Busted Indeed

By David Ott
In mid-May, the New York Times Magazine printed an excerpt from the book, Busted: Life inside the Great Mortgage Meltdown, by Edmund Andrews.

The article is fantastic and gripping because Andrews is a well-educated economics reporter for the Times, but in the article he seems like a true victim of the subprime mortgage crisis. The reader is definitely left with the feeling that what happened to him could happen to anyone.

When I saw the book at the airport, I was caught by the opening pages where Andrews confronts then Federal Reserve Chairman Alan Greenspan about his personal situation. Admittedly, Schadenfreude also played a role in my impulse buy.

The book is much like the article with much greater detail. Andrews describes the divorce of his wife of 21 years and how he sets out to live the American dream with his new wife, Patti. To live that dream, they need a house they can’t afford. As he says early in the book about his new house, “I couldn’t afford it, but that didn’t mean I couldn’t buy it.”

Sure enough, during the housing and credit bubbles, there were plenty of financial institutions willing to lend them money on very easy terms. One of the best characters in the book is his mortgage lender, Bob, who says, “I am here to enable dreams.”

With Bob’s help, Andrews starts with a ‘liar’s loan’ so that he doesn’t have to produce pay stubs or tax returns that would prove that he can’t afford the loan. As their situation deteriorates, Bob is always able to find a creative solution. Five years later, unable to have ever been able to make ends meet, the Andrews become delinquent on their mortgage.

Despite his angry tone, Andrews is straightforward about not being a victim, despite the tenor of the original Times article. He says time and time again that he knew what he was doing; it was a gamble for the love of his life that seemed rational during an irrational time.

Andrews delivers very clear, well-written explanations of the entire mortgage ecosystem, from the mortgage broker to the investment banks. He even uses his investigative journalism skills to figure out which toxic mortgage security ends up owning one of his loans.

The trouble with Busted, though, is that despite being a professional reporter, he fails to mention some key facts. A blogger for The Atlantic, Megan McArdle, found that his new wife Patti had some financial troubles that he didn’t feel were worth mentioning.

In fact, Pattie had declared bankruptcy twice before. At the time of her first bankruptcy, she and her ex-husband had $30,000 outstanding debt on eight credit cards and owed $200,000 in back taxes in addition to the mortgage, car loans and private school tuition bills. The second bankruptcy relieved Patti of an unpaid loan to her sister, who had helped her out after her first divorce and bankruptcy.

It’s impossible to know what happened between Patti, her ex-husband and her sister. Perhaps she did nothing wrong and is horribly unlucky. Or, more likely, she was accustomed to living above her means for decades and encouraged Andrews to do the same.

In another blog, he defends himself, saying that the first two bankruptcies had nothing to do with the financial calamity outlined in the book and he didn’t want to embarrass his wife.

The argument about embarrassing his wife would be more palatable if he hadn’t been so vivid about her role in their personal crisis and the vivid accounts of their marital problems. Although he always writes himself as the bitter villain, the dirty laundry about her inglorious financial past wouldn’t have been any more damaging than what was already in print.

What’s worse though, is that as a reporter, he should have known better. Even though this is a more of a cautionary memoir (a la A Million Little Pieces) and not a newspaper article, her previous dealings were material facts that he should have presented. As they say on Law & Order, “It goes to character, Your Honor.”

Busted goes a long way to show that you shouldn’t buy something just because you can. Andrews wasn’t a victim, he was a participant. To some extent, we all played a role in the crisis and bought into the same dream. In our heart of hearts, though, I think we all knew better just as Andrews did.

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Recommendation: Sell

Busted: Life Inside the Great Mortgage Meltdown

W.W. Norton & Company New York, New York

ISBN: 978-0-393-06794-1 (hardcover)

FedEx lifts guidance

FedEx (FDX) raised its first-quarter earnings forecast, citing better-than-expected international shipments and cost-cutting. The announcement, unsurprisingly, coincides with other recent encouraging economic indicators – FedEx has long been regarded as a proxy for the overall economy.

The world’s second largest-package delivery company said it expects earnings for the quarter ended August 31 of 58 cents a share, down 53% from a year ago but well above the average analyst estimate of 44 cents per share. In addition, the company’s forecast for the subsequent quarter of 65 to 95 cents a share versus the current consensus of 70 cents, leaves some room for upside surprise.

CEO Alan Graf, Jr. said in a statement: “Despite some encouraging signs in the global economy, it is difficult to predict the timing and pace of any economic recovery. Revenue per shipment declined year-over-year in each of our transportation segments, as fuel surcharges declined significantly and we continue to face a very competitive pricing environment combined with significant overcapacity in the LTL freight market.”

