2-Year Yield
10-Year Yield
Cliff J. Reynolds Jr., Junior Analyst
Thursday, June 18, 2009
Treasury Announces Next Week's Supply
The Treasury will auction $104 billion in two-, five- and seven-year notes next week, more than the $101 billion the market was expecting, sending Treasury prices lower and yield higher in today’s trading. Yields are still higher than this time last week, despite today’s selloff.
The-Year TIPS Breakevens
The measure of inflation that uses the spread between the yield on the Inflation Protected Treasury and the Nominal Treasury has come down from its high of 2.08% on 6/10. Disappointing PPI and CPI readings this week and a rally in the nominal coupons have eased concerns in the short term that, as you can tell from the graph below, have really spiked since mid-April.
The inflation trade is more of a long term play than some in the market might think. Sure, the market has been flooded with cash, but the recent run up was a little overdone for an event that is most likely a year away. A choppy market will likely persist while supply concerns for the Treasury market as a whole continue to ebb and flow.
Cliff J. Reynolds Jr., Junior Analyst
The inflation trade is more of a long term play than some in the market might think. Sure, the market has been flooded with cash, but the recent run up was a little overdone for an event that is most likely a year away. A choppy market will likely persist while supply concerns for the Treasury market as a whole continue to ebb and flow.
Cliff J. Reynolds Jr., Junior Analyst
Daily Insight
U.S. stocks ended mixed on Wednesday as the S&P 500 ended lower, while the tech-laden NASDAQ Composite managed a nice gain. The broad market, while lower for the third-straight session, was helped by a rally in health-care shares. Commodity-related shares pared earlier losses to help the overall market bounce back from its morning lows.
The latest results out of FedEx, and its downbeat forecast, sent the market lower at the open. While the world’s second-largest package delivery provider posted results that beat expectations and the 55% drop in operating profit (based on the year-ago level) was an improvement from the previous quarter’s yoy decline of 75%, the company stated current economic conditions continue to “throttle” the results.
If not for aggressive cost-cutting the firm’s results probably wouldn’t have beat expectations. Businesses can’t build on bottom line results via cost-cutting for an extended period without some business-cycle expansion. Now, a few quarters out, this reduction in costs means that profits can be high-powered when activity does bounce. For the meantime, however, the market was disappointed this major economic bellwether did not offer somewhat optimistic guidance.
Financial shares were the biggest losers yesterday after Standard & Poor’s reduced its rating on 18 U.S. banks, citing tighter regulations and the implementation of changes to reflect this new environment.
Market Activity for June 17, 2009
New Regime
The big news of the day was the proposed changes to the way the government oversees financial markets -- the new regulatory regime. I’m not going to waste a bunch of space on the specifics – besides it would be kind of tough to do so since I chose not the read the 80 page manifesto (opted for the summary instead), but will only touch on the overall issue and comment on the way the current administration views these things.
One can’t measure the cost, or more accurately the unintended consequences, these regulations will have on the economy – especially after Congress has its say. But I can take issue with President Obama’s belief that strong regulation is why people invest in the U.S. (Team Obama wants to guard against market participants taking “exorbitant” risks. But this topic of discussion is incomplete without acknowledging that the Fed’s reckless monetary policy, specifically in the years 2002-2005, drove real Fed funds negative and therefore played a key role in engendering a move farther out on the risk curve – a massive mispricing of risk as investors’ hunt for yield was on. There is also no mention of Washington’s two-decade drive to socially engineer the housing market. When that social engineering combined with negative real interest rates... well, that was a nasty brew.)
Actually, the reason capital is deployed in the U.S. is because of strong property rights law, low taxes on capital (and thus higher after-tax return expectations) and sound money policy. In the end, it’s a high risk-adjusted after-tax rate of return on capital that is the reason the world invests in America.
Problem is the administration sees no problem in forcing the abrogation of contract law (the Chrysler workout) and desires to raise tax rates on capital, while the Fed has not implemented sound monetary policy for several years. These issues are likely to create problems for us.
Let’s be clear, simply implementing massive levels of regulations – even if some aspects may prove beneficial (such as the receivership authority with regard to the largest financial institutions, which makes much more sense than ad hoc “bailouts”), you know many more will do harm – is not what attracts capital, capital that is very mobile and free to go almost anywhere it desires. If this were the case, hedge funds would find it impossible to raise capital.
Another disturbing aspect of the regulatory plan is that it seems to substantially change the structure of the Federal Reserve system by seeking to shift the process of regional bank presidents from the current appointment process (currently appointed by local boards) to a structure that is based on Senate approval. Uh, this is a major issue. The Fed is currently in very dangerous territory as most people already believe that they have lost their independence.
This proposed change, if implemented, would really increase doubt over the Fed’s ability to remain unlinked from the political process. It is a necessary condition for the Fed to be independent from politics -- when they are not, decisions that are essential to price stability are replaced by short-term politically expedient policy. This could be a major problem and if the market by and large believes the independent status has broken down, this will have adverse consequences with regard to inflation expectations. But Messrs. Obama, Geithner and Summers clearly believe they are smart enough to pull all of this off – maybe too smart for everyone else’s own good. We shall see, maybe I’m completely off base.
Mortgage Applications
The Mortgage Bankers Association reported that their mortgage apps index fell again, down 15.8% for the week ended June 12 – this marks the fourth week of decline as refinancing activity stopped when the 30-year fixed rate began to rise back toward 5.00%.
Purchases, which had risen (albeit slight) for three-straight weeks, fell 3.5% last week.
As we touched on yesterday, home sales just can’t keep going with the unemployment rate near 10% and likely to move above that level. The Fed can boost sales at the margin by taking action that pushes interest rates lower, but even this has a short window; if the market becomes concerned about future rates of inflation and massive debt issuance it will easily overwhelm anything the Fed has the capability of doing – unless they are going to take things to an entirely new level, which will assure runaway inflation down the road.
Consumer Price Index (CPI)
The Labor Department reported that the consumer price index registered another benign reading, rising just 0.1% in May. The core rate, which excludes food and energy, also rose 0.1% for the month.
The decline within the housing and food components, which make up 60% of the index, were the main reasons CPI remained so tame. I’m going to predict food prices will not remain held down for long, particularly with the heavy rain in the U.S. this spring. Farmers have been unable to get corn planted and wheat fields are flooded, just to name a couple of the big crops, and this should have an effect on the food component within the inflation gauges. Further, the producer price data shows some building in foods price within the early stages of production.
The gasoline component within CPI rose 3.6%, but this was partially offset by a large decline in utility costs – the third large monthly decline, down 1.3% in May, 1.7% in April and 1.4% in March. The rise in gasoline prices was held back due to the seasonal adjustment and with oil above $70 and wholesale gasoline up 10% in June, one should expect the energy component to boost the next print on CPI.
