Afternoon Review

Procter & Gamble (PG) posted better profits that expected and widened the lower end of its earnings target to $4.15 to $4.25 from $4.18 to $4.25, due to volatility of the energy and commodities market.

Net sales for 3Q increased nine percent to $22 billion. Price increases added three percent to net sales. Favorable foreign exchange contributed five percent to sales growth. Organic sales increased five percent in 3Q. The household care segment (the largest segment of the company) had 10 percent sales growth, and net sales in the beauty segment also increased by 10 percent.

Operating margin was down 60 basis points due to a commodity-driven decline in gross margin which more than offset lower SG&A (selling, general and administrative) expenses as a percentage of sales. Gross margin declined by 240 basis points to 50.5 percent as higher commodity and energy costs were partially offset by the impact of prices increases and manufacturing cost savings. SG&A expenses were down 180 basis points primarily scale leverage, overhead productivity improvements, and the positive impact of foreign transaction gains on working capital balances caused by strengthening of the U.S. dollar late in the quarter.

PG’s results solidify their reputations as a company whose earnings remain consistent in a slumping economy, since consumers rely on their products (click here to see a list of all the PG brands). To lure shoppers into buying more-expensive versions of items, rather than generic brands, PG introduces new styles of products (which are often very similar to old styles, but have different packaging).

PG fell 3.54 percent today.

Consumer staples Kraft (KFT) and Kellogg (K) also posted positive earnings today.

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Garmin Ltd (GRMN) missed earnings estimates and lowered their forecast; however, the forecast was not lowered as much as expected. 3Q revenue climbed 19 percent, but profits fell 12 percent because of costs related to the acquisition of some European distributors. Competition with Amsterdam-based TomTom NV has forced GRMN to cut prices, and the financial crisis is curbing demand for personal navigation devices.

GRMN had strong revenue growth in Auto (21 percent), outdoor/fitness (35 percent), and aviation (9 percent) segments, but revenues declined 8 percent in the marine unit. Auto unit now represents 72 percent of GRMN’s business. North American sales grew 21 percent, Europe sales rose 9 percent, and Asia Pacific revenues fell 21 percent.

GRMN said their new smartphone remains on track for launch in the first half of 2009 (the release was originally planned for Fall 2008, but was pushed back earlier this year).

CEO Min Kao said GRMN is scaling back operations “to better match current business conditions” and will make changes to inventory that will allow them to reduce inventory levels by $150 million by the end of the year. The company also plans to increase advertising spending.

GRMN advanced 2.43 percent today.

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Pharmaceutical companies fell after a closely watched annual forecast from IMS Health Inc. said sales in the U.S. (the world’s biggest market) will grow far less than originally forecast this year and are in for meager growth next year as economic turmoil and a lack of new products take their toll.

IMS now expects drug sales to rise just one to two percent this year and next, compared to their prior 2008 forecast of four to five percent sales growth. IMS attributes is weakening sales outlook to Americans visiting their doctors and filling prescriptions less in light of economic uncertainty, fewer new drug discoveries, and fewer medicines being approved by the FDA due to heightened safety awareness.

Earlier in this decade, the U.S. accounted for 40 to 50 percent of the growth in global pharmaceutical sales each year. Next year, the U.S. will account for just 9 percent, IMS forecast in its report, as the industry devotes more attention to emerging markets.

Insurers also are hurting sales by not quickly covering new drugs and by pushing consumers and doctors toward low-cost generic drugs. IMS also expects a slowdown in generic drug sales because intense competition among generic-drug makers in the U.S. and Europe is driving down prices. IMS predicted the global generic market will grow by five to seven percent next year, down from double-digit growth in the past.

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This DealBook article reviews the debate over mark-to-market accounting (or fair value accounting), as the SEC held a roundtable to discuss the pros and cons of the accounting standard and whether the current standard could be improved.

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Bloomberg reports that Fannie Mae will write down about $20 billion of assets due to the reduced value of deferred tax assets, which increases the likelihood of a cash injection from the U.S. Treasury.

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Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks jumped yesterday posting its second double-digit percentage gain in two weeks as investors brushed off the day’s downbeat economic releases to focus on Federal Reserve decisions that appear to be helping the credit markets incrementally return to normal.

The Dow’s 10.88% rally was the sixth-strongest in history; unfortunately, jumps of this size only occur in bear markets – so while these moves are very nice to see, it does remind us (as if we need it) of the market we are in. We’ve got another three trading sessions to get through to put October behind us. Getting past this relatively unscathed from here may be a nice psychological boost – October has shown to be the harshest month of them all on occasion.

