Ingersoll-Rand (IR) +14.12%
Despite total revenues declining 23% during the second-quarter and missing analysts’ estimates, IR’s cost controls drove better-than-expected productivity improvements and helped the diversified equipment maker deliver earnings that beat analysts’ projections.
The company expects lower demand in most of its major markets for the rest of the year; however, management sees some tentative positive signs in the residential HVAC (heating, ventilation, and air-conditioning) market, North American trailers, and China operations. Still, the nonresidential construction and European markets remain challenging.
Arch Coal (ACI) +7.53%
Arch Coal CEO Steven Leer said the coal market has “reached a bottom” and that there were signs of increased demand in the latter half of the second quarter.
These comments helped investors shrug off a bigger-than-expected loss and a cut to the company’s 2009 sales forecast. Arch Coal is continuing “aggressive efforts to reduce operating costs and capital spending across the organization to ensure profitability despite extremely weak market conditions.
T. Rowe Price Group (TROW) -1.75%
TROW’s earnings fell less than expected thanks to $3.5 billion of investor deposits during the second quarter and the recent market rally boosted the value of assets under management. Revenue fell 25% from a year earlier due to a 27% drop in investment advisory fees.
The amount of money TROW manages for clients dipped 19% from a year earlier to $315.6 billion, but assets rose 17% since March 31. Money poured into the company’s target-date funds to the tune of $1.8 billion, reaching $33.1 billion and 10% of total fund assets.
CEO James Kennedy said, “We’re beyond the panic stage in the market and beyond the worst in the economy. A big question is the consumer, with so much debt and without the capacity to turn to credit cards or home-equity loans.”
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Peter J. Lazaroff, Investment Analyst
Friday, July 24, 2009
SunPower shines, up 24% today
SunPower Corp (SPWRA), the second-biggest U.S. solar cell maker, is up 24% today after reporting a second-quarter profit of 26 cents a share, far surpassing the expected loss of 3 cents a share. Even more, SunPower raised the lower-end of sales guidance and boosted 2009 earnings projections to 45 cents to 90 cents, up from 25 cents to 75 cents estimated in April. The company cited “a highly visible pipeline of deals we expect to come through in the third quarter” as the reason for increased guidance.
Despite higher prices, tough credit, and general economic weakness, SunPower almost doubled panel shipments from last quarter and was able to maintain only a 10% quarter-over-quarter price decline despite rapidly falling China panel prices. These solid quarterly results are evidence of the strength of SunPower’s backlog of utility orders.
As the credit crunch reduced rooftop sales that use lower-margin individual panels, SunPower has shifted its focus to large-scale utility solar plants. The company’s vertically-integrated business model has widely been expected to capture significant market share in the U.S. utility scale market.
There were a few exciting aspects from a competitive advantage standpoint. One, there appears to be some brand awareness for SunPower products and SunPower’s Levelized Cost of Electricity (LCOE) proposition is compelling to end-customers. For more on SunPower’s LCOE, click here. Two, and even more exciting, are SunPower’s plans to reduce production costs and enhance economies of scale.
By manufacturing panels in Mexico and Malaysia, the company plans to reduce solar plant assembly costs and enhance economies of scale. That, in addition to cheaper silicon, will help drive costs down to less than $2 per watt by the fourth quarter and $1 per watt by 2014. In other words, SunPower will be as competitive (if not better) than the current cost-leader First Solar (FSLR).
SunPower has always offered the most efficient high-quality product in the solar power industry. Now it appears to be on track to match First Solar’s cost advantage and economies of scale. It also seems that SunPower’s brand name is strengthening. All of this bodes well for SunPower’s long-term competitive advantage.
For more on SunPower and the solar industry, see my initial write up here.
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Peter J. Lazaroff, Investment Analyst
Note: SPWRA finished the day +28.93%
Despite higher prices, tough credit, and general economic weakness, SunPower almost doubled panel shipments from last quarter and was able to maintain only a 10% quarter-over-quarter price decline despite rapidly falling China panel prices. These solid quarterly results are evidence of the strength of SunPower’s backlog of utility orders.
As the credit crunch reduced rooftop sales that use lower-margin individual panels, SunPower has shifted its focus to large-scale utility solar plants. The company’s vertically-integrated business model has widely been expected to capture significant market share in the U.S. utility scale market.
There were a few exciting aspects from a competitive advantage standpoint. One, there appears to be some brand awareness for SunPower products and SunPower’s Levelized Cost of Electricity (LCOE) proposition is compelling to end-customers. For more on SunPower’s LCOE, click here. Two, and even more exciting, are SunPower’s plans to reduce production costs and enhance economies of scale.
By manufacturing panels in Mexico and Malaysia, the company plans to reduce solar plant assembly costs and enhance economies of scale. That, in addition to cheaper silicon, will help drive costs down to less than $2 per watt by the fourth quarter and $1 per watt by 2014. In other words, SunPower will be as competitive (if not better) than the current cost-leader First Solar (FSLR).
SunPower has always offered the most efficient high-quality product in the solar power industry. Now it appears to be on track to match First Solar’s cost advantage and economies of scale. It also seems that SunPower’s brand name is strengthening. All of this bodes well for SunPower’s long-term competitive advantage.
For more on SunPower and the solar industry, see my initial write up here.
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Peter J. Lazaroff, Investment Analyst
Note: SPWRA finished the day +28.93%
Daily Insight
U.S. stocks rallied yesterday, sending the Dow above 9K for the first time since January and the S&P 500 chugged past the 950 handle as the broad market looks ready to test that Election Day mark of 1005.
I think the fact that President Obama is getting rebuffed on his desire to ram the most consequential legislation through Congress is what gave stocks a jolt yesterday. Yes, earnings reports out of AT&T, 3M and Ford were better-than-expected, but as we’ve talked about for a week now, in most cases results only look good compared to very low estimates. The housing data was helpful too but, darn I’m not trying to be a killjoy here, let’s be real the housing market’s issues will remain with the job market in the state it is in.
Delaying the vote until after the August recess increases the possibility that anything other than a very watered down version of government-run health care will be passed – many members of Congress are going to get hammered on this thing when they return to their districts as citizens are finally beginning to pay attention to just how destructive this policy would be to individual choice. This is the best news we’ve seen in quite a while and shows Americans are not willing to roll over and allow a major step toward a European-style system.
Digressing for a moment, for a second day now I’ve seen a headline commenting on how a big Wall Street name sees “a lot of bargains” among U.S. stocks. Funny how you see these stories after the market rallies 45% in a matter of 15 weeks – I don’t recall any headlines like this when the broad market traded at 10 times trailing earnings back in March; now that we’re at 16 times, the “stocks are a screaming buy” remarks begin to fly. It really is amusing to watch.
Basic material shares led the rally and have been on their horse over the last eight sessions, up nearly 18%. The broad market is up 11% over the same period.
Consumer staple and technology share were the laggards, although still up by 1.64% and 1.97%, respectively.
Volume was good relative to recent days, right in line with the three-month average of 1.3 billion shares on the Big Board. Eight stocks rose for every one that fell on the NYSE Composite.
Market Activity for July 23, 2009
The Dollar
It’s not looking good for old green, the USD only rallies when the safety trade rolls – needless to say a horrible sign for its direction looking out over the next year.
As a result, commodity prices have momentum again, illustrated by the CRB Index back above 250 – I’m watching for the 270-275 range to offer a break out scenario in commodity prices. But you don’t really have to watch the entire basket of commodities, only need to watch Dr. Copper – smarter than any PhD when it comes to the early detection of inflationary pressures.
Initial Jobless Claims
Initial jobless claims rose 30,000 in the week ended July 18, but remained below the 600K level, coming in at 554,000. The four-week average, a less volatile figure, fell 19,000 to 566,000.
Continuing claims fell 88,000 to 6.225 million in the week ended July 11 (one-week lag). This is on top of the massive record decline of 591,000 in the week ended July 4 that drove claims off of the all-time high of 6.904 million. My view is that there is either a statistical issue here that is driving the figure lower or the expiration of benefits is playing the role, maybe both. One doesn’t need to be a skeptic to view this decline as strange, if it were a mild move lower I could believe some real improvement was in the making, but a decline of this magnitude does not at all jibe with the realities within the labor market.
There are two ways to confirm this unprecedented decline in continuing claims is actually signaling the labor market is healing in a significant manner.
First, Congress is sending money to states so that they can extend jobless benefits to 59 weeks from 26 weeks. If the decline in continuing claims is for real, then they will keep falling even as the duration of benefits payments is extended – they will at the least flatten out. If they resume the move higher, we’ll know the latest decline is a function of benefits expiring.
Second, the next employment report (due out in a couple of weeks) will show a huge decline in the duration of unemployment. To the contrary, that figure rose at the largest degree since the recession began in the last jobs report, rising from 22.5 weeks to 24.5 weeks. If we don’t see a reversal in the duration number, that will be another sign something is awry with the continuing claims move lower.
Existing Home Sales
The National Association of Realtors reported that home resales rose 3.6% in June for a third-straight month (up 2.4% for single-family only), induced by the $8,000 tax credit, lower borrowing costs in the back-half of the month and foreclosure-driven price declines in certain regions.
Total existing home sales (condos, co-ops and single-fam.) rose to 4.89 million at an annual rate, the highest since October – beating the estimate of 4.84 million. Single-family homes rose to 4.32 million, still very depressed but up nicely from the 12-year lows we were hitting three months back.
The median price for existing single-family homes rose 4% to 181,800 in June, down 15.0% from the year-ago period.
The supply of homes (in months worth of supply at the current sales pace) made additional progress to 8.9 months from 9.1 in May.
June is traditionally one of the strongest months for home sales, so the gain is not a surprise (especially after the latest pending homes sales data). Stocks certainly got a lift from the news, and these rallies are enjoyable, but people shouldn’t get too excited, there are many fundamentals that will weigh on the housing market over the foreseeable future --- the fragile labor market conditions being the preponderant element. Even if rates remain in this low range of 5.00%-5.35%, the level of joblessness and the concern of losing one’s job will be pulling on demand. If rates tick up, which is a reasonable assumption once GDP begins to post positive readings, home-sale activity is likely to stagnate.
Have a great weekend!
Brent Vondera, Senior Analyst
I think the fact that President Obama is getting rebuffed on his desire to ram the most consequential legislation through Congress is what gave stocks a jolt yesterday. Yes, earnings reports out of AT&T, 3M and Ford were better-than-expected, but as we’ve talked about for a week now, in most cases results only look good compared to very low estimates. The housing data was helpful too but, darn I’m not trying to be a killjoy here, let’s be real the housing market’s issues will remain with the job market in the state it is in.
Delaying the vote until after the August recess increases the possibility that anything other than a very watered down version of government-run health care will be passed – many members of Congress are going to get hammered on this thing when they return to their districts as citizens are finally beginning to pay attention to just how destructive this policy would be to individual choice. This is the best news we’ve seen in quite a while and shows Americans are not willing to roll over and allow a major step toward a European-style system.
Digressing for a moment, for a second day now I’ve seen a headline commenting on how a big Wall Street name sees “a lot of bargains” among U.S. stocks. Funny how you see these stories after the market rallies 45% in a matter of 15 weeks – I don’t recall any headlines like this when the broad market traded at 10 times trailing earnings back in March; now that we’re at 16 times, the “stocks are a screaming buy” remarks begin to fly. It really is amusing to watch.
Basic material shares led the rally and have been on their horse over the last eight sessions, up nearly 18%. The broad market is up 11% over the same period.
Consumer staple and technology share were the laggards, although still up by 1.64% and 1.97%, respectively.
Volume was good relative to recent days, right in line with the three-month average of 1.3 billion shares on the Big Board. Eight stocks rose for every one that fell on the NYSE Composite.
Market Activity for July 23, 2009
The DollarIt’s not looking good for old green, the USD only rallies when the safety trade rolls – needless to say a horrible sign for its direction looking out over the next year.
As a result, commodity prices have momentum again, illustrated by the CRB Index back above 250 – I’m watching for the 270-275 range to offer a break out scenario in commodity prices. But you don’t really have to watch the entire basket of commodities, only need to watch Dr. Copper – smarter than any PhD when it comes to the early detection of inflationary pressures.Initial Jobless Claims
Initial jobless claims rose 30,000 in the week ended July 18, but remained below the 600K level, coming in at 554,000. The four-week average, a less volatile figure, fell 19,000 to 566,000.