On a year-over-year basis, CPI fell 1.3% in May, the largest decline since 1949. This will change. Currently, the year-over-year readings are matched against the figures that reflected the commodity-price spike of last spring/summer. By the end of the year, this will change in a meaningful manner.
The core rate rose 1.8% year-over-year, a slight deceleration from the 1.9% in April.
People will become, and have been, lulled into thinking inflation will not arise for a very long time, if at all. But these things take a little time to build; the ingredients are all there, they just need to be mixed together and that occurs when the economy bounces and credit begins to pick up again. Recall, the last time the Fed monetized the debt – coming out of the 1940s to ease the burden of financing WWII – CPI jumped from -2.9% on a year-over-year basis in July of 1949 to 9.5% by March of 1951.
This is just an example to make a point; it is not to say things will turn out the exact way this time. Inflation will begin a large issue at some point, and the problem for the economy is that this means the Fed will need to aggressively tighten -- unwind what they are currently doing and beyond.
The FOMC won’t do anything for a while as they will view a high unemployment rate and low capacity utilization as impediments to higher prices, which increases the chances of inflation rolling – we’ve known for three decades now that these Keynesian models are flawed. The tightening that will be necessary will be a major issue for the economy and will very likely make the eventual recovery short-lived – there’s just no way to get around what we are doing, and have done with regard to monetary policy for quite some years now. I’m looking down the road a ways, 18 (maybe 24) months, but short-sighted thinking can be dangerous in this environment.
Have a great day!
Brent Vondera
The latest results out of FedEx, and its downbeat forecast, sent the market lower at the open. While the world’s second-largest package delivery provider posted results that beat expectations and the 55% drop in operating profit (based on the year-ago level) was an improvement from the previous quarter’s yoy decline of 75%, the company stated current economic conditions continue to “throttle” the results.
If not for aggressive cost-cutting the firm’s results probably wouldn’t have beat expectations. Businesses can’t build on bottom line results via cost-cutting for an extended period without some business-cycle expansion. Now, a few quarters out, this reduction in costs means that profits can be high-powered when activity does bounce. For the meantime, however, the market was disappointed this major economic bellwether did not offer somewhat optimistic guidance.
Financial shares were the biggest losers yesterday after Standard & Poor’s reduced its rating on 18 U.S. banks, citing tighter regulations and the implementation of changes to reflect this new environment.
Market Activity for June 17, 2009
New RegimeThe big news of the day was the proposed changes to the way the government oversees financial markets -- the new regulatory regime. I’m not going to waste a bunch of space on the specifics – besides it would be kind of tough to do so since I chose not the read the 80 page manifesto (opted for the summary instead), but will only touch on the overall issue and comment on the way the current administration views these things.
One can’t measure the cost, or more accurately the unintended consequences, these regulations will have on the economy – especially after Congress has its say. But I can take issue with President Obama’s belief that strong regulation is why people invest in the U.S. (Team Obama wants to guard against market participants taking “exorbitant” risks. But this topic of discussion is incomplete without acknowledging that the Fed’s reckless monetary policy, specifically in the years 2002-2005, drove real Fed funds negative and therefore played a key role in engendering a move farther out on the risk curve – a massive mispricing of risk as investors’ hunt for yield was on. There is also no mention of Washington’s two-decade drive to socially engineer the housing market. When that social engineering combined with negative real interest rates... well, that was a nasty brew.)
Actually, the reason capital is deployed in the U.S. is because of strong property rights law, low taxes on capital (and thus higher after-tax return expectations) and sound money policy. In the end, it’s a high risk-adjusted after-tax rate of return on capital that is the reason the world invests in America.
Problem is the administration sees no problem in forcing the abrogation of contract law (the Chrysler workout) and desires to raise tax rates on capital, while the Fed has not implemented sound monetary policy for several years. These issues are likely to create problems for us.
Let’s be clear, simply implementing massive levels of regulations – even if some aspects may prove beneficial (such as the receivership authority with regard to the largest financial institutions, which makes much more sense than ad hoc “bailouts”), you know many more will do harm – is not what attracts capital, capital that is very mobile and free to go almost anywhere it desires. If this were the case, hedge funds would find it impossible to raise capital.
Another disturbing aspect of the regulatory plan is that it seems to substantially change the structure of the Federal Reserve system by seeking to shift the process of regional bank presidents from the current appointment process (currently appointed by local boards) to a structure that is based on Senate approval. Uh, this is a major issue. The Fed is currently in very dangerous territory as most people already believe that they have lost their independence.
This proposed change, if implemented, would really increase doubt over the Fed’s ability to remain unlinked from the political process. It is a necessary condition for the Fed to be independent from politics -- when they are not, decisions that are essential to price stability are replaced by short-term politically expedient policy. This could be a major problem and if the market by and large believes the independent status has broken down, this will have adverse consequences with regard to inflation expectations. But Messrs. Obama, Geithner and Summers clearly believe they are smart enough to pull all of this off – maybe too smart for everyone else’s own good. We shall see, maybe I’m completely off base.
Mortgage Applications
The Mortgage Bankers Association reported that their mortgage apps index fell again, down 15.8% for the week ended June 12 – this marks the fourth week of decline as refinancing activity stopped when the 30-year fixed rate began to rise back toward 5.00%.
Purchases, which had risen (albeit slight) for three-straight weeks, fell 3.5% last week.
As we touched on yesterday, home sales just can’t keep going with the unemployment rate near 10% and likely to move above that level. The Fed can boost sales at the margin by taking action that pushes interest rates lower, but even this has a short window; if the market becomes concerned about future rates of inflation and massive debt issuance it will easily overwhelm anything the Fed has the capability of doing – unless they are going to take things to an entirely new level, which will assure runaway inflation down the road.
Consumer Price Index (CPI)
The Labor Department reported that the consumer price index registered another benign reading, rising just 0.1% in May. The core rate, which excludes food and energy, also rose 0.1% for the month.
The decline within the housing and food components, which make up 60% of the index, were the main reasons CPI remained so tame. I’m going to predict food prices will not remain held down for long, particularly with the heavy rain in the U.S. this spring. Farmers have been unable to get corn planted and wheat fields are flooded, just to name a couple of the big crops, and this should have an effect on the food component within the inflation gauges. Further, the producer price data shows some building in foods price within the early stages of production.
The gasoline component within CPI rose 3.6%, but this was partially offset by a large decline in utility costs – the third large monthly decline, down 1.3% in May, 1.7% in April and 1.4% in March. The rise in gasoline prices was held back due to the seasonal adjustment and with oil above $70 and wholesale gasoline up 10% in June, one should expect the energy component to boost the next print on CPI.