FedEx is due to report full results on September 17.
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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks extended the latest winning streak to five-sessions as this peach of a market shows it has some juice left. A larger-than-expected drop in jobless claims, an increased forecast for oil demand and another Treasury auction that went swimmingly all provided impetus for the rally. (On the auction, it appears enough people just can’t keep enough of a 4.2% yield for 30 years – at some point the music’s going to stop but it appears it may be a while still.

Something does appear to be askew. Stock prices are rallying like the economy is out of the woods, yet the bond market is trading like it remains in a dark and dangerous place. Sure the Fed’s QE program (bond purchases) is skewing things, but I’ve got to say the differing outlooks from both of these market is extremely strange to watch.

Telecoms, energy and consumer discretionary shares led the rally.

Telecoms got a boost from an increased demand and sales forecast from Texas Instruments. The energy trade got a lift from the IEA’s boosted forecast for oil demand. Consumer discretionary shares may have been fueled by the initial jobless claims data, but as we’ll discuss below I’m not sure the numbers were suggesting consumer activity will surge any time soon. The index that tracks the group has been hot over the past two months, up 25% -- it now trades at a multiple that is above the long-term average; it seems the bid may have some unjustified euphoria in it with the jobless rate on its way to 10%.

We finally saw some good volume yesterday as roughly 1.5 billion shares traded on the NYSE Composite -- 28% above the three-month average.

Market Activity for September 10, 2009
Jobless Claims

The Labor Department reported that initial jobless claims fell 26,000 for the week ended September 5 – beating the expectation for a decline of just 10K, but the prior week’s number was revised up by 6K so it wasn’t off by quite that much. This is a really nice move lower, even if it is off of an upwardly revised number, after three weeks of averaging above 575K. Don’t get me wrong, as the chart we post each week illustrates, initial claims remain sky high, but this is a welcome decline.

The four-week average fell 2,750 to 570,000.

Continuing claims fell big, down 159,000 to 6.088 million. This is the closest we’ve gotten to the 5 million handle since April.

I still don’t think one can view the decline in continuing claims as a sign that job creation has begun, which believe it or not is what some took from the reading based on headlines. This is more a function of people exhausting benefits – Emergency Unemployment Compensation (an extension of benefits after they are exhausted) rose 73K to a new high of 3.102 million.

In addition, nothing in the monthly employment reports suggests such a thing. First, you must see an increase in temporary hirings before more permanent positions are created, and this segment of the data declined for the 20th straight month in August -- although the rate of decline has slowed. Further, you must see the duration of employment make a move lower. Yes, the average duration of unemployment (in weeks) fell to 24.9 in August, but this is just slightly off of the post-WWII high of 25.1 weeks in July.

What’s more, the percentage of those jobless for 52 weeks is still on the rise, as of the latest data.
But what this data does show is the degree of monthly job declines should continue to move in the correct direction. One hopes the monthly decline in payrolls will dip below the 200K level by the next employment report and this will enable us to get back to sub-100K losses (a statistically insignificant level) by early 2010.

The big question is, when will actual job creation occur? This varies by economic expansion. I’ve got a feeling since the bulk of the stimulus spending will arrive in 2010, we’ll see some payrolls added more quickly than is typically the case – largely via the construction industry.

However, the massive increase in government spending does crowd out the private sector (capital is diverted to buy the bonds to finance this spending and higher tax rates that follow damage profits) and also results in a prolonged period of caution among business decision makers. As a result, this largely offsets the short-term boost that will result from public spending and keeps the jobless rates high for a longer period of time than would otherwise be the case. We must remember that government construction jobs are not very permanent. When the road or building project is complete, that worker is out of a job again if the private sector is not there to pick them up. This was the lesson learned the last time we engaged in public projects on this scale. Some lessons need to be relearned apparently.

Trade Deficit

The trade deficit widened in July as the increase in imports outpaced that of exports. The figure widened to $32.0 billion in July from $27.5 billion for June.

Exports were up 2.2% for the month, driven by a 24.5% jump in auto exports, an 8.7% jump in computer-related equipment and an 8.1% rise in commercial aircraft. Imports increased 4.7%, driven by (again) a 21.5% boost in autos – clunker-cash baby, a 17% jump in commercial aircraft and a price-driven 7.6% rise in oil imports.

While these specifics are nice to talk about, and people who watch these things must be aware of what’s driving the figures, there are two main things people should take from this data:

One, you watch the import numbers as a gauge of consumer activity. The fact that autos were the main driver (and will be even more so for the August figure), helped immensely no doubt by Uncle Sugar’s clunker cash, is probably a sign that the boost in import activity will be short-lived.