Continuing claims fell 88,000 to 6.225 million in the week ended July 11 (one-week lag). This is on top of the massive record decline of 591,000 in the week ended July 4 that drove claims off of the all-time high of 6.904 million. My view is that there is either a statistical issue here that is driving the figure lower or the expiration of benefits is playing the role, maybe both. One doesn’t need to be a skeptic to view this decline as strange, if it were a mild move lower I could believe some real improvement was in the making, but a decline of this magnitude does not at all jibe with the realities within the labor market.There are two ways to confirm this unprecedented decline in continuing claims is actually signaling the labor market is healing in a significant manner.First, Congress is sending money to states so that they can extend jobless benefits to 59 weeks from 26 weeks. If the decline in continuing claims is for real, then they will keep falling even as the duration of benefits payments is extended – they will at the least flatten out. If they resume the move higher, we’ll know the latest decline is a function of benefits expiring.
Second, the next employment report (due out in a couple of weeks) will show a huge decline in the duration of unemployment. To the contrary, that figure rose at the largest degree since the recession began in the last jobs report, rising from 22.5 weeks to 24.5 weeks. If we don’t see a reversal in the duration number, that will be another sign something is awry with the continuing claims move lower.
Existing Home Sales
The National Association of Realtors reported that home resales rose 3.6% in June for a third-straight month (up 2.4% for single-family only), induced by the $8,000 tax credit, lower borrowing costs in the back-half of the month and foreclosure-driven price declines in certain regions.
Total existing home sales (condos, co-ops and single-fam.) rose to 4.89 million at an annual rate, the highest since October – beating the estimate of 4.84 million. Single-family homes rose to 4.32 million, still very depressed but up nicely from the 12-year lows we were hitting three months back.
The median price for existing single-family homes rose 4% to 181,800 in June, down 15.0% from the year-ago period.The supply of homes (in months worth of supply at the current sales pace) made additional progress to 8.9 months from 9.1 in May.June is traditionally one of the strongest months for home sales, so the gain is not a surprise (especially after the latest pending homes sales data). Stocks certainly got a lift from the news, and these rallies are enjoyable, but people shouldn’t get too excited, there are many fundamentals that will weigh on the housing market over the foreseeable future --- the fragile labor market conditions being the preponderant element. Even if rates remain in this low range of 5.00%-5.35%, the level of joblessness and the concern of losing one’s job will be pulling on demand. If rates tick up, which is a reasonable assumption once GDP begins to post positive readings, home-sale activity is likely to stagnate.Have a great weekend!
Brent Vondera, Senior Analyst
Thursday, July 23, 2009
KMB, EMC, GR, NOC, LLL earnings
KMB +6.13%
Higher selling prices and lower commodity prices lifted Kimberly’s second-quarter results above projections. The maker of Huggies diapers and Kleenex tissue raised its earnings and revenue forecasts to reflect lower commodity prices, stronger organic growth, and cost savings from job cuts.
EMC +4.09%
The biggest takeaway from EMC’s report was that the company offered guidance for the first time amid the downturn, offering a sign that the tech market is at least returning to more predictable conditions. Management said that IT budgets for EMC’s customers “firmed up quite a bit,” and they now have “better visibility and more confidence in the second half of 2009.”
GR -7.03%
Goodrich, the largest maker of aircraft landing gear, saw profit drop 5.1% and sales slump 8% on weaker demand for spare parts as airlines pared flights and routes in the recession. Aftermarket aircraft parts fell 16%, but the firm expects aftermarket sales to be higher in the third and fourth quarters of 2009. This expectation as well as strength in the defense and space unit led Goodrich to raise the lower end of its full-year forecast, which the firm has reduced twice this year.
NOC -1.85%
Defense company Northrop Grumman (NOC) reported second-quarter profit slipped 20% on pension-related expenses and an adjustment to shipbuilding costs. Revenue increased 3.8% to $8.96 billion, with revenue growth across all business segments except shipbuilding. The aerospace segment led the underlying units, posting 8% sales growth on higher volumes for manned and unmanned aircraft programs. Total backlog fell 8.5% sequentially to $70.4 billion on the termination of the U.S. government’s Kinetic Energy Interceptor program.
LLL +2.82%
Defense contractor L-3’s profit dropped 18%, but still beat expectations and the company raised its full-year forecast. Total revenue increased 6% thanks to increased demand and new business for airborne manned and unmanned platforms. Higher pension expenses contributed to a drop in operating income.
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Peter J. Lazaroff
Higher selling prices and lower commodity prices lifted Kimberly’s second-quarter results above projections. The maker of Huggies diapers and Kleenex tissue raised its earnings and revenue forecasts to reflect lower commodity prices, stronger organic growth, and cost savings from job cuts.
EMC +4.09%
The biggest takeaway from EMC’s report was that the company offered guidance for the first time amid the downturn, offering a sign that the tech market is at least returning to more predictable conditions. Management said that IT budgets for EMC’s customers “firmed up quite a bit,” and they now have “better visibility and more confidence in the second half of 2009.”
GR -7.03%
Goodrich, the largest maker of aircraft landing gear, saw profit drop 5.1% and sales slump 8% on weaker demand for spare parts as airlines pared flights and routes in the recession. Aftermarket aircraft parts fell 16%, but the firm expects aftermarket sales to be higher in the third and fourth quarters of 2009. This expectation as well as strength in the defense and space unit led Goodrich to raise the lower end of its full-year forecast, which the firm has reduced twice this year.
NOC -1.85%
Defense company Northrop Grumman (NOC) reported second-quarter profit slipped 20% on pension-related expenses and an adjustment to shipbuilding costs. Revenue increased 3.8% to $8.96 billion, with revenue growth across all business segments except shipbuilding. The aerospace segment led the underlying units, posting 8% sales growth on higher volumes for manned and unmanned aircraft programs. Total backlog fell 8.5% sequentially to $70.4 billion on the termination of the U.S. government’s Kinetic Energy Interceptor program.
LLL +2.82%
Defense contractor L-3’s profit dropped 18%, but still beat expectations and the company raised its full-year forecast. Total revenue increased 6% thanks to increased demand and new business for airborne manned and unmanned platforms. Higher pension expenses contributed to a drop in operating income.
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Peter J. Lazaroff
Noble (NE) boosted by long-term deepwater contracts
Despite crude oil prices falling during the second quarter, Noble (NE) managed to grow profits 4% thanks to lucrative long-term deepwater contracts. Revenue increased 11% to $898 million and operating margin came in at an impressive 54%, well above the industry average.
Looking ahead, management does not expect any significant changes to the near-term contracting environment despite the gradual recovery in oil prices. CEO David Williams said, “every day that crude prices stay at a reasonable level or continue to improve builds confidence in our future.”
Although they did not materially impact results, it’s also worth mentioning that Noble paid late-delivery penalties to Petrobras. Rig delivery delays not only result in cash penalties, but they also disappoint customers that are often managing time-sensitive drilling programs.
Looking ahead, management does not expect any significant changes to the near-term contracting environment despite the gradual recovery in oil prices. CEO David Williams said, “every day that crude prices stay at a reasonable level or continue to improve builds confidence in our future.”
Although they did not materially impact results, it’s also worth mentioning that Noble paid late-delivery penalties to Petrobras. Rig delivery delays not only result in cash penalties, but they also disappoint customers that are often managing time-sensitive drilling programs.
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Peter J. Lazaroff, Investment Analyst
Raymond James profit tumbles 39%
Raymond James Financial’s (RJF) earnings declined 39% as the economic downturn continues to affect the company, but the results marked a sharp improvement from the previous quarter. CEO Thomas James said “like the rest of corporate America, improved short-term profit results don’t reflect much revenue growth, symptomatic of the continuing deep recession.”
Net revenue fell 16% year-over-year to $624.8 million, which is a 6% improvement sequentially. Most major sources of the firm’s revenues recorded double-digit percentage declines form a year earlier, including 16% in securities commissions and fees to $405.9 mlilion. Revenue from investment banking fell 43% while revenue from investment advisory fees was down 46%.
The company recorded a $29.8 million provision for loan losses, more than double a year ago, but down 60% sequentially. The regional brokerage has suffered along with the rest of the sector from credit deterioration and weak economic conditions. However, the company decided in May to turn down a capital injection from the government.
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Peter J. Lazaroff, Investment Analyst
Net revenue fell 16% year-over-year to $624.8 million, which is a 6% improvement sequentially. Most major sources of the firm’s revenues recorded double-digit percentage declines form a year earlier, including 16% in securities commissions and fees to $405.9 mlilion. Revenue from investment banking fell 43% while revenue from investment advisory fees was down 46%.
The company recorded a $29.8 million provision for loan losses, more than double a year ago, but down 60% sequentially. The regional brokerage has suffered along with the rest of the sector from credit deterioration and weak economic conditions. However, the company decided in May to turn down a capital injection from the government.
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Peter J. Lazaroff, Investment Analyst
AT&T dials up a solid quarter
AT&T’s (T) second-quarter profit fell 15% as growth in wireless business couldn’t offset continued weakness in the wireline segment - still, the firm's results topped estimates.
AT&T increased total subscribers by 1.4 million during the quarter to 79.6 million. Solid customer growth was driven by 2.4 million new iPhone activations, a third of which were new customers. Wireless data-services revenue – what customers pay for Internet browsing and sending emails – jumped 37%.
On the opposite end of the spectrum, demand for traditional phone service is steadily shrinking and business spending remains weak, resulting in a 36% dip in wireline profits on a 6.1% decline in revenue. Margins contracted in the segment, which was expected since the firm took a big chunk of costs out of the business early in the year, making additional improvement difficult.
Despite revenue and margin pressure overall, free cash flow thus far in 2009 is running at more than twice the level of a year ago. A 25% decrease in capital spending has contributed about half the increase in cash flow.
With global handset sales falling at a record pace, AT&T and competitors are expanding their offering to include netbooks, or small laptop computers, in an effort to capture additional data-services revenue. Bloomberg published this story today about telecom betting on netbooks to spur growth.
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Peter J. Lazaroff, Investment Analyst
AT&T increased total subscribers by 1.4 million during the quarter to 79.6 million. Solid customer growth was driven by 2.4 million new iPhone activations, a third of which were new customers. Wireless data-services revenue – what customers pay for Internet browsing and sending emails – jumped 37%.
On the opposite end of the spectrum, demand for traditional phone service is steadily shrinking and business spending remains weak, resulting in a 36% dip in wireline profits on a 6.1% decline in revenue. Margins contracted in the segment, which was expected since the firm took a big chunk of costs out of the business early in the year, making additional improvement difficult.
Despite revenue and margin pressure overall, free cash flow thus far in 2009 is running at more than twice the level of a year ago. A 25% decrease in capital spending has contributed about half the increase in cash flow.
With global handset sales falling at a record pace, AT&T and competitors are expanding their offering to include netbooks, or small laptop computers, in an effort to capture additional data-services revenue. Bloomberg published this story today about telecom betting on netbooks to spur growth.
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Peter J. Lazaroff, Investment Analyst
3M (MMM) earnings impress
3M (MMM), the maker of 55,000 products from Post-It Notes and Scotch tape to electric road signs and power lines, easily topped estimates as the firm cut jobs and benefited from a “tremendous sequential surge” in demand for respiratory masks that protect against the swine flu. The company raised the lower end of its full-year profit guidance and tightened its sales projections.
Revenue fell 15% to $5.6 billion with sales down across all of the company’s major business lines and geographic markets, although sales climb 12.4% sequentially over wider profitability. Healthcare and consumer and office segments were once again the strongest performers. The company saw particular weakness in the automotive, construction, and telecom industries.
CEO George Buckley expressed that there is a risk that recent upticks in orders could be a “false down” caused by an over-correction in inventory levels earlier this year by 3M’s customers rather than a sustainable recovery in demand.
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Peter J. Lazaroff, Investment Analyst
Revenue fell 15% to $5.6 billion with sales down across all of the company’s major business lines and geographic markets, although sales climb 12.4% sequentially over wider profitability. Healthcare and consumer and office segments were once again the strongest performers. The company saw particular weakness in the automotive, construction, and telecom industries.
CEO George Buckley expressed that there is a risk that recent upticks in orders could be a “false down” caused by an over-correction in inventory levels earlier this year by 3M’s customers rather than a sustainable recovery in demand.
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Peter J. Lazaroff, Investment Analyst
Daily Insight
U.S. stocks wavered between gain and loss for the entire session on Wednesday as investors were torn between better-than-expected earnings reports (with the exception of the day’s financial-sector results) and the concern that a new wave of commercial real estate defaults would roil the markets – in the end the broad market closed fractionally lower.