On a year-over-year basis, CPI fell 1.3% in May, the largest decline since 1949. This will change. Currently, the year-over-year readings are matched against the figures that reflected the commodity-price spike of last spring/summer. By the end of the year, this will change in a meaningful manner.
The core rate rose 1.8% year-over-year, a slight deceleration from the 1.9% in April.
People will become, and have been, lulled into thinking inflation will not arise for a very long time, if at all. But these things take a little time to build; the ingredients are all there, they just need to be mixed together and that occurs when the economy bounces and credit begins to pick up again. Recall, the last time the Fed monetized the debt – coming out of the 1940s to ease the burden of financing WWII – CPI jumped from -2.9% on a year-over-year basis in July of 1949 to 9.5% by March of 1951.
This is just an example to make a point; it is not to say things will turn out the exact way this time. Inflation will begin a large issue at some point, and the problem for the economy is that this means the Fed will need to aggressively tighten -- unwind what they are currently doing and beyond.
The FOMC won’t do anything for a while as they will view a high unemployment rate and low capacity utilization as impediments to higher prices, which increases the chances of inflation rolling – we’ve known for three decades now that these Keynesian models are flawed. The tightening that will be necessary will be a major issue for the economy and will very likely make the eventual recovery short-lived – there’s just no way to get around what we are doing, and have done with regard to monetary policy for quite some years now. I’m looking down the road a ways, 18 (maybe 24) months, but short-sighted thinking can be dangerous in this environment.
Have a great day!
Brent Vondera
Wednesday, June 17, 2009
FedEx reports earnings
FedEx reported earnings that topped the consensus estimate, but delivered downside guidance due to the recent run-up in fuel prices. FedEx did not provide a full-year outlook for fiscal 2010 citing a lack of visibility into the economic recovery and jet-fuel costs.
Revenues fell 20% year-over-year to $7.85 billion, short of the $8.32 billion consensus, hurt by lower volumes due to the global recession as well as reduced fuel surcharges and lower shipment weight.
On the bright side, some numbers suggest that the decline has leveled off. International priority deliveries, one of FedEx’s most profitable offerings, slid 12%, less than the 13% drop in the previous quarter. U.S. express package volumes fell 2%, the smallest in five quarters.
Another positive note is the aggressive cost-cutting measures, such as idling planes and cutting back its work force, which resulted in higher cost savings than many anticipated.
The results also included $1.2 billion in write-downs, most of which was attributed to its 2004 acquisition of Kinko’s Inc. FedEx has taken write-downs totaling about 70% of Kinko’s purchase price.
--
Peter J. Lazaroff
Revenues fell 20% year-over-year to $7.85 billion, short of the $8.32 billion consensus, hurt by lower volumes due to the global recession as well as reduced fuel surcharges and lower shipment weight.
On the bright side, some numbers suggest that the decline has leveled off. International priority deliveries, one of FedEx’s most profitable offerings, slid 12%, less than the 13% drop in the previous quarter. U.S. express package volumes fell 2%, the smallest in five quarters.
Another positive note is the aggressive cost-cutting measures, such as idling planes and cutting back its work force, which resulted in higher cost savings than many anticipated.
The results also included $1.2 billion in write-downs, most of which was attributed to its 2004 acquisition of Kinko’s Inc. FedEx has taken write-downs totaling about 70% of Kinko’s purchase price.
--
Peter J. Lazaroff
The Next Generation of Nuclear Reactors
The Wall Street Journal reports that four power companies are expected to split $18.5 billion in federal financing to build the next generation of nuclear reactors, one of which is Southern Co. (SO). The companies would start building the reactors as early as 2011, with the plants expected to come online by 2015 or 2016.
The report describes this federal financing as “the biggest step in three decades to revive the U.S. nuclear industry and one that could vault the utilities ahead of some of the sector’s strongest players.”
New nuclear-utility builds is also good news for Curtiss-Wright (CW) who makes the pumps for nuclear-generating plants and companies that make nuclear reactors like General Electric (GE).
--
Peter J. Lazaroff
The report describes this federal financing as “the biggest step in three decades to revive the U.S. nuclear industry and one that could vault the utilities ahead of some of the sector’s strongest players.”
New nuclear-utility builds is also good news for Curtiss-Wright (CW) who makes the pumps for nuclear-generating plants and companies that make nuclear reactors like General Electric (GE).
--
Peter J. Lazaroff
Consumer Price Index
Consumer prices rose .1% in May from the previous month, excluding food and energy prices also rose .1%. On a yearly basis, CPI fell 1.3%, the largest decrease since April 1950. The YoY number will probably continue to worsen, considering we have yet to compare this recent trend in prices to last summer where YoY CPI hit a peak of +5.6% in July and was still +.3.7 in September.
This part of the business cycle also makes it very difficult for business to pass along production costs to the consumer. With so much money in the market today, thank you Helicopter Ben, it shouldn’t take much of a turnaround there to reverse the current trend in consumer prices.
Cliff J. Reynolds Jr., Junior Analyst
This part of the business cycle also makes it very difficult for business to pass along production costs to the consumer. With so much money in the market today, thank you Helicopter Ben, it shouldn’t take much of a turnaround there to reverse the current trend in consumer prices.
Cliff J. Reynolds Jr., Junior Analyst
Free Cash Flow (Part II)
Yesterday provided an introduction to the basics of using free cash flow in a company analysis. Part II of this discussion focuses on free cash flows limitations.
There are two ways to calculate free cash flow. The first uses the company’s cash flow statement and balance sheet.
Free Cash Flow = Cash Flow From Operations – Capital Expenditures
The second uses the income statement and balance sheet.
Net income
+ Depreciation/Amortization
-Change in Working Capital
-Capital Expenditure
-------------------------------
= Free Cash Flow
Without a regulatory standard for determining free cash flow, investors often disagree on exactly which items should classified as capital expenditures. As a result, it is important to “check under the hood” of companies with high levels of free cash flow and see if they under report capital expenditures and R&D.
Companies can also temporarily boost free cash flow by stretching out their payments, tightening payment collection policies, and depleting inventories. These activities diminish current liabilities and changes to working capital.
A more complicated accounting is the hiding of receivables. This occurs when a company records a revenue in which cash will not be received within a year, but places the receivable in another line item outside of “non-current” assets. Accordingly, revenue is recorded and cash from operations increases, but no current account receivable is recorded to offset revenues. Thus, cash from operations and free cash flow enjoy a big but unjustified boost.
Like all performance metrics, free cash flow has its limitations. Still, it is a great place to start searching for quality investments.
--
Peter J. Lazaroff
There are two ways to calculate free cash flow. The first uses the company’s cash flow statement and balance sheet.
Free Cash Flow = Cash Flow From Operations – Capital Expenditures
The second uses the income statement and balance sheet.