The broad-market’s advance almost wholly occurred in the final 90 minutes of trading. Hopefully this means something, but we’ll have to get past economic data over the next several days that will not give the investors a sense of optimism before we really know.

Market Activity for October 28, 2008
Consumer discretionary, basic material and financial stocks, the hardest hit during this tough slide, led the way yesterday soaring 13.10%, 12.65% and 12.50%, respectively. Energy also took off, as did tech – both were up more than 11%. The remaining five major sectors gained at least 7.50%.

Credit Markets

Sales of longer-term commercial paper – CP -- (short-term financing with maturities of no longer than 270 days) soared 10-fold after the Federal Reserve began buying CP through its new funding facility that began Monday.

Companies sold more than 1500 issues totaling $67.1 billion compared to 340 issues at $6.7 billion last week. It’s essential that the CP starts to flow again and is an early sign that the Fed’s latest efforts to unlock the credit markets is working.

Economic Data

On the economic front, the S&P Case/Shiller Home Price Index showed values declined in the year ended in August at the fastest pace yet, falling 16.6% over the last 12 months, driven by foreclosures. For a fifth-straight month, all cities covered by this index showed a decrease in prices compared to the year-earlier period.

On a month-over-month basis, the index showed prices in the 20 cities that it covers fell 1.03%. Just two cities showed an increase in property values – Cleveland and Boston. That’s down from six cities for the July data.

We’ll point out though, as we do each month, that this index is the least broad of the three major home-price gauges and it shows by far the largest decline in prices. Case/Shiller covers just 20 metro area (yes, many are the largest cities, but it is not a broad look) and 10 of which are the worst hit areas. Washington DC, Tampa, Detroit, Minneapolis, LA, Miami, San Diego, Las Vegas, Phoenix and San Francisco are all down 15-30% over the past year.


While this index receives the most press, averaging the three major gauges shows that home prices are down 10.5% over the past year, with the less speculative areas (which is most) averaging roughly 7-8% declines over the past year.

Foreclosures will continue to put pressure on home prices, this is the pig in the python as delinquencies will rise even as housing flattens and begins to recover. But these lower prices will also foster increased sales. The issue currently though is that more traditional triggers of housing weakness (weak job market for instance) are beginning to have an affect.

It is impossible to assess when the market will turn around, but as the credit markets slowly return to normal, we may see prices flatten out by next spring/summer. And as we’ve discussed before, the dramatic decline in new homes available for sales should help prices begin a slow progression as the inventory-to-sales ratio plunges once sales bounce back.

In a separate report, the Conference Board reported their Consumer Confidence survey tumbled to the lowest reading since records began in 1967 – falling 23.4 points to 38.0. This substantial decline was the third-lowest on record, trailing only two plunges in the early 1970s.


Much of this is due to the credit-market disturbance that has sent stocks down 30% in the past month as stock-market activity has a major effect on people. The degree of the decline has gathered much press for obvious reasons, putting consumer expectations that much lower.

For instance, the proportion of people who expect their incomes to rise over the next six months dropped to 10.8% from 15.1% in September – although the number of people expecting it to remain unchanged has hardly budged over the past year – that number stands at 69%.

The percentage of consumers judging jobs as being “plentiful” fell to 8.9% in October from 12.6% in September, while those viewing jobs as “hard to get” rose to 37.2% from 32.2%. Thus, the net “plentiful”/”hard to get” index deteriorated to -28.3%, the lowest since October 1993.

We generally do not report on this confidence reading as it is a very poor indication of the direction consumer activity takes. However, this level of decline is showing the current environment is having a substantial effect, so I thought we’d discuss what occured.

This situation is going to hit the personal consumption component in the GDP report hard and the fourth-quarter reading is going to post a traditional recessionary figure – something not seen since 1990-1991. (We have yet to even get the third-quarter reading, which comes tomorrow)

We have been touching on how consumer activity will be weak for three months now, and that will certainly be the case. Prior to the past six weeks, the business side of things was shaping up to offset some of this weakness but, alas, things have changed very quickly. Everything changed when Lehman went down on September 15, and boy did it.

I guess if there is a bright side to this it certainly appears that stocks have priced this weakness in, at least regarding near-term events – and much more considering the degree of the decline, the fact that the broad market trades 30% below the 200-day moving average, dividend yields are at a 17-year highs (on the S&P 500 and NYSE Composite) and valuations regarding an abundance of individual stocks are the most attractive in many years.

The test over the next several days will be some pretty bad economic data. We’ll get durable goods orders, GDP (which will post a negative reading) and manufacturing activity – all which will show the stresses of what’s occurred in the credit markets over the past six weeks. The big one will be next Friday’s job report which will be the worst we’ve seen yet during this 10-month labor market contraction.