Bernanke, for a second-straight day, addressed the commercial real estate topic stating that the Fed is carefully monitoring the situation. This, along with rising credit-card defaults (which hit a new high of 10.76% in June) are topics we’ve addressed as significant challenges for the financials system. For now, a very positively sloping yield curve (nearly the steepest on record) is helping banks offsets these drags, but I question it will be enough.
Energy was the worst performing sector as the weekly energy report showed a smaller-than-forecast decline in crude inventories. Consumer discretionary and tech shares were the top performers on the session. The NASDAQ Composite, led by those tech shares, rose for an 11th straight day.
Market Activity for July 22, 2009
Federal Housing Finance Agency’s Home-Price Index
The FHFA released its home-price data for May, showing prices rose 0.9% -- down 6.5% over the past year. This gauge shows the degree of decline as much milder than the other home-price figures are showing.
Case/Shiller, for instance, has prices down 18% (although this index is weighed down by areas that had the highest level of speculation during the boom and hence the most foreclosure activity in the bust; the index is also value-weighted so high-end homes have a larger effect – the FHFA index is equally weighted). Existing home sales out of the National Association of Realtors has prices down 16% over the past 12 months. The FHFA figure is a very broad look at the housing market, however it does miss the high-end home market as it does not capture jumbo mortgage properties. Basically, we like to average these three for a clearer picture – doing so results in a 13% decline in home prices, on a 12-month basis.
In terms of region, prices rebounded by the most on the West coast, up 2.7% in May, and New England showed the weakest results, down 2.0%. Home prices rose 1.4% in the Southeast and were up about 0.8% in the Midwest.
Mortgage Applications
The Mortgage Bankers Association reported that their mortgage apps index rose for a third-straight week in the period ended July 17, up 2.8% after a 4.3% advance in the previous week.
Purchases rose 1.3% after a 9.4% decline in the week prior, while refinancing activity rose 4.0% – the third-straight increase – even as the rate on the 30-year fixe mortgage rose to 5.31%. Back in April and May when the 30-year fixed rate moved below 5%, refinancing activity jumped; activity would suddenly cease when the rate moved back in the 5% handle. Now, borrowers are more willing to get refis done and the trigger point seems to be something closer to 5.30% now as many probably fear they won’t get a shot at sub-5.00% again.
The average loan size fell to $218,700 from $226,500 in the week prior and is down from $250,000 at the end of last year. Refinancing activity accounted for 55.5% of the index in this latest week.
In other mortgage-related news, the Washington Post reported that Freddie Mac will pick up the closing costs (up to 3.5% of the sale price) on the purchase of foreclosed properties. In addition, as part of their “Smart Buy” program Freddie is offering a two-year warranty on the home’s plumbing, a/c and heating systems, and appliances (water heaters, stoves, washers/dryers and dishwashers). This applies only to primary residencies, and to homes selling out of Freddie’s own foreclosure inventory. Oh, the plan also includes discounts on replacement appliances of up to 30%, and 15% on installation costs.
As we talked about when the agencies upped their refinancing LTV requirement to 125%, stating that this is a sign the government will take it to another level in using Fannie and Freddie to spark home buying and put the taxpayer on the hook for many more costs (as if they need more), it appears the great minds in government are just getting started in sticking it to people who have conducted their lives in a relatively responsible manner. And speaking of great ideas…
Government-Run Health Care
House Majority Leader Steny Hoyer left open the possibility that Congress may wait until after the August recess to vote on health-care legislation, as we briefly touched on yesterday. If they do, it would potentially be a serious positive for longer-term growth. There is opposition building as people learn more about the specifics and waiting certainly decreases the likelihood of passage.
Maybe some do not see the connection between this legislation and the economy.
First off, this additional financial burden (on top of the Social Security and Medicare time bombs) is hardly a necessity even if it were a smart thing to do – the actual number of uninsured Americans is much lower than the scaremongers incessantly state. Of the supposed 45 million uninsured, 10 million are eligible for either Medicaid or SCHIP but do not sign up – doesn’t matter anyway because these programs are available at the point of service so they are covered. Another 17 million live in $50,000-$75,000 households – these are people who can afford catastrophic insurance at a minimum (probably a lot of young people who simply prefer to go without) and half of those within this segment are transitory uninsured, meaning they lose their jobs and their health plan too, until they get a new job. Then you have another 5-8 million who are not even Americans, but the quacks that cause the uproar over the uninsured have to add in illegals to make the number sound scarier. This leaves us with about 12 million truly uninsured, and even these people cannot be refused care. While 12 million is a big number, one has a hard time finding a reason to venture down this government health-care road at the harm of everyone else. (These numbers are according to the 2007 Census Bureau report: “Income, Poverty, and Health Insurance Coverage in the United States.” the Heritage Foundation, and the Kaiser Family Foundation)
Now that that is out of the way, back to the economic harm of it all. To put it simply, our budget is already burdened in a structural way with enormous costs that will be harmful to both economic growth and the value of the dollar. The increase in tax rates alone in order to pay for this monstrosity would be the concrete boots that drown this economy over several years. Not to mention the damage this does to the American principle of self-reliance (however much of it is left anyway) – a principle that in the past has kept government spending at bay in terms of its percentage of GDP. If we add on another several hundred billion to a trillion dollars in government spending, especially via borrowing, you can forget about purchasing power of the dollar moving in the right direction. Let’s hope this thing that even the President admitted on Tuesday he had not read (there are a couple of competing bills), goes the way of the ash heap.
Have a great day!
Brent Vondera
Bernanke, for a second-straight day, addressed the commercial real estate topic stating that the Fed is carefully monitoring the situation. This, along with rising credit-card defaults (which hit a new high of 10.76% in June) are topics we’ve addressed as significant challenges for the financials system. For now, a very positively sloping yield curve (nearly the steepest on record) is helping banks offsets these drags, but I question it will be enough.
Energy was the worst performing sector as the weekly energy report showed a smaller-than-forecast decline in crude inventories. Consumer discretionary and tech shares were the top performers on the session. The NASDAQ Composite, led by those tech shares, rose for an 11th straight day.
Market Activity for July 22, 2009
Federal Housing Finance Agency’s Home-Price IndexThe FHFA released its home-price data for May, showing prices rose 0.9% -- down 6.5% over the past year. This gauge shows the degree of decline as much milder than the other home-price figures are showing.
Case/Shiller, for instance, has prices down 18% (although this index is weighed down by areas that had the highest level of speculation during the boom and hence the most foreclosure activity in the bust; the index is also value-weighted so high-end homes have a larger effect – the FHFA index is equally weighted). Existing home sales out of the National Association of Realtors has prices down 16% over the past 12 months. The FHFA figure is a very broad look at the housing market, however it does miss the high-end home market as it does not capture jumbo mortgage properties. Basically, we like to average these three for a clearer picture – doing so results in a 13% decline in home prices, on a 12-month basis.
In terms of region, prices rebounded by the most on the West coast, up 2.7% in May, and New England showed the weakest results, down 2.0%. Home prices rose 1.4% in the Southeast and were up about 0.8% in the Midwest.
Mortgage Applications
The Mortgage Bankers Association reported that their mortgage apps index rose for a third-straight week in the period ended July 17, up 2.8% after a 4.3% advance in the previous week.
Purchases rose 1.3% after a 9.4% decline in the week prior, while refinancing activity rose 4.0% – the third-straight increase – even as the rate on the 30-year fixe mortgage rose to 5.31%. Back in April and May when the 30-year fixed rate moved below 5%, refinancing activity jumped; activity would suddenly cease when the rate moved back in the 5% handle. Now, borrowers are more willing to get refis done and the trigger point seems to be something closer to 5.30% now as many probably fear they won’t get a shot at sub-5.00% again.
The average loan size fell to $218,700 from $226,500 in the week prior and is down from $250,000 at the end of last year. Refinancing activity accounted for 55.5% of the index in this latest week.
In other mortgage-related news, the Washington Post reported that Freddie Mac will pick up the closing costs (up to 3.5% of the sale price) on the purchase of foreclosed properties. In addition, as part of their “Smart Buy” program Freddie is offering a two-year warranty on the home’s plumbing, a/c and heating systems, and appliances (water heaters, stoves, washers/dryers and dishwashers). This applies only to primary residencies, and to homes selling out of Freddie’s own foreclosure inventory. Oh, the plan also includes discounts on replacement appliances of up to 30%, and 15% on installation costs.
As we talked about when the agencies upped their refinancing LTV requirement to 125%, stating that this is a sign the government will take it to another level in using Fannie and Freddie to spark home buying and put the taxpayer on the hook for many more costs (as if they need more), it appears the great minds in government are just getting started in sticking it to people who have conducted their lives in a relatively responsible manner. And speaking of great ideas…
Government-Run Health Care
House Majority Leader Steny Hoyer left open the possibility that Congress may wait until after the August recess to vote on health-care legislation, as we briefly touched on yesterday. If they do, it would potentially be a serious positive for longer-term growth. There is opposition building as people learn more about the specifics and waiting certainly decreases the likelihood of passage.
Maybe some do not see the connection between this legislation and the economy.
First off, this additional financial burden (on top of the Social Security and Medicare time bombs) is hardly a necessity even if it were a smart thing to do – the actual number of uninsured Americans is much lower than the scaremongers incessantly state. Of the supposed 45 million uninsured, 10 million are eligible for either Medicaid or SCHIP but do not sign up – doesn’t matter anyway because these programs are available at the point of service so they are covered. Another 17 million live in $50,000-$75,000 households – these are people who can afford catastrophic insurance at a minimum (probably a lot of young people who simply prefer to go without) and half of those within this segment are transitory uninsured, meaning they lose their jobs and their health plan too, until they get a new job. Then you have another 5-8 million who are not even Americans, but the quacks that cause the uproar over the uninsured have to add in illegals to make the number sound scarier. This leaves us with about 12 million truly uninsured, and even these people cannot be refused care. While 12 million is a big number, one has a hard time finding a reason to venture down this government health-care road at the harm of everyone else. (These numbers are according to the 2007 Census Bureau report: “Income, Poverty, and Health Insurance Coverage in the United States.” the Heritage Foundation, and the Kaiser Family Foundation)
Now that that is out of the way, back to the economic harm of it all. To put it simply, our budget is already burdened in a structural way with enormous costs that will be harmful to both economic growth and the value of the dollar. The increase in tax rates alone in order to pay for this monstrosity would be the concrete boots that drown this economy over several years. Not to mention the damage this does to the American principle of self-reliance (however much of it is left anyway) – a principle that in the past has kept government spending at bay in terms of its percentage of GDP. If we add on another several hundred billion to a trillion dollars in government spending, especially via borrowing, you can forget about purchasing power of the dollar moving in the right direction. Let’s hope this thing that even the President admitted on Tuesday he had not read (there are a couple of competing bills), goes the way of the ash heap.
Have a great day!
Brent Vondera
Wednesday, July 22, 2009
Pfizer's cost cutting ability leads to upside guidance
Pfizer (PFE) reported second quarter profit that beat expectations and boosted its 2009 profit view based on slightly higher revenue expectations and lower cost projections. Pfizer has historically shown great ability to lower costs, which makes me confident they can meet their new earnings goal.
Revenue during the quarter fell 9.4% to $10.98 billion, essentially all due to currency changes. On the operating side, Pfizer was able to reduce COGS, marketing and administrative costs, and R&D as a percentage of total sales. Gross margin improved 290 basis points to 84%.
Pfizer’s $65.64 billion acquisition of rival Wyeth (WYE) remains on track to close this year, but still requires U.S. antitrust approval. Pfizer, like much of the rest of the pharmaceutical industry, is trying to cope with decreasing revenue from patented drugs and difficulties developing new drugs.
Pfizer is acquiring Wyeth to gain access to fast-growing biotechnology drugs and vaccines as the world’s best-selling drug, Lipitor, faces patent expiration in 2011.
--
Peter J. Lazaroff
Revenue during the quarter fell 9.4% to $10.98 billion, essentially all due to currency changes. On the operating side, Pfizer was able to reduce COGS, marketing and administrative costs, and R&D as a percentage of total sales. Gross margin improved 290 basis points to 84%.
Pfizer’s $65.64 billion acquisition of rival Wyeth (WYE) remains on track to close this year, but still requires U.S. antitrust approval. Pfizer, like much of the rest of the pharmaceutical industry, is trying to cope with decreasing revenue from patented drugs and difficulties developing new drugs.