Two, the direction of the deficit gap has implications for GDP. The trade figure had narrowed in the previous two quarters and that helped to ease the contraction within the GDP readings. Now, the deficit is widening again, and any boost from auto production due to the clunker scheme will be partially offset by imports outpacing exports – one of the components of GDP is net exports (exports – imports). Thus when the deficit widens, it does subtract some from GDP.

We will get the first positive GDP print (third quarter) after four quarters of decline. However, this increase will be held back by the widening in the trade deficit and the relative unwillingness for firms to boost inventory levels, which doesn’t appear likely to really show up in GDP until the fourth quarter.

September 11

It has been eight years now, as time passes are we returning to a 9/10 mindset?


Have a great weekend!


Brent Vondera, Senior Analyst

Afternoon Review: T, PG, MON

S&P 500: +10.77 (+1.04%)
Markets rebounded from its lower open to extend its winning streak on fewer-than-expected jobless claims, rising forecasts for oil demand, and plethora of companies increasing their earnings guidance. The S&P 500 has declined in only 19 out 50 sessions thus far during the third quarter.

The Telecom sector led the pack higher after research firm ISuppli Corp said Apple may extend its exclusive wireless agreement with AT&T (T). The sector is also gaining momentum on expectations that companies will increase spending on communication and mobile equipment as the U.S. economy pulls out of the recession.

Oil prices continue to rise after OPEC left its production targets unchanged, as expected, and the IEA expects global demand to strengthen. Energy stocks were the second best performing sector today.

Procter & Gamble (PG) jumped 4.24% after the company reaffirmed its fiscal first quarter and 2010 earnings outlook. The consumer products company sees fiscal first quarter organic sales growth of zero to down 3%, but PG sees that trend reversing in the second quarter with organic sales growth between 1% and 4%.

The company attributes the stronger sales forecast to new product launches and investments in its portfolio as well as easier year-over-year comparisons.

Monsanto (MON) fell 5.01% as the company reaffirmed fiscal 2009 earnings guidance, but said earnings will fall in fiscal 2010. The company’s gross profit for Roundup and other glyphosate-based herbicides is expected to be lower than anticipated. As I explained in late June, Monsanto’s premium price for Roundup couldn’t possibly be sustainable with such a large supply of generic brands on the market.

On the bright side, the seed and genomics franchise appears to continue gaining market share and trait penetration. Despite near-term concerns about Roundup, there is little reason to believe that the seed business won’t continue its break-neck growth and ultimately increase the bottom line. Check out the earlier post for more on this topic.




Quick Hits

• Understanding the Inflation In the Pipeline
• When Will the Dollar Slide Stabilize?
• Seasonality: S&P 500 Return by Month
  
  

Peter Lazaroff, Investment Analyst

Monsanto (MON) falls on 2010 earnings prospects

Monsanto (MON) reaffirmed fiscal 2009 earnings guidance, but said earnings will fall in fiscal 2010 as the large supply generic herbicides is forcing the company to slash prices of Roundup weed killer. Weed killers generated 32% of 2008 gross profit, but will account for only 11% in 2010.

As I explained in late June, Monsanto’s premium price for Roundup couldn’t possibly be sustainable with such a large supply of generic brands on the market. Monsanto estimated in June that generic inventories would finish the year at a level equal to 40% of next year’s consumption, which puts extreme pricing pressure on both generic and branded products. Further pressuring Roundup’s price is the fact that distributors are slashing prices in order to move this excess inventory and generate cash.

I think there is a very good possibility that Monsanto divests the Roundup business after making it a separate unit and completing restructuring.

On the bright side, the seed and genomics franchise appears to continue gaining market share and trait penetration. Despite near-term concerns about Roundup, there is little reason to believe that the seed business won’t continue its break-neck growth and ultimately increase the bottom line. Genetically modiefied seed is already the standard in corn and soy in the U.S., while Brazil and Argentina are driving a new wave of growth. Don’t be surprised if China, Russia, and Easter Europe provide the next wave.


MON shares finished -5.01%

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Peter J. Lazaroff, Investment Analyst

Fixed Income Recap

A rally in equities couldn’t hold back the second strong Treasury auction in as many days from pushing yields lower. The long bond lagged behind the rest of the curve as it pulled back ahead of today’s 30-year auction.

Credit spreads have enjoyed a very nice week as shown below by the Markit Investment Grade CDS Index. A drop in the index represents a decrease in the cost to insure a broad basket of corporate debt against default.