Net income
+ Depreciation/Amortization
-Change in Working Capital
-Capital Expenditure
-------------------------------
= Free Cash Flow
Without a regulatory standard for determining free cash flow, investors often disagree on exactly which items should classified as capital expenditures. As a result, it is important to “check under the hood” of companies with high levels of free cash flow and see if they under report capital expenditures and R&D.
Companies can also temporarily boost free cash flow by stretching out their payments, tightening payment collection policies, and depleting inventories. These activities diminish current liabilities and changes to working capital.
A more complicated accounting is the hiding of receivables. This occurs when a company records a revenue in which cash will not be received within a year, but places the receivable in another line item outside of “non-current” assets. Accordingly, revenue is recorded and cash from operations increases, but no current account receivable is recorded to offset revenues. Thus, cash from operations and free cash flow enjoy a big but unjustified boost.
Like all performance metrics, free cash flow has its limitations. Still, it is a great place to start searching for quality investments.
--
Peter J. Lazaroff
Daily Insight
U.S. stocks dropped for a second-straight session as Best Buy posted poor same-store sales and another ugly industrial production reading outweighed a bounce in housing starts. Commodity prices fell for a third-straight day, here’s that retracement we’ve talked about – let’s see how far it goes, and basic material shares led the broad market lower as a result. People are beginning to doubt the timeline of the recovery as the data has yet to illustrate substantial improvement rather than just stabilization at a low level.
Best Buy reported that same-store sales plunged 6.7% last quarter, a 2.3% decline was expected and one would think they’d had been able to meet that number with major competitor Circuit City out of the game. Traffic in all stores was weak (the same-store sales figures measures just those stores open for more than a year). This didn’t seem to have an effect on investor sentiment initially, but when it combined with a poor industrial production reading, the market sold off.
A lot of people seem to be expecting consumer activity to bounce in the near-term simply because the numbers have been so weak. But this economy has to face big headwinds, one being debt liquidation within the consumer arena and this will weigh on the largest segment of the economy for an extended period.
Market Activity for June 16, 2009
Housing Starts
The Commerce Department reported that builders broke ground on significantly more houses than expected in May, offering signs that the industry has roused from its four-year slumber.
Housing starts jumped 17% in May to an annual rate of 532,000 after making a new low of 454,000 in April. Starts were led by a 61.7% leap in multi-family units after back-to-back declines in April and March of 49.4% and 26.3%, respectively. Single-family starts rose 7.5% in May.
These are nice improvements -- certainly the multi-family number is a surge but it’s from a deep record low and this segment is highly volatile – yet we still have a large supply burden to work off and this increase in housing starts is not going to help that glut. In terms of GDP, if this move continues into June, which the rise in building permits suggests will be the case (also released yesterday), residential construction may just contribute to economic activity for the first time in 10 quarters.
I think economists should refrain from getting too excited, which appeared to be the case by the reporting, that this jump in starts signals something has changed. I have no desire to offer a negative view here, but the levels are very depressed and any pickup is going to add to supply. Fact is sales will not bounce with the jobless rate at these heights unless fixed mortgage rates move well below 5.00% again, which seems unlikely.
I’ve been comparing the past few readings to the December figure, rather than simply using the previous month. The December reading is the one to gauge ensuing data against simply because the January and February readings really skewed things. (January housing starts were depressed because of really bad weather and February saw a big bounce as weather was better than normal). We have yet to get back to the level in December. When that reading is surpassed, which a mild increase for June should accomplish, it will then be safe to say we’ve seen the worst from this market. But without a sustained bounce in sales, I don’t see how residential construction can help GDP outside of possibly offering a little boost this quarter as we come out of the lowest activity on record.
Building permits rose 4% last month from the record low hit in April.
Industrial Production (IP)
Commerce also reported that industrial production fell for the 16th time in the past 17 months for May. This marks the deepest and most prolonged slump since the draw down in production coming out of WWII. And the decline cannot be blamed solely on a weak auto sector as declines in consumer goods and business-equipment production illustrate the manufacturing slump is broad based.
Industrial production (output at factories, mines and utilities) fell 1.1% in May, slightly worse than the 1.0% decline that was expected. A 7.9% plunge in motor vehicles and parts led the decline, but this segment makes up less than 5% of the index. Ex-vehicles, production fell 0.9%, which follows a 0.7% decline in April and is off by 12.2% from the year-ago level.
In terms of industry groups, manufacturing output fell 1.0%, utility output fell 1.4% (not weather-related as the national temp was slightly above average) and mining production slumped 2.1%.
In terms of market groups, consumer-goods production was off by 0.8% (down 7.1% year-over-year), pushed lower by a large 1.9% drop in home electronics; business equipment fell 1.4% (down 16.5% year-over-year), driven by a 1.0% decline in business supplies.
As we’ve stated over the past couple of months, people can talk about the second derivative (declining at a slower rate) all they want but the market will eventually become tired of this reality. Soon, industrial production will have to turn positive, and specifically this is true for the manufacturing sector, for the equity markets to expand upon this very nice surge we’ve enjoyed from the March lows. We continue to believe GDP will post a mild increase for the third quarter, but this IP reading better follow a plus sign when the June figure is released or we may have to push that estimate out a quarter.
On the positive side, corporate profits should explode a couple of quarters out. The slash and burn with regard to expenses (both payroll and overall business spending) means that it won’t take much in the way of higher sales to fuel the bottom line – year-ago comps will be easier to beat as well. Before we get there though, we may still have to fight through some rough waters.
Have a great day!
Brent Vondera
Best Buy reported that same-store sales plunged 6.7% last quarter, a 2.3% decline was expected and one would think they’d had been able to meet that number with major competitor Circuit City out of the game. Traffic in all stores was weak (the same-store sales figures measures just those stores open for more than a year). This didn’t seem to have an effect on investor sentiment initially, but when it combined with a poor industrial production reading, the market sold off.
A lot of people seem to be expecting consumer activity to bounce in the near-term simply because the numbers have been so weak. But this economy has to face big headwinds, one being debt liquidation within the consumer arena and this will weigh on the largest segment of the economy for an extended period.
Market Activity for June 16, 2009
Housing Starts
The Commerce Department reported that builders broke ground on significantly more houses than expected in May, offering signs that the industry has roused from its four-year slumber.
Housing starts jumped 17% in May to an annual rate of 532,000 after making a new low of 454,000 in April. Starts were led by a 61.7% leap in multi-family units after back-to-back declines in April and March of 49.4% and 26.3%, respectively. Single-family starts rose 7.5% in May.
These are nice improvements -- certainly the multi-family number is a surge but it’s from a deep record low and this segment is highly volatile – yet we still have a large supply burden to work off and this increase in housing starts is not going to help that glut. In terms of GDP, if this move continues into June, which the rise in building permits suggests will be the case (also released yesterday), residential construction may just contribute to economic activity for the first time in 10 quarters.