Pfizer is acquiring Wyeth to gain access to fast-growing biotechnology drugs and vaccines as the world’s best-selling drug, Lipitor, faces patent expiration in 2011.
--
Peter J. Lazaroff
St. Jude's largest segment has abnormal rhythm
St. Jude Medical (STJ) reported profit grew 14% and revenues were up 4%, both in line with the Street’s expectations. The medical-device company tightened the high-end its full-year sales forecast, but held its full-year earnings projection in place.
What really concerned investors today – the stock is down more than 9%– was that St. Jude lowered the top-end of revenue guidance for heart-rhythm devices such as pacemakers and defibrillators. This business segment, which makes up nearly 62% of total revenue, also reported considerably lower revenue growth compared to the last two years.
On the bright side, St. Jude reiterated its profit guidance for the full year, and gave a third-quarter forecast that was in line with estimates. The company also said it authorized a buyback of up to $500 million in stock.
--
Peter J. Lazaroff
What really concerned investors today – the stock is down more than 9%– was that St. Jude lowered the top-end of revenue guidance for heart-rhythm devices such as pacemakers and defibrillators. This business segment, which makes up nearly 62% of total revenue, also reported considerably lower revenue growth compared to the last two years.
On the bright side, St. Jude reiterated its profit guidance for the full year, and gave a third-quarter forecast that was in line with estimates. The company also said it authorized a buyback of up to $500 million in stock.
--
Peter J. Lazaroff
Some Specifics on CIT’s Emergency Funding from PIMCO and Friends
The interest rate for the 2.5 year loan is set at 1000 bps over Libor, with Libor floored at 3%. That means the rate will be 13% annually, payable monthly, and will increase only after Libor rises above 3%. Libor is currently at .5%.
CIT will pay a 5% commitment fee when they draw on the funds. This amounts to the lenders buying a 13% floating rate bond at a 95 dollar price. Which comes out to a 15.4% yield at the current coupon.
The loan to CIT is collateralized with assets with a book value of at least 5 times that of the funds drawn from the facility and the collateral must maintain a fair value of 3 times that of the loan. This part of the agreement makes the emergency loan essentially risk free for the lenders. If CIT defaults, the lenders will receive the collateral, which I would assume the lending group would be alright with considering those terms.
Talk about being desperate. This deal sounds better than the Treasury’s Super Senior Preferreds.
Cliff J. Reynolds Jr., Investment Analyst
CIT will pay a 5% commitment fee when they draw on the funds. This amounts to the lenders buying a 13% floating rate bond at a 95 dollar price. Which comes out to a 15.4% yield at the current coupon.
The loan to CIT is collateralized with assets with a book value of at least 5 times that of the funds drawn from the facility and the collateral must maintain a fair value of 3 times that of the loan. This part of the agreement makes the emergency loan essentially risk free for the lenders. If CIT defaults, the lenders will receive the collateral, which I would assume the lending group would be alright with considering those terms.
Talk about being desperate. This deal sounds better than the Treasury’s Super Senior Preferreds.
Cliff J. Reynolds Jr., Investment Analyst
Boeing reports decent results
Boeing (BA) second-quarter results beat expectations with profits jumping 17%, reflecting a year-earlier charge and strength at its defense business.
Boeing said it has identified a “technical solution” to the problem that caused the Dreamliner’s fifth delay and said an updated schedule will be released sometime in the third quarter. The Seattle Times reported today that the maiden flight is four to six months away, according to unidentified engineers with knowledge of the problem. The newspaper said Boeing must redesign the area where the 787’s wing joins the fuselage, and parts are difficult to install on the test planes that already have been built.
Revenue and total commercial airplane deliveries were roughly flat in the quarter, but the second half numbers should look strong due to very easy comparables (due to last year’s machinists’ strike). The defense business saw revenues rise 9% and operating earnings grow 38%, with growth in all underlying segments.
Operating cash flow totaled $1 billion during the period, marking a reversal of an operating cash outflow in the same quarter last year. Total company backlog fell 3% sequentially as Boeing continues to eat away at this large buffer – the commercial airplane segment’s backlog of $257 billion is still more than seven times annual segment revenue, however.
Given the well-known challenges with its commercial and defense markets, Boeing’s results should be viewed positively.
--
Peter J. Lazaroff
Boeing said it has identified a “technical solution” to the problem that caused the Dreamliner’s fifth delay and said an updated schedule will be released sometime in the third quarter. The Seattle Times reported today that the maiden flight is four to six months away, according to unidentified engineers with knowledge of the problem. The newspaper said Boeing must redesign the area where the 787’s wing joins the fuselage, and parts are difficult to install on the test planes that already have been built.
Revenue and total commercial airplane deliveries were roughly flat in the quarter, but the second half numbers should look strong due to very easy comparables (due to last year’s machinists’ strike). The defense business saw revenues rise 9% and operating earnings grow 38%, with growth in all underlying segments.
Operating cash flow totaled $1 billion during the period, marking a reversal of an operating cash outflow in the same quarter last year. Total company backlog fell 3% sequentially as Boeing continues to eat away at this large buffer – the commercial airplane segment’s backlog of $257 billion is still more than seven times annual segment revenue, however.
Given the well-known challenges with its commercial and defense markets, Boeing’s results should be viewed positively.
--
Peter J. Lazaroff
Daily Insight
U.S. stocks bounced between gain and loss several times yesterday but closed on the plus side even after pretty negative comments on the economy from Fed Chairman Bernanke. Earnings results, although very weak and revenues hammered, are beating estimates and this may have been what lifted stocks in the end. The gain pushed the broad market to a post-Election Day high.
The big earnings news of the day seemed to be Caterpillar’s results. The heavy-equipment maker whipped analysts’ estimates, even as earnings per share fell 58% from the year-ago period and sales plunged 41%. The firm raised its full-year earnings forecast (I’m not sure you can actually call their very wide range of $1.15 - $2.25 per share much guidance) as even the low end of this range is above the previous forecast of $1.12. Cat stated global stimulus plans (namely out of China) will help results. The news boosted basic material shares, and this is why you want to own the sector, or names related to it.
Health-care shares led the advance with utilities, energy and the aforementioned materials recording a nice session too. There is a possibility that Congress will wait until after the August recess to vote on health-care legislation. If they do, it decreases the chances of passing as the longer this thing sits out the worse it looks. It’s probably not a coincidence that health-care shares led the broad market higher.
Advancer just about matched the number of shares that declined on the Big Board. Some 1.1 billion shares traded on the NYSE Composite – the three-month average is 1.3 billion per day.
Market Activity for July 21, 2009
Bernanke Testimony
The Fed Chief was on Capitol Hill yesterday testifying before Congress on the state of the economy and shedding some light on the FOMC’s exit strategy -- the process of unwinding the unprecedented monetary easing they’ve been in engaged in for 18 months now.
Rather than getting into the specifics of the tools by which they’ll be able to tighten, and they are many, let’s just say it may prove politically difficult for the central bank to remove much of this liquidity as the unemployment rate is likely to remain elevated for a prolonged period – and that political battle will be fought both within and outside of the Fed system. He’ll have to battle those on the policymaking committee who depend on the unemployment rate to drive their decision-making process and those in Congress who will also put pressure on the Fed to keep monetary policy loose if the jobless rate remains heightened ahead of elections in both 2010 and 2012 – that is if Bernanke is even around by that time, he’s up for re-appointment in January 2010.
At least the Chairman does acknowledge inflation expectations to be a risk in the not-too-distant future, which is more than one can say for a number of FOMC members who believe price levels cannot rise when economic slack is this large. By slack we mean high unemployment and low plant use. The Chairman did downplay inflation concerns in the near term.
On current policy, Bernanke said that the economy remains too weak to start tightening policy and that despite improvements the fed funds rate will remain near zero for an extended period. He seemed to concentrate on the potential for commercial real estate default rates to cause another blow to the system, which is a topic we’ve mentioned several times over the past few months. The Fed Head also mentioned that household spending remains a key risk because of continued job losses and falling home values. And speaking of the consumer...
Consumer Activity – Don’t Count it to Lead the Economy
Monday night I listened to an economist (one of reasonable prominence) who was saying consumer activity was coming back just like nearly every other business-cycle turn from contraction to expansion. The person interviewing him stated that private sector incomes are stagnant to falling, isn’t that going to keep activity depressed? The economist stated that this is always the case at the end of recession, and this doesn’t stop the consumer from releasing pent up tendencies to purchase, they’ll do the same this time.
Yes, it is true that incomes go stagnant – even short-term negative – at the end of recession and into the next expansion. Incomes do not rebound quickly, just as job creation lags. Nevertheless, I just don’t see how one can count on consumer activity rebounding in a sustained manner.
Why is it different this time? The reasons are copious. Consumers generally have access to fairly easy credit (very easy credit coming out of the previous downturn), but this is hardly the case this time. Further, it is extremely unusual for stocks to fall to this magnitiude (currently the S&P 500 is 40% off the peak and down 57% at the March 9 nadir) and also for falling home prices to beat the consumer into submission.
Before continuing on, let me explain to relatively newer readers that I was the guy ripping on the inaccurate “consumer is tapped out” phrase back in 2004, and then again in 2005 and 2007 when the term made a comeback. Nothing could have been farther from the truth. Expectations that tax rates would remain low were high, credit was easy, the unemployment rate stood at 5% and real income growth was solid. Also, home prices were flying and stocks were back to record highs (the wealth effect was rolling!).
But today we have not one of these factors helping out. I’m not going to say the consumer is “tapped out” but it will take some time to get things right again, dealing with the debt levels that a low interest rate environment encourages is difficult to manage around with incomes, stock/home prices and unemployment all tugging in the wrong direction. Oh, and I wouldn’t rule out a large increase in the social security cap, which would result in easily the largest tax hike in history. And this is a job killer too, don’t forget that a higher cap on FICA taxes raises the cost of employment. This makes resurgence in consumer activity all the more unlikely.
As a result, we are going to see personal consumption as a percentage of GDP move back to 65% (the historic average) from the current 71% -- this will be a huge drag on economic growth. This will not be a consumer led recovery; it will be a statistical recovery by which some inventory rebuilding takes place after record-setting liquidations and exports add to growth as they easily outpace import activity. But the inventory dynamic is more of a short-term pop than something that lasts for years and export-driven GDP advances results in fairly low levels of growth.
By 2010, we will then have the government side of GDP helping out (that’s when the bulk of the stimulus program is released), but this nearly trillion in spending has the chance of crowding out the private sector as funds are sapped from businesses, workers and investors via higher tax rates. Therefore, it may very well work against itself.
The Dollar
One final comment, speaking of export activity helping to drive GDP, White House Chief Economic Advisor Larry Summers made comments over the weekend on how the U.S. needs to drive policy in a direction so to fire up exports. The market reads this as a weak dollar policy – and this is a terrible message to send to trading partners as you can bet that export-driven Asian economies will now have a reason to drive their currencies lower, this is how trade wars get started.
For sure the market is getting the message, as traders drive the greenback down again; the Dollar Index is back below 80. The Bush administration did a terrible job managing the dollar’s value, and certainly easy Fed policy did the most damage. One would hope for a turn in direction here but its going to be a while until sensible dollar policy returns, it seems.
Have a great day!
Brent Vondera
The big earnings news of the day seemed to be Caterpillar’s results. The heavy-equipment maker whipped analysts’ estimates, even as earnings per share fell 58% from the year-ago period and sales plunged 41%. The firm raised its full-year earnings forecast (I’m not sure you can actually call their very wide range of $1.15 - $2.25 per share much guidance) as even the low end of this range is above the previous forecast of $1.12. Cat stated global stimulus plans (namely out of China) will help results. The news boosted basic material shares, and this is why you want to own the sector, or names related to it.
Health-care shares led the advance with utilities, energy and the aforementioned materials recording a nice session too. There is a possibility that Congress will wait until after the August recess to vote on health-care legislation. If they do, it decreases the chances of passing as the longer this thing sits out the worse it looks. It’s probably not a coincidence that health-care shares led the broad market higher.
Advancer just about matched the number of shares that declined on the Big Board. Some 1.1 billion shares traded on the NYSE Composite – the three-month average is 1.3 billion per day.
Market Activity for July 21, 2009
Bernanke TestimonyThe Fed Chief was on Capitol Hill yesterday testifying before Congress on the state of the economy and shedding some light on the FOMC’s exit strategy -- the process of unwinding the unprecedented monetary easing they’ve been in engaged in for 18 months now.