The reopening of the on-the-run ten-year yesterday was a record setter in both size and performance. It was the biggest reopening ever at $20 billion and was also 55.3% bought by indirect bidders, the best ever by a reopening. The yield blew through the market rate by 2 bps, meaning that the price paid at the auction was higher than the market at the time and set the stage very well for the 30-year auction today. Fears that foreign demand will be missing for longer duration auctions were quieted yesterday so the main challenge facing today’s auction is gone. 30’s have also sold off a good bit since the announcement last week, which may also help them catch a bid today. Yes, believe it or not, many investors think the 30-year looks cheap at 4.3%.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks showed no desire to pullback just yet as Wednesday’s rally extended the latest winning streak to four days. This move has now erased last week’s decline plus a couple of points.

Stocks got off to a strong start after Goldman Sachs advised buying industrial shares but the broad market pared some of those gains after the Fed’s latest report on economic activity reinforced concerns regarding consumer activity; a final late-session push then got us almost back to the day’s highs.

(That’s really sweet of Goldman to recommend industrial shares, the S&P 500 index that tracks these shares has only bounced 70% since March. While the group remains 40% off its October 2007 high, I’m going to guess the bulk of this current move has been realized – waiting for a pullback at this point seems the appropriate course.)

And speaking of the March lows, yesterday marked six-months since hitting that wicked March 9 nadir of 666 on the S&P 500, we’ve now surged 56% since that (let’s hope) generational bottom.

Industrials (and those who increased exposure to the group early this year thank Goldman for this latest rally), financial and consumer discretionary shares led the rally. The laggards were two of the traditional safe-havens, consumer staples and utilities – the only sectors to post a loss on the day.

Volume was weak again, maybe the vacationers failed to get the memo that the summer holiday season is over, as less than 1.2 billion shares traded on the NYSE Composite.

Market Activity for September 9, 2009
Returning to Risk

I want to preface the following comment by saying that risk taking is generally good and the economy needs a confidence level that allows for this activity. However, there are points in time in which a certain level of risk aversion is appropriate and I’m not convinced that time has passed.

Now that that is out of the way. Investors are definitely returning to risk, and I’m not just talking about the equity markets. Via derivatives such as total return swaps, hedge funds and other investors are going for it again – and banks, the counterparty to this activity, put themselves in a vulnerable position as well.

Total return swaps are a low-cost financing tool that hedge funds use to accomplish leveraged exposure to a particular asset, thereby generating relatively high returns without tying up capital. The hedge fund can use the “purchased” (actually leased) assets as collateral for the loan, which when things go bad means both sides can get burned.

(To keep it simply, a total return swap goes like this: Bank (A) has an asset – a loan. A hedge fund, or other bank for that matter, can sell bank (A) a swap that guarantees against the downside and pays bank (A) LIBOR plus a spread. The swap seller (say the hedge fund) will receive the interest payments that run off of that loan plus any capital appreciation. However, if the asset declines in value the swap seller is on the hook and if that seller goes down as a result of bets gone bad [remember this is a leveraged position], who is there to guarantee the downside protection for the bank?)

Banks have also begun to repackage home and commercial mortgage loans in what some describe as mini CDOs. The strategy of course is to offer securities with a higher yield but also viewed as highly rated. Some of the most explosive land mines of the financial crisis are making a comeback

There’s nothing inherently bad with these instruments, but with the commercial mortgage land mine that has yet to hit (and don’t forget about the $500 billion in interest-only home loans that will reset 2010-2011, according to First American CoreLogic), I’m not sure this story is going to end well.

This is all one consequence of very easy Fed policy, just as we should have learned from the recent debacle. When the Fed pours money into the system and keeps rates very low, that money is going to search for return and the hunt for yield in this low interest rate environment can cause the multitudes to improperly assess the risk that accompanies these securities vehicles. There is a certain déjà vu concern here for those without short-term memory problems.

Mortgage Applications

The Mortgage Bankers Association reported that their mortgage apps index jumped 17% in the week ended September 4, the largest increase since March when the 30-year fixed rate moved below 5.00%. In this latest week, that 30-year rate settled in at 5.02%.

Applications to purchase a home rallied 9.5% as homebuyers rush to get in before that first-time tax credit of $8,000 expires. Applications to refinance an existing mortgage surged 22.5%.

Fed’s Beige Book

The Federal Reserve released their Beige Book – reports on the economic conditions within each of the Fed’s 12 districts, the survey is released about every six weeks.

The Fed stated that economic activity continued to stabilize in July and August. In terms of district, Dallas indicated activity has firmed, while Boston, Cleveland, Philly, Richmond and San Fran mentioned signs of improvement. Atlanta, Chicago, KC, Minneapolis and NY generally described activity as stable or showing signs of stabilization. St. Louis described the pace of decline appeared to be moderating.