I think economists should refrain from getting too excited, which appeared to be the case by the reporting, that this jump in starts signals something has changed. I have no desire to offer a negative view here, but the levels are very depressed and any pickup is going to add to supply. Fact is sales will not bounce with the jobless rate at these heights unless fixed mortgage rates move well below 5.00% again, which seems unlikely.
I’ve been comparing the past few readings to the December figure, rather than simply using the previous month. The December reading is the one to gauge ensuing data against simply because the January and February readings really skewed things. (January housing starts were depressed because of really bad weather and February saw a big bounce as weather was better than normal). We have yet to get back to the level in December. When that reading is surpassed, which a mild increase for June should accomplish, it will then be safe to say we’ve seen the worst from this market. But without a sustained bounce in sales, I don’t see how residential construction can help GDP outside of possibly offering a little boost this quarter as we come out of the lowest activity on record.
Building permits rose 4% last month from the record low hit in April.
Industrial Production (IP)
Commerce also reported that industrial production fell for the 16th time in the past 17 months for May. This marks the deepest and most prolonged slump since the draw down in production coming out of WWII. And the decline cannot be blamed solely on a weak auto sector as declines in consumer goods and business-equipment production illustrate the manufacturing slump is broad based.
Industrial production (output at factories, mines and utilities) fell 1.1% in May, slightly worse than the 1.0% decline that was expected. A 7.9% plunge in motor vehicles and parts led the decline, but this segment makes up less than 5% of the index. Ex-vehicles, production fell 0.9%, which follows a 0.7% decline in April and is off by 12.2% from the year-ago level.
In terms of industry groups, manufacturing output fell 1.0%, utility output fell 1.4% (not weather-related as the national temp was slightly above average) and mining production slumped 2.1%.
In terms of market groups, consumer-goods production was off by 0.8% (down 7.1% year-over-year), pushed lower by a large 1.9% drop in home electronics; business equipment fell 1.4% (down 16.5% year-over-year), driven by a 1.0% decline in business supplies.
As we’ve stated over the past couple of months, people can talk about the second derivative (declining at a slower rate) all they want but the market will eventually become tired of this reality. Soon, industrial production will have to turn positive, and specifically this is true for the manufacturing sector, for the equity markets to expand upon this very nice surge we’ve enjoyed from the March lows. We continue to believe GDP will post a mild increase for the third quarter, but this IP reading better follow a plus sign when the June figure is released or we may have to push that estimate out a quarter.
On the positive side, corporate profits should explode a couple of quarters out. The slash and burn with regard to expenses (both payroll and overall business spending) means that it won’t take much in the way of higher sales to fuel the bottom line – year-ago comps will be easier to beat as well. Before we get there though, we may still have to fight through some rough waters.
Have a great day!
Brent Vondera
Tuesday, June 16, 2009
Free Cash Flow
Many investors tend to use a company’s earnings to evaluate performance, but net income can easily be distorted by accounting gimmicks. Free cash flow, on the other hand, is difficult to fake (though not impossible) and provides a more transparent view of a company’s ability to generate cash and profits.
Free cash flow is the cash left over after a company meets its necessary expenses. A company can reinvest their free cash to grow its own business and, in turn, boost shareholder returns. Alternatively, free cash flow can be returned to shareholders through bigger dividend payments or share buybacks.
There are many ways to use free cash flow in a company analysis. I will use beverage giant Coca-Cola (KO), which is a great example of a company that consistently generates high free cash flows, which often exceed its reported net income – a sign of high earnings quality.
Free cash flow to Revenue
In 2008, Coca-Cola produced $5.6 billion in free cash flow from $31.9 billion revenues. Thus, Coca-Cola’s free cash flow to revenue ratio was an impressive 16.6 percent – a good rule of thumb is to look for companies with free cash flow that is more than 10 percent of sales revenue.
Free cash flow multiples
It is also important to look at free cash flow multiples. Free cash flow yield allows you to compare how much cash power the share price buys, or how much investors pay for one dollar of free cash flow. Price to free cash flow is similar to the more commonly known price/earnings (P/E) ratio.
Comparing Coca-Cola to direct competitor Pepsi Co. using these multiples suggests that Coca-Cola is reasonably priced.
Efficiency Ratios
Besides looking for low free cash flow multiples, we also seek out attractive efficiency ratios. An attractive Return on Equity (ROE) can help ensure that the company is reinvesting its cash at a high rate of return.
On this front, Coca-Cola performed exceedingly well with a ROE of nearly 26%. In other words, Coca-Cola was able to generate 26 cents worth of profits from each dollar invested by shareholders.
To double check that the company is not using debt leverage to give ROE an artificial boost, we also examine Return on Assets (ROA).
A ROA higher than 5% is normally considered to be solid for most companies. Coca-Cola has an impressive 12.6 % ROA, which should reassure investors that the company is doing a good job of reinvesting its free cash flow.
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Peter J. Lazaroff
Producer Price Index
The headline number for May PPI came in at +.2% MoM, (+.6% expected) while the core (excluding food and energy) was -.1% MoM (+.1% expected). Although TIPS are indexed off of CPI, a measure of prices paid by consumers, the correlation between PPI and CPI is dependent on producer’s ability to pass along an increase in costs to consumers. TIPS sold off soon after the release of the data and are underperforming nominal Treasuries today by .4% as of this post. The CPI for May will be released tomorrow morning.
Cliff J. Reynolds Jr., Junior Analyst
Cliff J. Reynolds Jr., Junior Analyst
Amgen's cancer drug is a potential blockbuster
Bloomberg posted an interesting article today about Amgen’s (AMGN) experimental drug denosumab. One of the biggest reasons that we like Amgen is our expectations for this potential blockbuster – a drug that generates $1 billion in annual sales – which we expect to be a key growth driver.
Amgen is currently seeking U.S. approval to sell denosumab for osteoporosis, but studies have shown that the drug can also halt cancer’s spread in bones. According to some estimates, denosumab could generate $1.8 billion a year for halting prostate tumors and an added $1.2 billion for breast malignancies.
Amgen’s currently has five blockbuster drugs, which helped push global sales to $15 billion in 2008. Still, a potential blockbuster like denosumab could really help take the pressure off Amgen’s other drugs, which are facing higher scrutiny from the FDA as well as increased competition from both branded and biosimilar (generic biologic).
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Peter J. Lazaroff
Amgen is currently seeking U.S. approval to sell denosumab for osteoporosis, but studies have shown that the drug can also halt cancer’s spread in bones. According to some estimates, denosumab could generate $1.8 billion a year for halting prostate tumors and an added $1.2 billion for breast malignancies.