Rather than getting into the specifics of the tools by which they’ll be able to tighten, and they are many, let’s just say it may prove politically difficult for the central bank to remove much of this liquidity as the unemployment rate is likely to remain elevated for a prolonged period – and that political battle will be fought both within and outside of the Fed system. He’ll have to battle those on the policymaking committee who depend on the unemployment rate to drive their decision-making process and those in Congress who will also put pressure on the Fed to keep monetary policy loose if the jobless rate remains heightened ahead of elections in both 2010 and 2012 – that is if Bernanke is even around by that time, he’s up for re-appointment in January 2010.
At least the Chairman does acknowledge inflation expectations to be a risk in the not-too-distant future, which is more than one can say for a number of FOMC members who believe price levels cannot rise when economic slack is this large. By slack we mean high unemployment and low plant use. The Chairman did downplay inflation concerns in the near term.
On current policy, Bernanke said that the economy remains too weak to start tightening policy and that despite improvements the fed funds rate will remain near zero for an extended period. He seemed to concentrate on the potential for commercial real estate default rates to cause another blow to the system, which is a topic we’ve mentioned several times over the past few months. The Fed Head also mentioned that household spending remains a key risk because of continued job losses and falling home values. And speaking of the consumer...
Consumer Activity – Don’t Count it to Lead the Economy
Monday night I listened to an economist (one of reasonable prominence) who was saying consumer activity was coming back just like nearly every other business-cycle turn from contraction to expansion. The person interviewing him stated that private sector incomes are stagnant to falling, isn’t that going to keep activity depressed? The economist stated that this is always the case at the end of recession, and this doesn’t stop the consumer from releasing pent up tendencies to purchase, they’ll do the same this time.
Yes, it is true that incomes go stagnant – even short-term negative – at the end of recession and into the next expansion. Incomes do not rebound quickly, just as job creation lags. Nevertheless, I just don’t see how one can count on consumer activity rebounding in a sustained manner.
Why is it different this time? The reasons are copious. Consumers generally have access to fairly easy credit (very easy credit coming out of the previous downturn), but this is hardly the case this time. Further, it is extremely unusual for stocks to fall to this magnitiude (currently the S&P 500 is 40% off the peak and down 57% at the March 9 nadir) and also for falling home prices to beat the consumer into submission.
Before continuing on, let me explain to relatively newer readers that I was the guy ripping on the inaccurate “consumer is tapped out” phrase back in 2004, and then again in 2005 and 2007 when the term made a comeback. Nothing could have been farther from the truth. Expectations that tax rates would remain low were high, credit was easy, the unemployment rate stood at 5% and real income growth was solid. Also, home prices were flying and stocks were back to record highs (the wealth effect was rolling!).
But today we have not one of these factors helping out. I’m not going to say the consumer is “tapped out” but it will take some time to get things right again, dealing with the debt levels that a low interest rate environment encourages is difficult to manage around with incomes, stock/home prices and unemployment all tugging in the wrong direction. Oh, and I wouldn’t rule out a large increase in the social security cap, which would result in easily the largest tax hike in history. And this is a job killer too, don’t forget that a higher cap on FICA taxes raises the cost of employment. This makes resurgence in consumer activity all the more unlikely.
As a result, we are going to see personal consumption as a percentage of GDP move back to 65% (the historic average) from the current 71% -- this will be a huge drag on economic growth. This will not be a consumer led recovery; it will be a statistical recovery by which some inventory rebuilding takes place after record-setting liquidations and exports add to growth as they easily outpace import activity. But the inventory dynamic is more of a short-term pop than something that lasts for years and export-driven GDP advances results in fairly low levels of growth.
By 2010, we will then have the government side of GDP helping out (that’s when the bulk of the stimulus program is released), but this nearly trillion in spending has the chance of crowding out the private sector as funds are sapped from businesses, workers and investors via higher tax rates. Therefore, it may very well work against itself.
The Dollar
One final comment, speaking of export activity helping to drive GDP, White House Chief Economic Advisor Larry Summers made comments over the weekend on how the U.S. needs to drive policy in a direction so to fire up exports. The market reads this as a weak dollar policy – and this is a terrible message to send to trading partners as you can bet that export-driven Asian economies will now have a reason to drive their currencies lower, this is how trade wars get started.
For sure the market is getting the message, as traders drive the greenback down again; the Dollar Index is back below 80. The Bush administration did a terrible job managing the dollar’s value, and certainly easy Fed policy did the most damage. One would hope for a turn in direction here but its going to be a while until sensible dollar policy returns, it seems.
Have a great day!
Brent Vondera
Fixed Income Recap
Bernanke’s comments, beginning with his op-ed that was published in yesterday’s Wall Street Journal and continuing into the early afternoon with his testimony on Capitol Hill, sent Treasuries higher and rates lower.
The Fed Chairman stressed the wide range of tools available to the Federal Open Market Committee including beginning to liquidate their portfolio of Treasuries and MBS, cutting back their lending facilities such as TALF, and entering into reverse repo agreements that pull money out of the system. Bernanke also discussed a new tool the Fed has at their disposal. In the fall Congress gave the Fed the authority to pay interest on reserves that banks are required to hold at the Federal Reserve. That rate is currently in line with Fed Funds (.25%), but can be adjusted to persuade some banks to either hold more than the required amount at the Federal Reserve or charge more on loans they make. Either of these outcomes would result in a contraction of money. Bernanke again said, “The FOMC anticipates that economic conditions are likely to warrant maintaining the federal funds rate at exceptionally low levels for an extended period”, maintaining the stance that although there are many things the Fed can do to pull back liquidity, they don’t plan to do anything for some time.
Bernanke of course did a little self glorification, citing the alphabet soup of programs like TALF, MMIFF, TSLF and CPFF. I agree that the financial landscape as a whole looks much better than it did last fall, but at times the programs appeared less like a series of calculated steps and more like the Fed was blindly throwing handful of darts at the board, and then cheering when one stuck. Many will argue that all of the programs were necessary. Others will say that programs like TALF will never reach their lofty goals, ($1 trillion anticipated vs. less than $30 billion done so far).
Bernanke’s speech quelled inflation concerns a bit as TIPS breakevens eased and the curve flattened. The risk still lies in the Fed’s ability to ratchet back the liquidity at the right time, both in term of using their tools effectively and being left to act independently.
Cliff J. Reynolds Jr., Investment Analyst
The Fed Chairman stressed the wide range of tools available to the Federal Open Market Committee including beginning to liquidate their portfolio of Treasuries and MBS, cutting back their lending facilities such as TALF, and entering into reverse repo agreements that pull money out of the system. Bernanke also discussed a new tool the Fed has at their disposal. In the fall Congress gave the Fed the authority to pay interest on reserves that banks are required to hold at the Federal Reserve. That rate is currently in line with Fed Funds (.25%), but can be adjusted to persuade some banks to either hold more than the required amount at the Federal Reserve or charge more on loans they make. Either of these outcomes would result in a contraction of money. Bernanke again said, “The FOMC anticipates that economic conditions are likely to warrant maintaining the federal funds rate at exceptionally low levels for an extended period”, maintaining the stance that although there are many things the Fed can do to pull back liquidity, they don’t plan to do anything for some time.
Bernanke of course did a little self glorification, citing the alphabet soup of programs like TALF, MMIFF, TSLF and CPFF. I agree that the financial landscape as a whole looks much better than it did last fall, but at times the programs appeared less like a series of calculated steps and more like the Fed was blindly throwing handful of darts at the board, and then cheering when one stuck. Many will argue that all of the programs were necessary. Others will say that programs like TALF will never reach their lofty goals, ($1 trillion anticipated vs. less than $30 billion done so far).
Bernanke’s speech quelled inflation concerns a bit as TIPS breakevens eased and the curve flattened. The risk still lies in the Fed’s ability to ratchet back the liquidity at the right time, both in term of using their tools effectively and being left to act independently.
Cliff J. Reynolds Jr., Investment Analyst
Tuesday, July 21, 2009
FCFS cashes in on Mexico
Pawn shop operator and payday lender First Cash Financial Services (FCFS) posted a 42% increase profits, helped by higher revenue from its Mexico pawn operations, and reaffirmed its 2009 profit outlook.
U.S. payday loan revenue fell 10% for the quarter and the company is investing more in their pawn operations as stricter regulations and rising unemployment make payday loans less attractive.
Pawn revenue from its Mexico operations rose 31% to $40.2 million and U.S. pawn revenue rose 4% to $30.1 million. Because access to consumer finance is limited in Mexico, the country has a huge market for pawn lending. In addition, Mexico’s culture is more accepting of these types of lending arrangements than the U.S. The company said it is on pace to meet its target of 55 to 60 new store openings in Mexico during 2009.
First Cash’s older and more mature network of operations in Mexico allows them to capture more growth than their competitors. Management expects the new and existing store base in Mexico to be a strong source of revenue and profit growth for years to come.
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Peter J. Lazaroff
U.S. payday loan revenue fell 10% for the quarter and the company is investing more in their pawn operations as stricter regulations and rising unemployment make payday loans less attractive.
Pawn revenue from its Mexico operations rose 31% to $40.2 million and U.S. pawn revenue rose 4% to $30.1 million. Because access to consumer finance is limited in Mexico, the country has a huge market for pawn lending. In addition, Mexico’s culture is more accepting of these types of lending arrangements than the U.S. The company said it is on pace to meet its target of 55 to 60 new store openings in Mexico during 2009.
First Cash’s older and more mature network of operations in Mexico allows them to capture more growth than their competitors. Management expects the new and existing store base in Mexico to be a strong source of revenue and profit growth for years to come.
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Peter J. Lazaroff
Quest Diagnostics (DGX)
Quest Diagnostics (DGX) reported that profit grew 17% in the second quarter as the diagnostic testing company improved margins and revenues. Cost cutting efforts, positive revenue mix, and the increased Medicare fee for lab testing contributed to higher prices and improved margins.
A 4.6% increase in pricing per test drove the 4% revenue growth in clinical testing, which accounts for about 91% of total revenues. Testing volume declined 0.6% year-over-year as drug-abuse testing tumbled 24%. This drop-off was expected since drug-abuse testing is highly sensitive to hiring and companies are ordering fewer drug tests for new employees. Excluding drug-abuse testing, testing volume grew 1.1%.
Quest raised its 2009 earnings projections citing increased demand for testing for cancer, sexually transmitted diseases, and allergies. We can’t expect pre-employment drug screening to rebound in the near-term, but at least we know that Quest can grow revenues and profits in a difficult environment.
A 4.6% increase in pricing per test drove the 4% revenue growth in clinical testing, which accounts for about 91% of total revenues. Testing volume declined 0.6% year-over-year as drug-abuse testing tumbled 24%. This drop-off was expected since drug-abuse testing is highly sensitive to hiring and companies are ordering fewer drug tests for new employees. Excluding drug-abuse testing, testing volume grew 1.1%.
Quest raised its 2009 earnings projections citing increased demand for testing for cancer, sexually transmitted diseases, and allergies. We can’t expect pre-employment drug screening to rebound in the near-term, but at least we know that Quest can grow revenues and profits in a difficult environment.
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Peter J. Lazaroff
UnitedHeath Group (UNH) tops Street's view
Higher premiums and growing Medicare enrollment helped UnitedHealth Group (UNH) beat analysts’ estimates and the health insurer raised the lower end of its 2009 forecast. Profit of 73 cents a share was more than double the prior-year number; however, earnings only improved 8% when excluding the prior-year charges including a legal settlement. (Still a solid improvement, but it’s necessary to clarify.)
Revenues rose 7% to $21.66 billion, despite a 5.5% yearly decline in commercial membership. Revenue growth was driven by pricing increases as well as membership gains in the government business (Medicare and Medicaid).
The medical-loss ratio – the percentage of premium revenue used to pay patient bills – rose to 83.6% from 83.2% a year earlier. Medical expenses are watched as an indicator of future industry profits. The uptick in the medical-loss ratio was a result of increases in costlier Medicare and Medicaid patients, as well as increased illness due to the H1N1 swine flu virus.
While UnitedHealth had a good quarter, but the reliance on government business raises caution and might deter excitement about this outperformance. The government business could be less profitable for the company in the long run as payments from their government plans are expected to fall.
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Peter J. Lazaroff
Revenues rose 7% to $21.66 billion, despite a 5.5% yearly decline in commercial membership. Revenue growth was driven by pricing increases as well as membership gains in the government business (Medicare and Medicaid).