A majority of districts reported flat retail sales – helped by clunker-cash. (Note: Odds are retail activity would have been lower without clunker-cash, which begs the question: What will this segment of the Beige Book look like for the current six-week period now that the subsidy has expired and consumers have increased debt levels at the margin – remember, auto loans ran at an LTV of 92% in July).

Downward pressure on home prices continued in most districts – Dallas and NY noted local prices were firming. On the commercial side, all districts suggested demand for space remained weak and rent concessions and the postponement of property improvements were prevalent.

Manufacturing activity improved in most districts. Contacts remain cautiously optimistic but cost control measures would remain in place, according to the report.

Labor market conditions remained weak across all districts. However, several districts did note an increase in temporary hiring – this is what you want to see as it is an early indication of more permanent hiring. That said, contacts in Boston questioned whether these gains will persist. (Note: There was no evidence in last week’s August employment report of temp. hiring as it fell for the 20th straight month.)

Most districts reported loan demand was weak, and one gets the sense that this would have been even weaker if not for the increase in auto loans.


Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review: Industrials, Financials, UNFI

U.S. stocks moved higher for the fourth straight day led by Industrials and Financials.

Goldman Sachs advised buying Industrials, especially multi-industry companies, citing “the historical tendency for meaningful outperformance when the ISM moves sustainably above 50.” As part of its call, Goldman upgraded Illinois Tool Works (ITW) and raised its price target on General Electric (GE), United Technologies (UTX), and 3M Company (MMM).

Financials were boosted by a flurry of analyst upgrades. Citigroup lifted ratings on Capital One Financial and MasterCard explaining that the “big negative adjustment” in consumer spending has already taken place. The analyst also notes “the credit cycle has begun to recover for U.S. credit cards…and an improving U.S. economy will support local bank credit stabilization” in 2010.

Meanwhile, J.P.Morgan upgraded Morgan Stanley citing valuation as the stock has lagged behind investment banking peers. The note added that by the end of 2009, Morgan Stanley will have a core Tier 1 ratio of 12%, which could be enough to support $8 billion of stock buybacks, split between 2010 and 2011.

Oil prices extended their recent gains on the expectation that OPEC will leave production targets unchanged. Ongoing weakness in the U.S. dollar has also helped prop up prices.

The Fed’s Beige Book says economic activity continues to stabilize, but Calculated Risk says it best: “Stabilization is not new growth. Just more beige shoots…”

United Natural Foods (UNFI) earnings beat projections, but sales fell short of expectations. Despite the weak top-line, the distributor of natural and organic foods improved profitability and cash flow due thanks to lower fuel expenses, efficient cost controls, and operational improvements at its distribution centers.

In addition to disappointing revenues, UNFI’s projected 2010 EPS range of $1.48-$1.58 didn’t measure up well to analysts’ forecast of $1.57.

Although UNFI, like its competitors, have been hit as consumers trade down to lower priced groceries, it is clear that UNFI is reaping the benefits of years of distribution-network expansion, as well as its entry into the specialty-foods business in 2007.



Quick Hits

• Finance Overhaul Falters as ’08 Shock Fades
• Inflation Fear Pushes U.S. Endowments Deeper Into Commodities
• Can You Name These 14 Bubbles?
• Walmart’s Project Impact: A Move to Crush Competition

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Peter J. Lazaroff, Investment Analyst

Fixed Income Recap

A strong 3-year auction was outweighed by the rally in stocks yesterday as yields rose across the curve. The curve steepened for the fourth session in a row to 254 basis points, its steepest point since it finished at 256 bps on August 12.

The market was really focused on the rally in risky assets, so the auction wasn’t able to bring Treasury yields lower yesterday. I mentioned last week that Tuesday’s auction could have some difficulties given it’s very short “when issued” period – the auction was just announced Thursday afternoon – but that was no problem at all. Bid/cover was over 3 for the first time since November 2008 – yesterday was 3.02 – and 54.2% of the notes were taken down by indirect bidders, in line with the average.

The Fed took down $4.95 billion in the 7-10 year sector, leaving less than $20 billion to be purchased. The Fed will purchase Treasuries again on Tuesday and Wednesday of next week.

The Treasury will bring $20 billion of the existing 10-year note to market today. Bank demand, both domestic and foreign, has really made for breezy short-duration auctions as of late but longer-duration auctions have had more difficulty establishing a clearing price so yesterday’s success is not guaranteed to carry through to today.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

Due to technical difficulties, tables and graphs will posted later.

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U.S. stocks engaged in a post-Labor Day rally as traders came back looking to get in on this thing. The market held onto the rally despite a plunge in consumer credit for July, which followed a huge downward revision for June. While this is a backward-looking indicator, credit is kind of a key driver for economic growth, so in that sense it was surprising to see stocks hold momentum – more on this below.