Amgen’s currently has five blockbuster drugs, which helped push global sales to $15 billion in 2008. Still, a potential blockbuster like denosumab could really help take the pressure off Amgen’s other drugs, which are facing higher scrutiny from the FDA as well as increased competition from both branded and biosimilar (generic biologic).
--
Peter J. Lazaroff
Daily Insight
U.S. stocks sold off on Monday, led by commodity-related shares, as concerns over global economic growth increased after New York-area manufacturing activity contracted in June at a greater rate than the previous month. And it’s not only the worry that a global expansion may take longer to arrive than many had hoped but one should also view a 2.40% pull back (and frankly more days like this should be expected) as a natural occurrence after the 14-week gain that had sent the broad market 40% above the deep depths of March.
Commodity prices in general, as measured by the CRB, have sold off about 4% in the past two days and the basic materials index, which largely tracks the direction of commodity prices, has given back five percentage points of the 56% gain from the March lows. As we touched on last Monday, such things are to be expected after a run of this magnitude. Additional short-term weakness is likely but it’s doubtful this group will remain down as a declining dollar, large global infrastructure projects, an eventual bounce in economic activity and the probability that China will continue to stockpile commodities (as a dollar hedge) foments the resumption of the uptrend.
Financial shares were also one of the main losers yesterday. I think it’s likely the group will weigh on the market again today as traders will avoid the sector until President Obama unveils his regulatory oversight plan on Wednesday – in fact, unless today’s economic data surprises to the upside traders may sit on the sidelines altogether. We’ve got a decent outline of what they want to do (and the model will give the Fed enormous authority and oversight – let’s hope the Federal Reserve regains its independence, which is not currently the case) but the devil is in the details so there will likely be a wait and see approach.
Market Activity for June 15, 2009
Empire Manufacturing
The New York Federal Reserve Bank stated factory activity in the region contracted at a faster pace this month, falling to -9.4 after posting -4.6 for May. (Readings below zero on Empire Manufacturing mark contraction, whereas 50 is the line of demarcation for the nation-wide ISM and Chicago surveys, just to clarify for new readers)
The road to recovery within the factory sector will take additional time, particularly as auto-sector woes continue to put pressure on the figures. What we are watching here is for the inventory and workweek gauges to tick higher. At some point, the inventory dynamic (stockpiles have been liquidated on a massive scale and it will take little in the way of a demand boost to drive inventories to dangerous levels, which means increased production when it occurs) will occur to catalyze growth; the market is betting on this to take place soon, hence these will be the two most important aspect of the factory reports for a while.
To this point, these indicators have yet to show signs of a bounce. The inventory index remains very weak, firms are unwilling to boost stockpiles as a sales rebound has yet to occur.
The workweek reading is another key indicator as one cannot expect the employment picture to improve. Businesses are never quick to boost hiring when an economy turns as they wit to make sure the recovery is for real. As a result, they demand more output from existing workers, and this will show up via marginal improvement in the workweek index. Nothing so far illustrates such activity has taken place – only stabilization from very low levels.
If a bounce within these segments of the manufacturing sector fails to occur in the next two months, you’ll see third-quarter GDP expectations (which currently call for GDP to post its first positive print in a year) reduced and that could weigh heavily on stocks. We continue to believe that growth will show a mild advance in the third quarter, followed by a more robust reading by the fourth, but the economy faces major headwinds (debt liquidation within the consumer arena and the affect higher tax rates and regulations will have on the business community) so it is especially difficult to judge..
The market has received a boost as these manufacturing readings ascended from the deep levels of contraction the economy endured late-2008/early-2009. From here, continued improvement will be needed to go much higher; the market is watching these regional reports very closely for signs of progress.
Empire Manufacturing also offered a series of supplemental questions, chief among them was an inquiry into capital spending plans for 2009 relative to their actual 2008 spending. To no one’s surprise capital outlays will be lower, significantly lower in fact. Across all respondents, firms averaged $1.9 million in capital spending plans, down 24% from 2008 spending.
Net Foreign Investment Flows
Net foreign investment flows into U.S. financial assets (equities, government and corporate notes, bonds and agency bonds) grew but at a slower pace in April, up $11.2 billion compared to $55.4 billion in March – analysts expected an increase of $60 billion and I haven’t seen the forecast missed by this degree in a long time. However, foreign holdings of Treasury securities, alone, rose $41.9 billion compared with $55.3 in March – despite the big miss from an expectations standpoint on the headline figure, this last number is pretty good and the latest Treasury auctions showed foreign demand remains healthy.
The concern here is based on a longer-term perspective. China, Brazil, Russia, et al. have expressed a desire for a new global currency reserve as the dollar’s value hasn’t exactly been stable for several years (a direct result of monetary policy up until now; from here massive budget deficits may also put pressure on the greenback). But a new currency reserve will not occur overnight, which means we have time to get monetary and fiscal policy right again. What these numbers can illustrate in the meantime is the direction of interest rates over time. If we get a multi-month period in which foreign purchases of Treasurys slows, watch out.
It will be important to keep the watch segmented (specifically to the Treasury aspect of the report) as the hunt for yield resulted in a flood into corporate debt, which will drive the overall readings in coming months. Rates will move prior to the release of these figures due to the lag, but the readings can still give the market a picture of where rates will go from there based on this inflows trend and the extent to which foreign government become fed up with their dollar holdings, if only at the margin.
There are really only two ways to create a relatively strong and stable currency: one is sound monetary policy and the other is low tax rates on capital. When both of these policies move in the other direction, unsound monetary policy combined with higher tax rates on capital, you can be sure the greenback will lose purchasing power over time. Our deep and liquid markets can offset some of this pressure for a while, but eventually the world will find something better if the dollar is not it.
Have a great day!
Brent Vondera
Commodity prices in general, as measured by the CRB, have sold off about 4% in the past two days and the basic materials index, which largely tracks the direction of commodity prices, has given back five percentage points of the 56% gain from the March lows. As we touched on last Monday, such things are to be expected after a run of this magnitude. Additional short-term weakness is likely but it’s doubtful this group will remain down as a declining dollar, large global infrastructure projects, an eventual bounce in economic activity and the probability that China will continue to stockpile commodities (as a dollar hedge) foments the resumption of the uptrend.
Financial shares were also one of the main losers yesterday. I think it’s likely the group will weigh on the market again today as traders will avoid the sector until President Obama unveils his regulatory oversight plan on Wednesday – in fact, unless today’s economic data surprises to the upside traders may sit on the sidelines altogether. We’ve got a decent outline of what they want to do (and the model will give the Fed enormous authority and oversight – let’s hope the Federal Reserve regains its independence, which is not currently the case) but the devil is in the details so there will likely be a wait and see approach.