The medical-loss ratio – the percentage of premium revenue used to pay patient bills – rose to 83.6% from 83.2% a year earlier. Medical expenses are watched as an indicator of future industry profits. The uptick in the medical-loss ratio was a result of increases in costlier Medicare and Medicaid patients, as well as increased illness due to the H1N1 swine flu virus.
While UnitedHealth had a good quarter, but the reliance on government business raises caution and might deter excitement about this outperformance. The government business could be less profitable for the company in the long run as payments from their government plans are expected to fall.
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Peter J. Lazaroff
Lockheed Martin (LMT) disappoints
Lockheed Martin’s (LMT) profit fell 17% on pension-related charges and delays (due to protests) to three of its largest new information contracts. The quarterly profit decline is Lockheed’s largest since a 25% drop in the third quarter of 2003. Despite challenges, Lockheed remains on track to meet sales and earnings targets for 2009.
Revenues posted a slight gain of 1.8% to $11.24, but higher costs caused gross margins to decrease by 180 basis points. Sales increased at two of Lockheed’s four businesses, information systems and aircraft, and declined at the other two, electronics and space.
Lockheed is the first of the five largest U.S. defense companies to report earnings this quarter. The defense industry is coping with changes in the U.S. defense budget, with some programs still up in the air. Lockheed has already gotten backing for its biggest program, the F-35 Joint Strike Fighter, which will account for 10% of sales this year and could make up 15% to 20% of revenue in the next five to seven years.
These results were not what the market was looking for, but at least Lockheed was able to maintain its financial guidance, primarily because of the size and breadth of their portfolio.
Another positive is that Lockheed continues to generate strong cash flows, $2.4 billion in the second quarter, which the company expects to continue using for repurchasing shares, paying dividends, and making acquisitions.
Lockheed has a bit more expensive valuation relative to its peers, but this pull back may present a nice opportunity to invest in the largest defense company in the U.S. Check out my March 5 post, which has many of the reasons I like Lockheed as a long-term investment.
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Peter J. Lazaroff
Revenues posted a slight gain of 1.8% to $11.24, but higher costs caused gross margins to decrease by 180 basis points. Sales increased at two of Lockheed’s four businesses, information systems and aircraft, and declined at the other two, electronics and space.
Lockheed is the first of the five largest U.S. defense companies to report earnings this quarter. The defense industry is coping with changes in the U.S. defense budget, with some programs still up in the air. Lockheed has already gotten backing for its biggest program, the F-35 Joint Strike Fighter, which will account for 10% of sales this year and could make up 15% to 20% of revenue in the next five to seven years.
These results were not what the market was looking for, but at least Lockheed was able to maintain its financial guidance, primarily because of the size and breadth of their portfolio.
Another positive is that Lockheed continues to generate strong cash flows, $2.4 billion in the second quarter, which the company expects to continue using for repurchasing shares, paying dividends, and making acquisitions.
Lockheed has a bit more expensive valuation relative to its peers, but this pull back may present a nice opportunity to invest in the largest defense company in the U.S. Check out my March 5 post, which has many of the reasons I like Lockheed as a long-term investment.
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Peter J. Lazaroff
Cost-cutting, not revenue growth boosts earnings
As I sat on my couch eating Honey-Nut Cheerios and watched earnings releases from Caterpillar (CAT) and United Technologies (UTX), among others, it occurred to me that many companies thus far were beating earnings expectations on cost cutting rather than sales growth. Apparently Brent noticed the same thing as he was writing today’s Daily Insight.
To echo Brent’s comments, expectations are extremely low and it would be nice to see more revenue growth in these reports. Of course, we don't view these cost cuts as a bad thing. After all, this is what a business cycle is all about. Companies trim fat during a downturn so that they are more efficient and productive when the expansion phase of the cycle returns. It’s pretty obvious that the second-half will have easier comparisons and those companies that have trimmed excesses will post nice profits.
What should raise red flags are companies that are not aggressively trying to reduce costs. It is crucial for companies to be as lean as possible going forward – especially with the growing fear of a “double-dip” recession, or W-shaped recovery.
To echo Brent’s comments, expectations are extremely low and it would be nice to see more revenue growth in these reports. Of course, we don't view these cost cuts as a bad thing. After all, this is what a business cycle is all about. Companies trim fat during a downturn so that they are more efficient and productive when the expansion phase of the cycle returns. It’s pretty obvious that the second-half will have easier comparisons and those companies that have trimmed excesses will post nice profits.
What should raise red flags are companies that are not aggressively trying to reduce costs. It is crucial for companies to be as lean as possible going forward – especially with the growing fear of a “double-dip” recession, or W-shaped recovery.
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Peter J. Lazaroff
Caterpillar surges for second straight day
Profits at Caterpillar (CAT), the world’s largest maker of bulldozers and excavators, fell 66%, but still crushed expectations as cost cutting offset a disappointing 41% slide in revenues.
Yesterday, shares advanced 7.83% on an analyst upgrade that called a bottom for the construction market. The analyst predicted Caterpillar’s second-quarter results would mark the bottom for the company’s machinery unit and the engine segment will stabilize in the second half of 2009.
Today, shares are marching higher on optimism from management and upside guidance. CEO Jim Owens sees “signs of stabilization” as stimulus programs and improved credit markets helped stabilize demand.
The company raised its full-year forecast to $1.15 to $2.25 a share, above analysts’ average estimate of $1.12. Sales will be from $32 billion to $36 billion for the year, in line with the average estimate of $34.8 billion.
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Peter J. Lazaroff
Yesterday, shares advanced 7.83% on an analyst upgrade that called a bottom for the construction market. The analyst predicted Caterpillar’s second-quarter results would mark the bottom for the company’s machinery unit and the engine segment will stabilize in the second half of 2009.
Today, shares are marching higher on optimism from management and upside guidance. CEO Jim Owens sees “signs of stabilization” as stimulus programs and improved credit markets helped stabilize demand.
The company raised its full-year forecast to $1.15 to $2.25 a share, above analysts’ average estimate of $1.12. Sales will be from $32 billion to $36 billion for the year, in line with the average estimate of $34.8 billion.
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Peter J. Lazaroff
United Technologies beat estimates by a penny
United Technologies’ (UTX) cost-cutting efforts helped second-quarter profit dropped 23% to $1.05 a share, beating estimates by a penny. As the recession impacts the markets for aerospace and building-construction products, UTX cut its full-year revenue and lowered the top end of profit guidance, but both cuts are in line with analysts’ estimates.
Revenues decreased 17% to $13.2 billion, short of estimates, with revenue at the company’s heating and ventilation-systems business (Carrier) falling 29% on a slide in commercial new-equipment orders. Carrier accounts for about one-fourth of UTX’s annual revenue. The only one of UTX’s business divisions to post sales and profit growth was the Sikorsky helicopter unit.
The company said restructuring costs hurt profits by about 22 cents a share during the quarter. Excluding restructuring costs and a non-cash gain from an Otis joint venture, all of UTX’s segments had operating margins of more than 10%. Currency effects – overseas sales account for about 60% of revenue – reduced profit by 11 cents a share.
CEO Louis Chenevert said orders remain lower than UTX anticipated, but “the rate of decline in orders across the businesses appears to have stabilized.” He added that he saw acquisition opportunities this year, especially in aerospace and the highly fragmented fire-security industry.
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Peter J. Lazaroff
Revenues decreased 17% to $13.2 billion, short of estimates, with revenue at the company’s heating and ventilation-systems business (Carrier) falling 29% on a slide in commercial new-equipment orders. Carrier accounts for about one-fourth of UTX’s annual revenue. The only one of UTX’s business divisions to post sales and profit growth was the Sikorsky helicopter unit.
The company said restructuring costs hurt profits by about 22 cents a share during the quarter. Excluding restructuring costs and a non-cash gain from an Otis joint venture, all of UTX’s segments had operating margins of more than 10%. Currency effects – overseas sales account for about 60% of revenue – reduced profit by 11 cents a share.
CEO Louis Chenevert said orders remain lower than UTX anticipated, but “the rate of decline in orders across the businesses appears to have stabilized.” He added that he saw acquisition opportunities this year, especially in aerospace and the highly fragmented fire-security industry.
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Peter J. Lazaroff
Daily Insight
U.S. stocks kept the rally alive, as the broad market added to last week’s gain, up 8% now over the past six sessions. The major indices began the session higher on the news that CIT was able to find a private-sector rescue, and building on this momentum after the June index of leading economic indicators increased for a third-straight month.
Real quick on CIT, basically they are going to need the FDIC and Federal Reserve to offer them an exemption so that they can transfer funds from the holding company to the bank. This $3 billion in financing the company has just received isn’t going to do much good with $8 billion in debt coming due in 2010. With the exemption, CIT will be able to use deposits to fund assets, largely with regard to their factoring business – factoring refers to the receivables that they own; basically, they buy receivable accounts from manufacturers, pay the manufacturer cash and collect the payments when the customers pay, plus the fee from the manufacturer for the immediate cash payment. Funding is needed for this and since their commercial paper funding has dried up, having the ability to use deposits to fund these operations is about the only thing that will keep CIT from bankruptcy. This is where the big bondholders come in. Many of these investors are politically connected, and now that they have even more money at risk with this additional $3 billion in financing they’ve provided. I’m going to bet they’ll convince the Fed and FDIC to offer the exemption – call me a cynic but I doubt this additional money would have been put at risk without the belief that they (the big bond players) would be able to persuade the authorities, if you will.
Also helping to boost prices was Goldman Sachs’ call for 1060 on the S&P 500 by year end – increasing their target from 940. I see that Credit Suisse has also upped their target this morning to 1050. These are very typical target-price increases, the big investment banks have a track record of increasing forecasts when things are running. I recall Goldman’s target price for oil of $200 per barrel last July when crude hit $140. Point is, while 1050-1060 is not out of the question – although I find it hard to believe and also pretty unjustified for the broad market to trade at 19-20 times earnings in this environment – don’t expect it just because the big guys are saying it.
The S&P 500 marched past the 946 hurdle yesterday (which had been a seven-month high) closing within two points of the post-Election Day high of 953. This time around the trailing P/E on the index is a bit richer at 15.3 times vs.13 back in November – although we’re naturally closer to a rebound in profits at this stage. We expect a statistical recovery to begin this quarter, likely the first positive GDP print in a full year by the time it is reported in October, and higher profits should result three-six months later. (My concern is that those results will prove short-lived as the direction of policy will do its best to choke off a nascent rebound). For now though, stock have momentum working, even the Dow Industrials have gone positive for the year.
Consumer discretionary shares led the rally, with basic material and industrial shares close behind. All 10 major industry groups closed to the plus side; the relative losers being traditional areas of safety, namely health care and consumer staple shares – it was only two weeks ago in which these safety trade sectors were in vogue. How quickly things change these days.
Market Activity for July 20, 2009
Early Excitement
This latest rally in stocks is largely on early profit reporting (just 20% of S&P 500 members have reported thus far) as 75% of firms have beat expectations – the longer-term average is closer 65%. But these are very low-quality earnings, the expectations bar is set very low. A couple of examples are yesterday morning’s release out of Johnson Controls (JCI) and last week’s results from Intel.
JCI stated operating earnings per share easily beat the expectation for 19 cents a share as actual results came in at 27 cents. However, this result means profit is down 64% from the year-ago period; revenue was down 30% and missed expectations. In terms of Intel, the chip giant reported earnings per share of 20 cents, which blew by the eight-cent estimate. Still, earnings were off by 31% from the year-ago period. Heck, DuPont’s results are just out this morning and their numbers easily surpassed the estimate by 15%. However, this number is 48% lower from the year-ago and next quarter’s figure is expected to be off by 44%. Revenues were down 22%.
Another thing to consider is a number of important industries that will post the largest profit declines have hardly reported. Energy profits were crushed in Q2, and just one of the 40 S&P 500 members within the industry has reported. Industrials were hit especially hard as well, probably showing 35%-40% decline in bottom line results; just seven of the 58 members in this industry have reported. Then we have basic material shares, hammered by the plunge in commodity prices and very soft mining activity. These firms ramped up production due to the commodity-price spike of last year, but couldn’t possibly adjust to the speed at which activity shut down – that destroys profit growth. Only 15% of these companies have reported. These three industries make up 25% of the S&P 500. Throw in financials (now your up to roughly 40% of the broad market) where only 16% have reported, and with earnings are on pace to decline 45% we’re looking at some real weakness.