Commodity related shares led the rally as energy and basic materials were the best-performing sectors. Industrial and consumer stocks were close behind. The laggards were the traditional safe-havens, utilities and health-care – the latter being the only of the 10 major industry groups to close down on the session.

Volume was a bit more robust yesterday now that the summer vacation season has ended as 1.275 billion shares traded on the NYSE Composite. While this is fairly weak activity from a longer-term perspective, about 12% below the two-year average, it is nearly 10% above the three-month average. Advancers beat decliners by close to a three-to-one margin.

The latest Treasury auction, this one for $38 billion of three-year notes went off without a hitch. The massive supply that is coming through is not causing any problems yet as the notes came in at a yield of 1.487%, below the 1.493% just before the auction, and the bid-to-cover ratio (the main gauge of demand) was strong, at 3.02 – the average from the past 10 auctions is 2.58.

Market Activity for September 8, 2009
Gold’s Three-Peat

The price on the front month gold futures moved above $1,000 yesterday, before pulling back to $995. For reference, it crossed the four-figure mark for the first time in March 2008 and for the second time during the “welcome to the jungle” period back in late February. While equity traders, always short-term in their thinking, favor easy money Fed policy, gold investors may be looking beyond the here and now to the cost the economy will have to bear as result of another round of prolonged easy money, along with runaway fiscal spending and heightened geopolitical risks (North Korea’s claim to have weaponized plutonium, rough going in Afghanistan and the uncertainties that loom between Israel and Iran).

And speaking of Iran, quickly, I see their president carted himself over to Venezuela this past weekend to cement a deal with Hugo Chavez in which he’ll provide Iran with gasoline. Why is this important? Because it is one of Iran’s major weaknesses; they have loads of oil, but little capacity with which to refine it. That was to be one of the most effective sanctions we had, whenever it is that we were to get around to using it. That one appears to be off the table right now, the options are dwindling. And then in an Op-Ed yesterday, the venerable Manhattan DA Robert Morgenthau suggests that Iran may be building weapons in Chavez country – I’ve got a feeling Mohamad El Baradei and the IAEA aren’t looking there. Sorry for the digression but is kind of an important element in explaining one of the reasons gold is on the rise.

Further, we can see by way of the past couple of TIC reports (data that shows foreign flows into the U.S. Treasury security market) that China is shifting their purchases to the short-end of the curve, buying more T-bills and easing their purchases of T-notes and bonds. While the Chinese must continue to buy dollar-denominated assets for fear their own currency will rally and harm export activity, they can accomplish this and still hedge against dollar weakness by keeping things short. They can go a step further, which I believe they are doing, by also purchasing hard assets, like gold. This will help them to hold down the risk of future dollar damage.


Let me make clear, one can never tell where gold is going – and obviously this is true with everything but especially so on the gold trade. As a result, owning commodity-related stocks (with their earnings streams and dividends) seems like a more reasonable play to us, especially for those that have more than a very short-term trading mindset.

In addition, while one has to acknowledge that things are set up to favor gold over the next two years, there’s always the risk of the trade shifting to oil – it would get the dollar-hedge/uncertainty trade accomplished just the same.

I bring this topic up because gold’s move over the past few sessions seems like an important market development. I’m not specifically advocating a position in gold at this level as it hardly seems practical to chase these things; waiting for pullbacks in this market seems the more appropriate course. That said, at least coming from someone who does have concern over the chances for harmful levels of inflation to result and heightened geopolitical risks, it’s tough to argue against the gold bulls.


Latest NFIB Survey

It’s been a while since I’ve reported on the monthly National Federation of Independent Business survey (small business optimism on economic trends), so long in fact even longer-term readers have likely forgotten it. There have been so many things to talk about and we can only fit so much into this letter on a daily basis.

Anyway, the NFIB’s survey for August showed a slight decline of 1.3 points to 86.5. This marks the second month of decline after the survey rebounded off of its lowest reading for this recession, which was 81.0 in March – the all-time low was hit in 1981 at just below 80.0. The main cause for the August decline was deterioration in expectations that business conditions would improve six months out.

On hiring plans, the net percent planning to hire (firms planning to “increase” hiring minus those planning to “decrease”) over the next three months fell to -3 from -1 in July; prior to this recession, you have to go back to the 1980 recession for the last time this measure recorded a negative reading. Owners stated they are reducing compensation, on average, as well.

These are not good trends for the employment picture since small business is the main engine for U.S. job creation and obviously doesn’t speak well to the chances of consumer activity making a sustained comeback. This is a theme we’ve touched on for some time now.