Market Activity for June 15, 2009
Empire Manufacturing
The New York Federal Reserve Bank stated factory activity in the region contracted at a faster pace this month, falling to -9.4 after posting -4.6 for May. (Readings below zero on Empire Manufacturing mark contraction, whereas 50 is the line of demarcation for the nation-wide ISM and Chicago surveys, just to clarify for new readers)
The road to recovery within the factory sector will take additional time, particularly as auto-sector woes continue to put pressure on the figures. What we are watching here is for the inventory and workweek gauges to tick higher. At some point, the inventory dynamic (stockpiles have been liquidated on a massive scale and it will take little in the way of a demand boost to drive inventories to dangerous levels, which means increased production when it occurs) will occur to catalyze growth; the market is betting on this to take place soon, hence these will be the two most important aspect of the factory reports for a while.
To this point, these indicators have yet to show signs of a bounce. The inventory index remains very weak, firms are unwilling to boost stockpiles as a sales rebound has yet to occur.
The workweek reading is another key indicator as one cannot expect the employment picture to improve. Businesses are never quick to boost hiring when an economy turns as they wit to make sure the recovery is for real. As a result, they demand more output from existing workers, and this will show up via marginal improvement in the workweek index. Nothing so far illustrates such activity has taken place – only stabilization from very low levels.
If a bounce within these segments of the manufacturing sector fails to occur in the next two months, you’ll see third-quarter GDP expectations (which currently call for GDP to post its first positive print in a year) reduced and that could weigh heavily on stocks. We continue to believe that growth will show a mild advance in the third quarter, followed by a more robust reading by the fourth, but the economy faces major headwinds (debt liquidation within the consumer arena and the affect higher tax rates and regulations will have on the business community) so it is especially difficult to judge..
The market has received a boost as these manufacturing readings ascended from the deep levels of contraction the economy endured late-2008/early-2009. From here, continued improvement will be needed to go much higher; the market is watching these regional reports very closely for signs of progress.
Empire Manufacturing also offered a series of supplemental questions, chief among them was an inquiry into capital spending plans for 2009 relative to their actual 2008 spending. To no one’s surprise capital outlays will be lower, significantly lower in fact. Across all respondents, firms averaged $1.9 million in capital spending plans, down 24% from 2008 spending.
Net Foreign Investment Flows
Net foreign investment flows into U.S. financial assets (equities, government and corporate notes, bonds and agency bonds) grew but at a slower pace in April, up $11.2 billion compared to $55.4 billion in March – analysts expected an increase of $60 billion and I haven’t seen the forecast missed by this degree in a long time. However, foreign holdings of Treasury securities, alone, rose $41.9 billion compared with $55.3 in March – despite the big miss from an expectations standpoint on the headline figure, this last number is pretty good and the latest Treasury auctions showed foreign demand remains healthy.
The concern here is based on a longer-term perspective. China, Brazil, Russia, et al. have expressed a desire for a new global currency reserve as the dollar’s value hasn’t exactly been stable for several years (a direct result of monetary policy up until now; from here massive budget deficits may also put pressure on the greenback). But a new currency reserve will not occur overnight, which means we have time to get monetary and fiscal policy right again. What these numbers can illustrate in the meantime is the direction of interest rates over time. If we get a multi-month period in which foreign purchases of Treasurys slows, watch out.
It will be important to keep the watch segmented (specifically to the Treasury aspect of the report) as the hunt for yield resulted in a flood into corporate debt, which will drive the overall readings in coming months. Rates will move prior to the release of these figures due to the lag, but the readings can still give the market a picture of where rates will go from there based on this inflows trend and the extent to which foreign government become fed up with their dollar holdings, if only at the margin.
There are really only two ways to create a relatively strong and stable currency: one is sound monetary policy and the other is low tax rates on capital. When both of these policies move in the other direction, unsound monetary policy combined with higher tax rates on capital, you can be sure the greenback will lose purchasing power over time. Our deep and liquid markets can offset some of this pressure for a while, but eventually the world will find something better if the dollar is not it.
Have a great day!
Brent Vondera
Monday, June 15, 2009
GE Capital's performance remains on target
Bloomberg reports that GE Capital is performing in line with their March forecast as they shrink their balance sheet. By shrinking their balance sheet, GE Capital aims to contribute only 30 percent of the parent company’s annual profit.
GE Capital has been able to sell debt without FDIC backing and has “pre-funded” all the debt coming due in 2009, both are encouraging signs for GE. GE Capital CEO Michael Neal said the balance sheet could be shrunk faster, “but the idea is to end up smaller but more profitable company that relies less on a wholesale funding model.”
Peter J. Lazaroff
GE Capital has been able to sell debt without FDIC backing and has “pre-funded” all the debt coming due in 2009, both are encouraging signs for GE. GE Capital CEO Michael Neal said the balance sheet could be shrunk faster, “but the idea is to end up smaller but more profitable company that relies less on a wholesale funding model.”
Peter J. Lazaroff
Coal stocks getting crushed
Arch Coal (ACI) and Peabody Energy (BTU)
This article from today’s Wall Street Journal explains the cost disadvantage of coal versus natural gas, a key concern surrounding coal producers like ACI and BTU. The facts presented in the article are not new information, but there is a good chance that the article contributed to today’s negative sentiment for coal producers.
Coal currently accounts for about half of the nation’s electricity, compared with 21% from natural gas. But, as the article notes, natural gas plants can be built more quickly and inexpensively than coal plants. Even more, natural gas plants release about half as much carbon dioxide as coal to produce similar amounts of electricity. This could put coal at a big disadvantage if Congress passes a climate-change bill that caps such carbon emissions.
The article also points out that power companies are beginning to ratchet back investments in coal-generated plants to take advantage of low gas prices and hedge against costly climate-change legislation. Gas generators are beginning to chip away at coal market share with lower prices. Also aiding natural gas’ cost advantage is the fact that gas-fired power plants can convert fuel into electricity more efficiently than coal units, and it is much cheaper to move natural gas than coal.
Peter J. Lazaroff
This article from today’s Wall Street Journal explains the cost disadvantage of coal versus natural gas, a key concern surrounding coal producers like ACI and BTU. The facts presented in the article are not new information, but there is a good chance that the article contributed to today’s negative sentiment for coal producers.
Coal currently accounts for about half of the nation’s electricity, compared with 21% from natural gas. But, as the article notes, natural gas plants can be built more quickly and inexpensively than coal plants. Even more, natural gas plants release about half as much carbon dioxide as coal to produce similar amounts of electricity. This could put coal at a big disadvantage if Congress passes a climate-change bill that caps such carbon emissions.
The article also points out that power companies are beginning to ratchet back investments in coal-generated plants to take advantage of low gas prices and hedge against costly climate-change legislation. Gas generators are beginning to chip away at coal market share with lower prices. Also aiding natural gas’ cost advantage is the fact that gas-fired power plants can convert fuel into electricity more efficiently than coal units, and it is much cheaper to move natural gas than coal.