As we’ve talked about many times now, earnings are beating expectations as the cost-cutting that has taken place was more massive than analysts calculated. Cost-cutting is a good thing and an essential aspect of economic downturns. Streamlining makes a business more sound and leads to higher profit results over the longer term, but we need to see final demand make a comeback and that means top-line growth, which we are not even close to seeing.
I just don’t think stocks have much more upside potential here (which absolutely does not mean prices won’t go higher, but in my view it will be unjustified) until we see improvement in revenue results and better-year-over-year bottom line growth, which is likely a ways out still. You’ve got to be careful not to chase these rallies, be patient and wait for your spots. High-powered profits may very well present occur a couple of quarters out (and that may be too optimistic) as the degree to which payrolls have been cut almost guarantees it, especially as year-ago comparisons will be much easier to beat. But this market is mercurial to the extreme and if the current earnings season fails to surpass expectations by the time all reports are in… well that’s why its important to pick your spots in these trading-range environments.
Leading Economic Indicators (LEI)
The Conference Board’s LEI index (a gauge that is supposed to predict economic activity six months out) increased for a third straight month in June, up 0.7% after strong readings in the prior two months of 1.3% and 1.0%, respectively. The components that contributed most to the last month’s reading were building permits, interest-rate spreads (the yield curve) and stock prices.
While seven of the 10 components rose in June, just like on earnings, I’d caution from making too much of this trend.
Building permits were the biggest contributor to LEI, accounting for a third of the index’s gain. When one factors in the high level of home supply and the likelihood that home sales (due to tough labor market conditions) are not likely to be sufficient to absorb this supply anytime soon, I don’t think we can count on residential building construction to propel this figure higher in a sustainable manner.
The interest-rate spread (much lower short-term rates than long term) component accounted for half of the gain in June LEI and a third of the May and April gains. The spread we often talk about is that between the 10-yr and 2-yr Treasury notes, which remains near a two-decade high (it may be an all-time high) of 275 basis points hit in late May. The actual spread measured by LEI is that between the 10-year and fed funds, which is ultra wide since the FOMC has pushed fed funds to essentially zero. While this spread is undoubtedly very helpful for growth, it is also a function of the Fed holding the short end very low. This spread is always a function of Fed policy, so no difference in that respect, but I don’t like to see the LEI index as dependent on this one component as it is today. Surely the ability for banks to borrow low and lend much higher is a huge incentive to make loans. But let’s not forget that it’s not only about the supply of loans, but the demand for credit is soft. Firms continue to cancel projects, there are fewer business upstarts and credit standards are much tighter – and appropriately so. Even a massively upwardly sloping yield curve can’t fix this, only time can mend this situation.
Then we have stock prices, which accounted for 15% of the pick up in LEI (so these three components were responsible for 98% of the June increase), and with the activity we’ve seen over the past several months – rallies met by subsequent weakness that has kept us range bound – it’s tough to view stocks as an indicator that economic conditions have changed to an environment in which we’ll see the typical business cycle expansion.
What’s more, what I consider one of the most important components of the index (orders for business equipment) declined in June. As business managers have expressed via earnings reports, firms continue to delay equipment purchases and one should be concerned this trend will continue as economic policy (specifically higher tax rates on small business) is not inspiring the outlook for growth over the next two years. This component has to rise in order to confirm what LEI is suggesting.
All of this said, a rising LEI is certainly better than it declining, as it did in 16 of the previous 18 months prior to this three-month trend higher. However, as we’ve expressed a number of times, one needs to be carful here as the normal indicators may not be as reliable as is usually the case. In a letter back June I stated that June will be the month by which the NBER (official arbiter of the business cycle) marks the end to this recession. We may have to push this up to July or August, but when they do call it one of these months will mark their end date. However, things may remain quite soft even as we do rebound because we see the eventual expansion as a statistical bounce off of very low levels of activity. The economy will have to deal with a few serious drags on growth, specifically consumer activity that will take an extended period of time to come back.
Caterpillar is just out with earnings results as I type. The heavy-equipment maker destroyed the estimate, reporting 72 cents per share vs. the 22-cent estimate. This has turned stock futures to positive territory. Cat’s year-over-year results are down 58% and revenue was crushed, off by 41%.
Have a great day!
Brent Vondera
Real quick on CIT, basically they are going to need the FDIC and Federal Reserve to offer them an exemption so that they can transfer funds from the holding company to the bank. This $3 billion in financing the company has just received isn’t going to do much good with $8 billion in debt coming due in 2010. With the exemption, CIT will be able to use deposits to fund assets, largely with regard to their factoring business – factoring refers to the receivables that they own; basically, they buy receivable accounts from manufacturers, pay the manufacturer cash and collect the payments when the customers pay, plus the fee from the manufacturer for the immediate cash payment. Funding is needed for this and since their commercial paper funding has dried up, having the ability to use deposits to fund these operations is about the only thing that will keep CIT from bankruptcy. This is where the big bondholders come in. Many of these investors are politically connected, and now that they have even more money at risk with this additional $3 billion in financing they’ve provided. I’m going to bet they’ll convince the Fed and FDIC to offer the exemption – call me a cynic but I doubt this additional money would have been put at risk without the belief that they (the big bond players) would be able to persuade the authorities, if you will.
Also helping to boost prices was Goldman Sachs’ call for 1060 on the S&P 500 by year end – increasing their target from 940. I see that Credit Suisse has also upped their target this morning to 1050. These are very typical target-price increases, the big investment banks have a track record of increasing forecasts when things are running. I recall Goldman’s target price for oil of $200 per barrel last July when crude hit $140. Point is, while 1050-1060 is not out of the question – although I find it hard to believe and also pretty unjustified for the broad market to trade at 19-20 times earnings in this environment – don’t expect it just because the big guys are saying it.
The S&P 500 marched past the 946 hurdle yesterday (which had been a seven-month high) closing within two points of the post-Election Day high of 953. This time around the trailing P/E on the index is a bit richer at 15.3 times vs.13 back in November – although we’re naturally closer to a rebound in profits at this stage. We expect a statistical recovery to begin this quarter, likely the first positive GDP print in a full year by the time it is reported in October, and higher profits should result three-six months later. (My concern is that those results will prove short-lived as the direction of policy will do its best to choke off a nascent rebound). For now though, stock have momentum working, even the Dow Industrials have gone positive for the year.
Consumer discretionary shares led the rally, with basic material and industrial shares close behind. All 10 major industry groups closed to the plus side; the relative losers being traditional areas of safety, namely health care and consumer staple shares – it was only two weeks ago in which these safety trade sectors were in vogue. How quickly things change these days.
Market Activity for July 20, 2009
Early ExcitementThis latest rally in stocks is largely on early profit reporting (just 20% of S&P 500 members have reported thus far) as 75% of firms have beat expectations – the longer-term average is closer 65%. But these are very low-quality earnings, the expectations bar is set very low. A couple of examples are yesterday morning’s release out of Johnson Controls (JCI) and last week’s results from Intel.
JCI stated operating earnings per share easily beat the expectation for 19 cents a share as actual results came in at 27 cents. However, this result means profit is down 64% from the year-ago period; revenue was down 30% and missed expectations. In terms of Intel, the chip giant reported earnings per share of 20 cents, which blew by the eight-cent estimate. Still, earnings were off by 31% from the year-ago period. Heck, DuPont’s results are just out this morning and their numbers easily surpassed the estimate by 15%. However, this number is 48% lower from the year-ago and next quarter’s figure is expected to be off by 44%. Revenues were down 22%.
Another thing to consider is a number of important industries that will post the largest profit declines have hardly reported. Energy profits were crushed in Q2, and just one of the 40 S&P 500 members within the industry has reported. Industrials were hit especially hard as well, probably showing 35%-40% decline in bottom line results; just seven of the 58 members in this industry have reported. Then we have basic material shares, hammered by the plunge in commodity prices and very soft mining activity. These firms ramped up production due to the commodity-price spike of last year, but couldn’t possibly adjust to the speed at which activity shut down – that destroys profit growth. Only 15% of these companies have reported. These three industries make up 25% of the S&P 500. Throw in financials (now your up to roughly 40% of the broad market) where only 16% have reported, and with earnings are on pace to decline 45% we’re looking at some real weakness.
As we’ve talked about many times now, earnings are beating expectations as the cost-cutting that has taken place was more massive than analysts calculated. Cost-cutting is a good thing and an essential aspect of economic downturns. Streamlining makes a business more sound and leads to higher profit results over the longer term, but we need to see final demand make a comeback and that means top-line growth, which we are not even close to seeing.
I just don’t think stocks have much more upside potential here (which absolutely does not mean prices won’t go higher, but in my view it will be unjustified) until we see improvement in revenue results and better-year-over-year bottom line growth, which is likely a ways out still. You’ve got to be careful not to chase these rallies, be patient and wait for your spots. High-powered profits may very well present occur a couple of quarters out (and that may be too optimistic) as the degree to which payrolls have been cut almost guarantees it, especially as year-ago comparisons will be much easier to beat. But this market is mercurial to the extreme and if the current earnings season fails to surpass expectations by the time all reports are in… well that’s why its important to pick your spots in these trading-range environments.
Leading Economic Indicators (LEI)
The Conference Board’s LEI index (a gauge that is supposed to predict economic activity six months out) increased for a third straight month in June, up 0.7% after strong readings in the prior two months of 1.3% and 1.0%, respectively. The components that contributed most to the last month’s reading were building permits, interest-rate spreads (the yield curve) and stock prices.
While seven of the 10 components rose in June, just like on earnings, I’d caution from making too much of this trend.
Building permits were the biggest contributor to LEI, accounting for a third of the index’s gain. When one factors in the high level of home supply and the likelihood that home sales (due to tough labor market conditions) are not likely to be sufficient to absorb this supply anytime soon, I don’t think we can count on residential building construction to propel this figure higher in a sustainable manner.
The interest-rate spread (much lower short-term rates than long term) component accounted for half of the gain in June LEI and a third of the May and April gains. The spread we often talk about is that between the 10-yr and 2-yr Treasury notes, which remains near a two-decade high (it may be an all-time high) of 275 basis points hit in late May. The actual spread measured by LEI is that between the 10-year and fed funds, which is ultra wide since the FOMC has pushed fed funds to essentially zero. While this spread is undoubtedly very helpful for growth, it is also a function of the Fed holding the short end very low. This spread is always a function of Fed policy, so no difference in that respect, but I don’t like to see the LEI index as dependent on this one component as it is today. Surely the ability for banks to borrow low and lend much higher is a huge incentive to make loans. But let’s not forget that it’s not only about the supply of loans, but the demand for credit is soft. Firms continue to cancel projects, there are fewer business upstarts and credit standards are much tighter – and appropriately so. Even a massively upwardly sloping yield curve can’t fix this, only time can mend this situation.
Then we have stock prices, which accounted for 15% of the pick up in LEI (so these three components were responsible for 98% of the June increase), and with the activity we’ve seen over the past several months – rallies met by subsequent weakness that has kept us range bound – it’s tough to view stocks as an indicator that economic conditions have changed to an environment in which we’ll see the typical business cycle expansion.
What’s more, what I consider one of the most important components of the index (orders for business equipment) declined in June. As business managers have expressed via earnings reports, firms continue to delay equipment purchases and one should be concerned this trend will continue as economic policy (specifically higher tax rates on small business) is not inspiring the outlook for growth over the next two years. This component has to rise in order to confirm what LEI is suggesting.
All of this said, a rising LEI is certainly better than it declining, as it did in 16 of the previous 18 months prior to this three-month trend higher. However, as we’ve expressed a number of times, one needs to be carful here as the normal indicators may not be as reliable as is usually the case. In a letter back June I stated that June will be the month by which the NBER (official arbiter of the business cycle) marks the end to this recession. We may have to push this up to July or August, but when they do call it one of these months will mark their end date. However, things may remain quite soft even as we do rebound because we see the eventual expansion as a statistical bounce off of very low levels of activity. The economy will have to deal with a few serious drags on growth, specifically consumer activity that will take an extended period of time to come back.Caterpillar is just out with earnings results as I type. The heavy-equipment maker destroyed the estimate, reporting 72 cents per share vs. the 22-cent estimate. This has turned stock futures to positive territory. Cat’s year-over-year results are down 58% and revenue was crushed, off by 41%.
Have a great day!