In another theme we’ve spent time on, the low likelihood that firms will increase capital spending outlays in a manner that is consistent with that seen during the normal recovery, this survey showed capital outlay plans over the next three months was essentially unchanged at 18, just above the all-time low of 16 hit in March. Only 5% of firms characterized the current period as a good time to expand facilities, a very low historical reading.

In addition, NFIB showed small business owners continue to liquidate inventories, this segment of the survey remains at a record low, and plans to increase inventories over the next 3-6 months remains low at -5 (but nothing near the record low of -15 back in 1980 – of course you had more inventory bloat back then).

I continue to believe current-quarter GDP will get a boost from inventory rebuilding (that inventory dynamic we keep referring to) but it may be quite tempered and the more data we view it appears the economy will have to wait until the fourth quarter for the big inventory boost.

The commentary from the survey stated “consumers and business owners’ emergency reserves are depleted, jobs have not returned, and the stimulus seems to have failed on the ground (even if observers agree its effects are yet to come, expectations were set for a quick rescue). The recession is wearing Main Street folks down.”

Small business is very important for our economy and it appears things have yet to improve much for this vital segment.

Consumer Credit

Finally, the Federal Reserve reported that consumer credit took a big hit in July, down $21.6 billion, or 10% at an annual rate. That was more than five times as much as forecast as banks restricted lending and the demand for loans declined due to the labor market conditions and already heightened debt levels.

Revolving loans, such as credit cards, fell $6.1 billion, or 8%, and non-revolving, such as auto loans, fell $15.4 billion, or nearly 12%. (Mortgage loans are not included in this data)

This is something to keep our eyes on, especially considering the shape the labor market is in, and the real possibility that the jobless rate will remain above average for a prolonged period this go around. The fact that we don’t have credit to grease the wheel this time may make it so. This is a harsh, but needed, reality for longer-term stability. In the near term, as consumers reduce debt it will weigh on economic activity.

The whole process of the debt paydown may very much have been delayed by the clunker-cash scheme. I would expect we’ll see the August reading on consumer credit rise on increased car loans (which ran at an average 92% loan-to-value in July – whoa!). This will help in the short term but put back the process needed, which is a reduction in debt levels.


Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review: GE, KFT

U.S. stocks finished followed the rest of the globe’s markets higher on a pickup in M&A activity, higher energy and material prices, and the G20 reiterating their commitment to keep massive monetary and fiscal policies in place.

Kraft Foods made a $16.7 billion bid for Cadbury PLC, which represents a 34% premium for the maker of Dairy Milk chocolate and Trident chewing gum. Cadbury quickly rejected the offer, saying in a statement that the proposal “fundamentally undervalues” the company and its prospects. Conagra Foods (CAG) +4.44% and H.J. Heinz (HNZ) +5.08% rallied along with other packaged foods companies following Kraft’s rejected bid.

High profile deals involving Disney, Proctor & Gamble, and eBay in recent weeks are a welcome sign to investors that the market is recovering and the worst of the downturn could be over.

Meanwhile, energy and materials shares benefited from rising gold, copper, and oil futures. Big gainers on the Approved List included Noble (NE) +3.41%, Transocean (RIG) +4.17%, Peabody Energy (BTU) +6.01%, and Arch Coal (ACI) +3.25%.

General Electric (GE) gained 4.4% after JPMorgan upgraded the shares to “overweight” from “neutral,” saying the stock may be the “last of the low-expectations plays.”

Quick Hits

• Missing Lehman Lesson of Shakeout Means Too Big Banks May Fail
• Anything-But-Treasuries Gains as Credit Rebounds After AIG Death in China
• Stocks Cheapest Since ’89 Show Why Analysts Say Economists Wrong on Growth
• Closely Watched Buffett Recalculating His Bets

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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks, after moving into negative territory at the open, rallied to post strong gains on Friday. The broad market’s 1.31% rise pared the week’s loss to 1.22%.

The Labor Department’s monthly jobs report showed payroll declines continue to move in the right direction and I suspect another healthy increase in hourly wages provided the impetus for traders to push prices higher.

There also seemed to be a sense that the jump in the unemployment rate helped the stock rally as well. This seems counterintuitive but what it does is cement in traders’ minds that the Fed is a long way from removing their current easy-money stance.

Normal trading should return today now that the Labor Day holiday and summer vacation run has passed, so we’ll see how investors and traders react to things this week.

Technology, energy, telecom and consumer discretionary shares were the top performing sectors on the session. Financials and utility shares were the laggards, but still posted upticks of 0.83% and 0.34%, respectively.

Market Activity for September 4, 2009
No reason to beat around the bush; let’s get to that August jobs report.

The Labor Department reported that payrolls declined 216,000 in August, beating the consensus estimate for a decline of 230,000 and a nice improvement from the 276K in losses for July.