Of course, we’ll also have the election, which has surely weighed on the market over the past couple of months as well. I believe stocks have discounted the worst-case scenarios, but one never knows and it will be key to get through the next week without additional damage.

The Fed

Today the Fed’s two-day meeting adjourns and we’ll get their rate-cut decision, which will be either 25 or 50 basis points (bps) in the fed funds rates. Most expect a cut of 50, which will bring fed funds down to 1.00% -- we’ve seen this scene before haven’t we?

The move will be more symbolic than anything. The effective fed funds rate has spent much time below 1.00% over the past several weeks and has averaged 0.75% -- due to the massive amounts of liquidity they have pumped into the system. The last thing the FOMC wants to do right now is disappoint the market – which does expect the 50 bps point cut. I’m not saying I agree with this view, just stating they are not likely to disappoint. The decision will come at 1:15 CT.


Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review

The Dow Jones Industrial Average posted the second largest one-day point gain of 889 points as bargain hunting fueled the afternoon rally on moderate volume.

The Boeing (BA) machinists’ eight-week strike appears to be coming to an end as union negotiators unanimously support BA’s contract proposal, which the machinists will vote on within five days. Workers get a 15 percent raise and bonuses totaling at least 8,000 in the first three years, while health care costs freeze for employees at the 2005 level. Changes were also made to the three key areas of outsourcing the union had identified, including parts-delivery by suppliers within factories, job security for maintenance workers, and the ability to bid for more projects in the future.

BA retained most of the flexibility they need to manage their business and the four-year contract (contracts usually are three years) gives BA an extra year of peace with 27,000 machinists that have struck four times since 1989. BA will start final negotiations with their 21,000 engineers on October 29. BA’s engineers have threatened to strike over similar disputes with job security and compensation.

BA advanced 15.46 percent. Goodrich (GR), a supplier for Boeing, was also lifted by the news and gained 15.76 percent on the day.

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McGraw-Hill (MHP), owner of Standard & Poor’s, gained 12.71 percent after having better earnings than expected. 3Q profit dropped 14 and lowered its full-year forecast as a global credit freeze dries up demand for new debt ratings. MHP cut 270 jobs in 3Q, bringing the yearly total to 1,000. The financial-services unit recorded a 14 percent drop in sales after capital markets seized up at the end of the quarter. The dollar volume of new bond issuance dropped almost 70 percent in the U.S. during 3Q, led by an 83 percent slide in September, according to estimates from Goldman Sachs.

CEO Harold McGraw said S&P is managing conflicts of interest in its business, improving ratings transparency, and making more information available to the public. He expects the SEC to announce new rules for ratings companies next month.

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Investors cheered Johnson Controls’ (JCI) decision to shut down an Ohio factory in December as General Motors closes the SUV plant that relies on the parts. Closing down the Ohio plant that employs 330 workers, is part of the commitment JCI made in September to start paring output and jobs. JCI also announced they will close down a Kentucky plant in mid-2009 that makes metal parts for seats. JCI ended the day up 12.02 percent.

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Cynosure (CYNO) declined 21.76 percent today after reporting 3Q revenue that missed analyst estimates. Management acknowledged that the healthcare equipment industry (and especially the aesthetic industry) is not immune to the current economic turmoil. CYNO is continuing to invest in direct sales and marketing infrastructure in North America, Europe, and Asia. International product revenue increased 29 percent in 3Q compared with the year-ago period. Lower gross profit margins are a result of CYNO reducing prices to “better manage their inventory.” Balance sheet has no debt and plenty of cash. CYNO is aggressively investing in its business to create a global brand.

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Wal-Mart (WMT) had its biggest jump in 20 years (up 11.07 percent) after it said it is “operating from a position of strength” with its strategy of moderating store growth and increasing operating cash flow. At WMT said today that capital spending for fiscal 2009 is projected to decline 13 percent to $13 billion and store growth is expected to slow in 2009 and 2010 as part of its capital efficiency model, which WMT said has made them “far better prepared for current economic conditions.” While WMT pares back U.S. spending, they plan to increase international capital spending in emerging markets. WMT’s CFO said the current year’s sale growth is approximately 8 percent and he sees next fiscal year sales growth of 5 to 7 percent.

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AT&T (T) advanced 13.2 percent after Morgan Stanley boosted the holdings of the company in their model U.S. equity portfolio.

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Transocean (RIG) was down most of the day on news that Northern Offshore Ltd. canceled the $750 million purchase of two semi-submersible drilling rigs from RIG after it was unable to obtain financing. RIG finished the day 4.14 percent higher.

