demand compared to a 2.19 average for the last four auctions. More supply comes tomorrow when the Treasury will auction $26 billion in seven-year notes.

The increased supply is certainly making its presence felt in the market but it doesn’t deserve all the credit for the recent selloff. With all the talk of a Q3-Q4 end to the recession many are starting to wonder what will come of all the excess liquidity in the market. If the Fed is unable to pull the liquidity from the market appropriately, then inflation, simply defined as too much money chasing too few goods, will result. A larger than expected rate of inflation spells danger for investors who aim to protect the purchasing power of their savings.

Today’s auction results seem to point more towards inflation concerns rather than supply. Today’s supply was no surprise. The market has known about the record Treasury issuance that will be coming this year for some time now. The strong demand is just coming at a higher price for the US Treasury as investors look to protect against inflation. TIPS outperformed comparable nominal Treasurys by 75 basis points today, showing investor’s preference for inflation-indexed bonds compared to nominal (non-adjusted) Treasurys.

Have a great evening.

Cliff J. Reynolds Jr., Junior Analyst