Brent Vondera
Fixed Income Recap
Treasuries started the morning lower but finished yesterday higher on a market oddity that follows large corporate debt issuance. Companies will either short Treasuries or enter into interest rate swaps in order to hedge against the risk of rates rising from the time the company decides to issue bonds to when the bonds actually price in the market. When a large amount of hedges are unwound all at once, it can have a material impact on the market. Short-staffed trading desks due to the vacation season exacerbated the move upward.
Atlanta Fed President Dennis Lockhart spoke yesterday on the Fed’s exit strategy, saying, "One should not assume at this point that extraordinary measures to shrink the balance sheet are required to contain inflationary pressures." Bernanke is scheduled to start two days of testimony today, where he is likely to continue the same sort of message. Although the minutes from the previous FOMC meetings show some member’s hesitation to increase lending and securities purchase programs, according to public statements by Lockhart and other Fed presidents a tighter overall policy is still a ways off. We will be listening to Bernanke’s comments closely to see if any more insight is given by the Fed Chairman.
Atlanta Fed President Dennis Lockhart spoke yesterday on the Fed’s exit strategy, saying, "One should not assume at this point that extraordinary measures to shrink the balance sheet are required to contain inflationary pressures." Bernanke is scheduled to start two days of testimony today, where he is likely to continue the same sort of message. Although the minutes from the previous FOMC meetings show some member’s hesitation to increase lending and securities purchase programs, according to public statements by Lockhart and other Fed presidents a tighter overall policy is still a ways off. We will be listening to Bernanke’s comments closely to see if any more insight is given by the Fed Chairman.
Cliff J. Reynolds Jr.
Monday, July 20, 2009
Quick Hits
- 7 Reasons Why Housing Isn’t Bottoming Yet
- Quiz: Some Surprising Trends in Global Aging
- U.S. Bailout Costs May Reach $23.7 Trillion, TARP Inspector Says
- Why Toxic Assets Are So Hard to Clean Up
- America is for now still blowing bubbles
- Bernanke May Hold Rates Down by Showing He Can Reverse Course
- U.S. Economy: Leading Index Shows Recession May Be Nearing End
The Always Improving Market of Credit Default Swaps
The cost of protecting bonds against default has improved greatly, and is essentially back to pre-Lehman collapse levels. Of the 125 companies represented in the index below, CIT is the most expensive, it will cost you $400k per year to insure $1mm in CIT bonds against default for five years. Other names that remain elevated include AIG ($160k/year/$1mm notional), GE Capital ($38k/year) and MetLife ($51k/year). Just for a comparison, the cheapest bonds to insure are those issued by AT&T ($2k/year/$1mm notional).
This weekend, CIT used a lifeline and phoned their friends, or a mobile shout out for those of you who prefer Cash Cab over Millionaire, but the CDS market didn’t even flinch at the possibility of CIT’s default. A good sign? Depends on how you look at it. From one perspective, perhaps CIT’s bankruptcy would be inconsequential to the market as a whole and the system could keep on its current path. Or maybe our memories are just too short for us to be worried about what could still become the fifth-largest bankruptcy in US history.
Cliff J. Reynolds Jr.
Cost cutting helps JCI get back in the black
Auto-parts and heating-systems maker Johnson Controls (JCI) reported fiscal third quarter earnings that topped expectations, as cost cutting initiatives partially offset lower-than-expected revenue.
Sales in the auto-parts division fell 38% to $3 billion, while the battery division revenues fell 39% to $856 million because of fewer orders from automakers. Johnson Controls gets 55% of its revenue from auto-parts and batteries units.
The rest of the company’s revenue come from the buildings-services division, which saw revenues drop 14% from a year ago as construction spending contracts and companies defer discretionary maintenance and retrofit projects.
Johnson Controls is bidding on about 2,700 projects worth about $800 million related to the U.S. government’s stimulus package. The company expects the stimulus programs to have a “meaningful positive impact on financial performance in the second half of fiscal 2010.”
Management said uncertainties remain in their businesses, but global automotive production “appears to be stabilizing.” In addition, management estimated that commercial buildings and residential HVAC markets would bottom in the next six to nine months.
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Peter J. Lazaroff
Sales in the auto-parts division fell 38% to $3 billion, while the battery division revenues fell 39% to $856 million because of fewer orders from automakers. Johnson Controls gets 55% of its revenue from auto-parts and batteries units.
The rest of the company’s revenue come from the buildings-services division, which saw revenues drop 14% from a year ago as construction spending contracts and companies defer discretionary maintenance and retrofit projects.
Johnson Controls is bidding on about 2,700 projects worth about $800 million related to the U.S. government’s stimulus package. The company expects the stimulus programs to have a “meaningful positive impact on financial performance in the second half of fiscal 2010.”
Management said uncertainties remain in their businesses, but global automotive production “appears to be stabilizing.” In addition, management estimated that commercial buildings and residential HVAC markets would bottom in the next six to nine months.
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Peter J. Lazaroff
Daily Insight
U.S. stocks ended mixed on Friday -- as the Dow and NASDAQ managed to close on the plus side, while the S&P 500 closed fractionally lower – but it was a very good week as the broad market gained nearly 7%. This followed four weeks of decline and unfortunately that’s what it takes for rallied these days. We’re closing in on the post-Election Day level again of 952 on the S&P 500 and about a half of a percentage point from 946, which has proven to be a mark we haven’t been able to eclipse for several months.
A good (all things considered) housing-market report helped to buoy stocks on Friday. Even though earnings reports are beating expectations, it looked like the market was going to fall apart in early trading as profit reports out of GE and Bank of America mirrored what JP Morgan’s earnings report clearly stated: the consumer is in trouble and delinquency rates continue to climb and commercial real estate issues are still in early innings. While more residential home building will not be helpful for supply, the market did like seeing a much better-than-expected housing starts figure and that helped to combat early-session weakness.
Tech, telecom, basic material and energy shares were the best performers. Financials and industrials were the laggards. Financials were hurt by rising consumer-segment default rates. Industrials probably had a little profit taking weighing on these shares after six-straight sessions in which the group jumped 10.2%.
Market Activity for July 17, 2009
Housing Starts
The Commerce Department reported that housing starts rose 3.6% in June after the large 17.3% jump in May as the figure came off of a the all-time low hit in April. But unlike last month’s increase, in which the very volatile multi-family segment drove the reading higher, single-family construction drove the June reading. (Multi-family starts fell 25.8% in June after a massive 65.9% jump in May; single-family units were up just 5.9%. In this latest reading singles were up a strong 14.4%). For a bit of perspective, housing starts are down 46% from June 2008.
While this reading will be good for GDP – residential construction accounts for about 3% of GDP – we don’t really need more supply. Sales need to rise in order to absorb this supply and that is going to be tough with the labor market in the shape it is in. The sales data will be helped as mortgage rates have come lower again, hovering just above 5% on the 30-year fixed rate. Foreclosures continue to rise though (up 33% in June from a year-ago) and that also adds supply.
What we have here are probably offsetting developments. The low rates will help but I’m not sure how long they’ll stay down, that short-term scare we got via higher rates about a month ago underscore this issue. Too, I’m just not sure the rate environment is enough, outside of one-two month pops, to offset the labor market and foreclosure conditions.
Public Health Care
The national health-care bill made it through committee on Thursday night and the way they plan on paying for it is by burdening the successful. You burden the only people with the means to pull this economy out of its doldrums and the results aren’t going to be pretty. Whether it’s adding surtaxes to top income tax rates that will already rise alone (and how weak is that, if you’re a politician that believes in higher tax rates then say it instead of some mealy-mouthed “surtax” locution) or boosting the tax burden on small businesses that have payrolls over $400,000 the middle class is hurt far more than the wealthy people that politicians have bulls-eyed. The top tax bracket will see their federal rate move to 39.6% at the end of 2010, then they’ll have this 5.4% “surcharge” added on if the legislation passes (and even in this Congress it’s hard to believe it will). On small business, those firms that have payrolls of $400K and do not offer health-care plans will be hit with an additional eight percentage point payroll tax – that brings the rate to roughly 23% from 15%; this is on top of income taxes. Individuals who do not buy health insurance will be smacked with an additional 2-5% tax.
These people aren’t this stupid are they? What do you think small businesses will do? They’ll make damn sure their payrolls remain below $400,000 and that doesn’t exactly bode well for job creation.
Outside of the burden related to paying for this insanity, there are even larger implications to national health care. You like freedom? Then you don’t like government-run medical insurance. I think people will be amazed how quickly national health care will meld into the government’s right to tell you how to live your life in order to access this health care.
A well-known remark from Thoreau: “If I knew for certain that a man was coming to my house with the conscious design of doing me good, I should run for my life.” What one views as “good” for you, may be quite different from what you yourself consider as good. Too many people these days are more than willing to allow government the power to state what is good for them. If this trend continues to roll, individual freedom will evaporate at blinding speed.
When President Clinton engaged in his shot at national health-care it ran into a brick wall as his party didn’t have a huge majority, his poll-driven tendencies caused him to pullback and the nation still had more of it individual ruggedness/self-reliant principles intact. Currently, I’m not sure those principles are fully intact, President Obama is rushing to get this thing done as he races to outrun his declining poll numbers and the proponents of this catastrophic bill have a huge majority.
If this thing fails to pass, I think it’s a sign to marginally become longer-term bullish. On the other hand, if it passes, I’m sorry, but I don’t see how one can expect past growth rates to continue.
Futures
Stock-index futures are higher this morning on news that CIT found some private-sector financing to stave off bankruptcy for now. While the situation at CIT illustrates the fragile nature of things (their inability to get normal financing in order to fund operations), the fact that we’ve got private-sector vultures willing to step up to offer the firm a lifeline I think is pretty optimistic – even if the terms of the financing is austere – 10.5% for 2.5 years).
CIT remains in a precarious situation as 2.5-year funding is not exactly the same thing as capital, and the uncertainty within the entire system is heightened in fact as banks still rely on FDIC backstopping to issue debt – at least at terms that are not strict. CIT was not awarded FDIC backstopping (the TGLP program), hence their problems.
Have a great day!
Brent Vondera
Fixed Income Recap
Treasuries turned lower and rates higher as the short end outperformed to move the curve steeper by 6.5 bps to +265.5, the steepest it has been since June 4.
CIT Grouped staved off bankruptcy this weekend by securing $3 billion in financing from existing bondholders including PIMCO. Many of the details are not yet public because some specifics have yet to be hammered out, but the cost of the financing is rumored to be 1000 bps over three-month Libor, (50.5 bps as of this morning), and may require CIT to post specific collateral in exchange for the loan, according to The Wall Street Journal. The deal, expected to be officially announced later today is more of a temporary band aid than a cure all. It does solve CIT’s short term liquidity problems, but still leans on some sort of debt restructuring in the future.
A group of outside lenders, including JP Morgan, were in talks with CIT Friday to provide debtor in possession financing, a form of financing for companies wishing to maintain operations during bankruptcy protection. To see CIT’s situation deteriorate so far as to take steps to negotiate that kind of financing, but instead emerge with a plan that gives Cit the chance to restructure outside of Chapter 11 is a decent sign. CIT’s chances of restructuring existing debt also improves as current bondholders put more on the line to protect their existing stake. However, over 10% for short term financing is very expensive and details the risk that existing lenders see with the deal. The longer CIT takes to restructure its debt load the more penalizing that rate will be.
Cliff J. Reynolds Jr., Investment Analyst
CIT Grouped staved off bankruptcy this weekend by securing $3 billion in financing from existing bondholders including PIMCO. Many of the details are not yet public because some specifics have yet to be hammered out, but the cost of the financing is rumored to be 1000 bps over three-month Libor, (50.5 bps as of this morning), and may require CIT to post specific collateral in exchange for the loan, according to The Wall Street Journal. The deal, expected to be officially announced later today is more of a temporary band aid than a cure all. It does solve CIT’s short term liquidity problems, but still leans on some sort of debt restructuring in the future.
A group of outside lenders, including JP Morgan, were in talks with CIT Friday to provide debtor in possession financing, a form of financing for companies wishing to maintain operations during bankruptcy protection. To see CIT’s situation deteriorate so far as to take steps to negotiate that kind of financing, but instead emerge with a plan that gives Cit the chance to restructure outside of Chapter 11 is a decent sign. CIT’s chances of restructuring existing debt also improves as current bondholders put more on the line to protect their existing stake. However, over 10% for short term financing is very expensive and details the risk that existing lenders see with the deal. The longer CIT takes to restructure its debt load the more penalizing that rate will be.
Cliff J. Reynolds Jr., Investment Analyst
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