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Despite poor 3Q earnings results, Fidelity National Information Services (FIS) climbed 27.27 percent as the payment processor forecasted earnings that exceed analyst estimates.

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Reinsurance Group of America (RGA/A) rose 11.27 percent on news that it will be added to the S&P Midcap 400 Index.

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Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks, after beginning the session lower, trended higher for much of the day but lost momentum shortly after lunch, which may have increased redemption calls and thus the need to sell additional shares.

The S&P 500 lost 3.3% in the final 30 minutes of trading – ending down 5% from the session’s peak. The same was true for the Dow average and NASDAQ Composite.

Energy, basic material and financial shares took the brunt of the sell-off on concerns that global growth will show substantial damage from the credit-market lock up and the increased caution from the business community, even for those that have not been directly affected by the event.

There continues to be distressed sellers that look for any upside as an opportunity to get out at a slightly higher level and that appears to be what occurred yesterday. Although volume certainly wasn’t heavy, with 1.2 billion shares trading on the NYSE Composite, so it’s tough to be sure.

Market Activity for October 27, 2008
Last week you got a sense of my pessimism – largely driven by the direction it appears policy will go (especially regarding the possibility of a filibuster-proof Senate). Increasing capital gains, dividends, payroll and top income-tax rates (75% of which is small business) as some propose would be very bad for stocks and is likely in the process of being priced in. Remember, stocks move based on future after-tax return expectations, and higher tax rates would obviously lower those expectations.

This week though it’s back to optimism, and there are reasons to be optimistic. Yesterday we touched on how the broad market trades 35% below the 200-day moving average, which has not occurred to this extent since the 1974 bear market – a tremendously powerful long-term buying opportunity. We also touched on cash levels; there’s enough money sitting in money-market funds to buy 45% of the S&P 500 and 30% of the NYSE Composite.

Yes, cash hoarding is all-around right now, not just within the financial sector but economy-wide as investors and firms delay plans to deploy this capital until mass uncertainty subsides. But the system has trillions in cash available and we do not believe it will take much improvement in sentiment to get this train rolling again.

From there, specifically the duration and sustainability of a rally will be determined by economic policy (tax rates, trade pacts and the regulatory regime.) But even assuming just about the worst-case scenario it’s quite likely we’ll engage in a powerful rally from these levels. In terms of the election, if we can simply get a filibuster-capable Senate, stocks could really take off. I’ll repeat, the duration of an upswing will depend on the direction of policy.

Commodity Prices and the Dollar

Nearly all commodity prices have plunged, as measured by the Commodity Research Bureau. As the chart below illustrates, the decline has been massive as de-leveraging and global-growth fears drive commodities down from the fed-induced peak.


Crude-oil continues its precipitous fall, and may move back to the $40 handle, for the immediate future at least – the past economic downturns/recessions do show crude declines by a divisor that ranges 2.5 to 3.0.


In the meantime, the greenback is on fire.


That said one ought not to expect commodity prices to remain depressed – which is a minority view at this point, so if you repeat this claim to most economists they’ll call you crazy; just a warning – as the Fed pumps liquidity like there is no tomorrow, which may be the case (just kidding).

The way the Fed is going (and they’ll cut again tomorrow when their latest meeting adjourns), if inflation rates do not fall abruptly, real fed funds will become even more negative (inflation rate is running above the rate of fed funds). Real fed funds is currently -3.4%. This means inflation may rage once the current problems run their course – for now the Fed has an immediate issues on its hands (the credit disturbance, so inflation takes a backseat), but the irony is the decisions to keep their target rate below the rate of inflation 2003-2005 meant they subsidized debt and is what got us into this situation in the first place (no surprise we’re dealing with so much leverage today and a housing bubble gone bust).

The chart below shows the spread, or real fed funds, sits at -2.90%. This is because we haven’t received the October CPI yet, which means the graph below is not factoring in the October 8 inter-meeting cut (notice how the top chart, which shows the two pieces of data – CPI and fed funds – has fed funds at 2.00%; the orange number). That figure is currently at 1.50%, which give us the negative 3.4% real fed funds rate – 1.50% fed funds target rate minus the 4.90% CPI rate.

When the Fed is able to raise rates again to take away this massive easing campaign, it must be accompanied by reductions in tax rates. To tighten monetary policy, while at the same time raising tax rates means economic death; it is the opposite strategy of what Reagan and Volcker engaged in during the early 1980s. But that’s a year away or so, and there’s just too much going on to look out that far right now on the policy front.