Peter J. Lazaroff
ITW and UTX update earnings guidance
Illinois Tool Works (ITW)
ITW said its updated forecast assumes a total revenue improvement of 5% to 11% from last quarter and raised its second-quarter earnings forecast by 4 cents a share. But don’t get too excited.
The reason for the increased forecast is that ITW moved its Decorative Surfaces segment back into continuing operations because they couldn’t find a buyer for the segment. It is generally not a good thing to see a company move a business in and out of the Continuing Operations portion of their income statement.
United Technologies (UTX)
UTX reaffirmed its 2009 earnings and revenue outlook and also said it sees free cash flow equal to or in excess of net income, a sign of high earnings quality.
Tomorrow's Afternoon Report will take a closer look at free cash flow and explain its importance to investors.
Peter J. Lazaroff
ITW said its updated forecast assumes a total revenue improvement of 5% to 11% from last quarter and raised its second-quarter earnings forecast by 4 cents a share. But don’t get too excited.
The reason for the increased forecast is that ITW moved its Decorative Surfaces segment back into continuing operations because they couldn’t find a buyer for the segment. It is generally not a good thing to see a company move a business in and out of the Continuing Operations portion of their income statement.
United Technologies (UTX)
UTX reaffirmed its 2009 earnings and revenue outlook and also said it sees free cash flow equal to or in excess of net income, a sign of high earnings quality.
Tomorrow's Afternoon Report will take a closer look at free cash flow and explain its importance to investors.
Peter J. Lazaroff
Daily Insight
U.S. stocks ended mixed on Friday as the Dow and S&P 500 gained some ground, while the NASDAQ Composite slipped a bit. The gain in the S&P 500 helped the broad market advance for a fourth-straight week, although we’ve been in a very tight range for the past six weeks (929-946 on the S&P 500).
Utility shares led the market higher for the third session now as a bill out of the House to curtail austere emissions standards helped the group’s profit outlook and the concern over higher interest rates has eased over the past couple of sessions – these interest-rate sensitive shares normally have a tough time advancing when the market expects higher rates because it makes these high dividend-paying shares less attractive.
Basic material, energy and technology were the worst performing sectors as some doubts over the degree of an impending economic rebound increased on Friday.
Volume remained very weak, which has been the trend over the past couple of weeks. A computer glitch caused very low NYSE volume on Friday as just 850 billion shares traded – 40% below the three-month average. Beyond that, activity has been weaker for while here.
Market Activity for June 12, 2009
Its Crystal Clear, Policy if for Large and Long-lasting Government Programs
National Economic Council Director Larry Summers gave a speech on Friday to the Council on Foreign Relations and at the end offered what most would see as a really appealing analogy. While talking about the financial crisis and signaling the direction the Obama Administration would take, he stated that his daughters learned American history in their final years in high school (surely throughout all four years one hopes). He said they didn’t learn about the 1974 recession, the 1981-82 recession, the stock market crash of 1987, or the financial crises of the late 1980s and mid 1990s but did learn about the Great Depression. He went on to state that his goal is that kids in 2040 do not learn about the financial crisis of 2008-2009.
What he was getting at was a defense of the New Deal (as he explicitly stated within the speech). According to Summers, if not for the government intervention of the 1930s then all recessions and crises hence would have been much more severe. Well, you can’t prove a counterfactual, so simply from that perspective I have a real issue with the comments. What’s more, it is pretty clear, except for the most rabid of Keynesians, that most of those programs actually prolonged the depression. One of the best examples is the National Industrial Recovery Act (NIRA) that had the government setting prices, which led to massive market distortions. Beyond that, if not for failed monetary policy, combined with higher tax rates and applying trade-killing tariffs, the recession of the early 1930s would have been just that. Those mistakes made it a depression. I found it rich that he neglected to touch on these realities of the era
It’s concerning that the current leadership thinks this way, particularly since some of the major programs of the 1930s are with us to this day and are among the most financially crushing and unsustainable aspects of the budget. They ignore the faults of government intervention and seem ebulliently eager to repeat them.
I’m sorry to say, our sons and daughters, and grandsons and granddaughters, will learn of this era. Thankfully, new policies will eventually arrive to ameliorate the damage to be done by Washington’s current direction.
Never in Doubt
Incumbent President Mahmoud Ahmadinejad won a second term this weekend. It’s amazing the number of people who had believed a true election was taking place -- that the Iranian people’s vote would actually have been counted. Instead, while there is voting, it’s completely within the circle of the mullahs. And with Ahmadinejad’s approach working (for now) there was no way the opposition candidate (Mousavi, who has yet to be heard from) had a chance.
I saw an oil analyst on Friday – a big name in this field – surmise that if Mousavi won, oil prices would come much lower. Even Intrade (a pay-to-play prediction market) had the chances of Ahmadinejad winning at only 21% at one point on Friday.
What were people thinking? The disturbing aspect of this thought process is that maybe it signals the market in general is ignoring geopolitics. Let’s hope not; it better have this stuff priced in, which had been the assumption, but now I’m not sure.
Futures
Stock-index futures are under pressure this morning on the aforementioned news and the G8 meeting this weekend. Actually, the press is blaming lower futures solely on the G8 meeting, in which the main topic involved discussions on how and when to remove the stimulus that major economies are in the process of injecting into the global system.
In reality, governments will not be removing fiscal stimulus plans any time soon – although I wish they would in exchange for policies that incentive private-sector production but it’s not going to happen.
Here in the U.S. less than 10% of our stimulus program has been funded to this point, and roughly half of the $787 billion will find its way structurally into the budget – the entitlement spending isn’t going away until there’s a democratic shift in Washington, and even then it will be very difficult. China is pumping massive amounts of stimulus (in terms of their GDP) and isn’t about to hold back anytime soon. No one should believe governments are anywhere near pulling this spending back, and we’ll watch as the bulk of it comes as the economy has already bounced back without it.
If anything (and determining what drives the market on a daily basis is all but impossible to begin with) the market is lower this morning because the administration has shown their goal of large government is charging full-steam ahead and, unfortunately, the market has been ignoring the hard fact that we’re not going to see a change in direction out of Iran. These are big issues that will have long-lasting implications if not properly addressed.
Today’s Data
This morning we get New York-area manufacturing (June) along with foreign investment flows into U.S. securities (April). The New York factory gauge will get most of the attention. The foreign inflow number is important to watch but it’s just too outdated to have much impact on trading. If the Empire reading can move above zero, it may be able to offset these other issues tugging on investor sentiment this morning. If not, its looks like we’ll give some gains back.
Have a great day!
Brent Vondera
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