However, the previous two months of data were revised higher to show 50,000 more job losses than previously reported.

While last month’s level of job losses remains large, we are seeing significant improvement from the sky-high declines that occurred up to just four months back when monthly payrolls were plunging 550K on average. This latest reading sends the monthly losses to levels that are at the low end of the worst we see during the typical recession and makes our call for below 200K in losses by September in play – an estimation I expressed concern over after Wednesday’s ADP report suggested deeper declines may result.

In terms of specifics, the goods-producing industries shed just 136,000 positions, pretty much in line with last month’s losses but much better than the three-month average of 182,000 in monthly declines.

The construction segment of this sector lost 65,000, a bit better than July’s 73,000 decline. The manufacturing segment shed 63,000 positions, worse than the 43,000 lost in the prior month, but a huge improvement from the 104K in average losses for the previous three months and the wickedly deep losses of 170K per month during the first six months of the year.

Service-providing industries shed 80,000 positions in August, jut half the decline recorded for July and that goes for the three-month average as well, which was 165,000.

Again, health care and education services was the only private-sector component to post gains – this segment has not posted a monthly loss during this entire malaise – up 52,000 in August. The three-month average is +35K.

The government cut 18,000 positions, largely due to the branch closings within the postal service. I’m going to bet the government side of the employment picture is not going to post monthly declines for much longer.

The unemployment rate jumped to 9.7% from 9.4% and we are surely headed to 10% and above as there really weren’t many workers returning to the job market. The return of workers looking for work again, as they feel the environment has improved, is usually what pushes the jobless rate higher even as the economy begins to grow again. In August, though, the labor force only increased 73,000 – still 355K below the level of the second quarter. When these unemployed persons come back in to look for work, the jobless rate will move past 10% and give the post-WWII record of 10.8% a run for its money.

The U6 jobless rate (this is the official unemployment rate, plus discouraged workers – those not looking for work during the survey period, plus those working part time for economic reasons – they want to work full time but can only find part time work) hit a new high, up to 16.8% from 16.3% in July.

Those working part-time for economic reasons jumped 278,000 in August to 9.1 million – as a share of the work force this is the highest level since the 1982 recession.

And on part-time work, teenage employment rose to 25.5% last month, I’m sure the boost in the minimum wage that went into effect two months back is not helping the teenage situation.

The duration of long term unemployment (the percentage of the unemployed who have been out of work for over 27 weeks) did decline from a record of 33.8% in July to 33.3%. Good sign, but still very high. The figure remains a large 4.3 percentage points above the record set in June before that July figure surpassed it.

As has been true in so many regards these days, many analysts/economists appear to be getting carried away by extrapolating from the overall decline in monthly payroll losses. Some point to the current trajectory of the slower rate of decline in job losses and state that we’ll have job gains by year end. I would be cautious about accepting this view and the tendency to move farther out of the risk curve by thinking things will move to normal growth mode.

The reduction in the rate of decline has been a function of deep job losses earlier in the year and just because we have seen a 250-300K improvement in the level of monthly payroll declines, I don’t think it is correct to believe that this trajectory will remain in play now that we are back to a more normal level of losses. This assumption appears to be fraught with error in my judgment.
The fact that we continue to shed 200K-plus jobs per month now darn close to two years into this recession (at least as measured by the NBER – the official arbiter in defining business-cycle expansions and troughs) is rather telling; the state of the labor market remains very fragile.

Here’s a picture of this story from Calculated Risk.

We also must take those working part-time for economic reasons and turn them into full time positions before we even begin to send the official unemployment rate lower.

On a brighter note, wages have been ticking higher. Average hourly wages rose 0.3% in August and are up 2.6% year-over-year – that’s a nice move so long as the inflation gauges remain flat. (Overall personal incomes are falling, and the wage&salary component of that overall figure is down 4.7% year-over-year due to the damage done to the salary side of that component).

But the rise in wages -- even though firms continue to hold weekly hours worked at a pathetic 33.1, just above the all-time low (since records began in 1964) of 33.0 hit in June -- is helpful and we’ll take any help consumer activity can get right now.

Today’s Early Trade

Everything is higher this morning, stock-index futures, Treasurys, gold above $1,000 and oil approaching $70 again after last week’s pullback to the $67 handle.

Something will crack; I don’t know what it will be but when you’ve got the risk trade back in the game, yet the key element of the safety trade – Treasury buying – rolling on, it seems something is very much awry. How do you have the risk trade off the bench and a sub-1.00% yield on the two-year and the 10-yr trading at 3.42% at the same time? These are strange days.


Have a great day!


Brent Vondera, Senior Analyst