New Homes Sales

On the economic front, the Commerce Department reported new home sales rose 2.7% in September to 464,000 units at an annual rate from 452,000 in August – the reading was expected to decline 2.2%. The jump follows a 12.6% decline for August – new home sales remain 33% below year-ago levels.

New home sales are counted when a contract is signed, as opposed to when it is closed (which could take a month or so) for the existing home sales figures. As a result, new home sales data give us a better look at current conditions – such as the credit-market disturbance. So with that in mind, it was very good news to see sales increase.

However, one has to view this series with some caution as it is subject to contract cancellations if the buyer has trouble obtaining a mortgage. We’ll have to wait for the October figures to get a true indication of how the credit-market issues have affected the housing market. For now, though, things look relatively unscathed.

The median price of a new home fell roughly 1% in September to $218,400, which is down 9.1% over the past 12 months.


The number of new homes available for sale continues to decline, falling 7.3% in September to 394,000 units -- the 17th straight monthly decline, and sits at the lowest level since June 2004. This development, while harsh for now as it shows housing will continue to be a drag on GDP, is important. While the supply of new homes as a percentage of sales (effectively the inventory-to-sales ratio for new homes – two charts down) remains very elevated, the massive decline of homes available for sale (not adjusted to sales) will allow the inventory-to-sales ratio to come down very quickly once sales bounce back in a sustained way.



Have a great day!



Brent Vondera, Senior Analyst

Afternoon Review

Stocks finished at new lows today. It kind of makes you wonder where it all ends. WSJ.com posted this nice table with a historical look at past recessions.

Arch Coal (ACI) reported 3Q EPS that more than tripled to $0.68, beating estimates by eight cents. Higher prices and output aided results, and it continues to expect a strong financial performance in 2009 despite a weaker global economic environment. ACI did, however, mention “near-term softening” in the demand for coal and it lowered its full-year EPS guidance from a range of $2.50-2.85 to $2.30-2.55. 3Q was also hurt by trading losses, although the losses could have been worse.



Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stock indices erased another 3.5% on Friday, but considering futures hit ‘limit down” prior to the bell, as overseas markets got clocked 5-10% the night prior, we’ll consider it a moral victory. It wasn’t a stretch to expect an 8% down day based on those pre-market indications. The very broad NYSE Composite lost 4.3%.

The economic data may have helped a bit – existing home sales blew through the expectation – although the market realizes next month’s data will reflect the credit-market disturbance of the past five weeks. It is a distinct possible the selling may be close to exhaustion as the S&P 500 has plunged 30% since September 19 – down 44% from the peak hit on October 9, 2007. Regarding the NYSE Composite, the index is down 34% since September 19 and 48% from its peak, hit on October 31, 2007.

The good news is there is $3.8 trillion sitting in money market funds, waiting. That’s enough to buy 47% of the S&P 500 and 30% of the NYSE Composite.

Market Activity for October 24, 2008

In addition to concerns about global growth – which has combined with the credit-market freeze-up to keep pressure on stock indices – the market is now worried about lower-than-expected earnings guidance. (Although I’ll point out ex-financial S&P 500 profits are holding up well for now as the current earnings-season’s results are up 8.2% -- about half of firms have reported to this point.

But everyone is focused on guidance to get a sense of how badly the credit-market disturbance has affected overall growth prospects – our feel is that this event has done substantial damage to the next couple of quarters. But on guidance, let’s not get too carried away just yet, what we’ve seen so far is not disastrous. Then, consider that firms have been low-balling guidance for five years now – and will certainly err on the side of caution this go around for sure. No doubt profit growth is going down, but assuming S&P 500 profits come in 50% below current expectations, the market remains quite cheap.

Compounding global growth fears is the pummeling every currency across the globe has endured, save the yen and U.S. dollar. Global institutions made bets that the greenback would continue to fall, and thus virtually all other currencies would continue to rally. But fears have caused the typical flight to safety to take place and that means dollar buying. (This is yet another effect of Federal Reserve policy mistakes. These currency bets would have never have been put on in the first place if the Fed hadn’t erred on the easing side so badly (keeping rates too low for too long) and now that things have snapped in the opposite direction, it is going to do additional damage to emerging market economies – which means more pressure on global growth. Further, it may not inspire great feelings among trading partners as everyone looks around for someone to blame, and that isn’t good news for trade pacts.

All of that said, such deep bear markets do offer opportunities, and the 40% pummeling the indices have endured over the past year does present a gift that only occurs every 35 years or so – now one must reach out and grab that gift. This does not mean we think stocks will engage in a prolonged rally anytime soon – we’ve got legislative uncertainties to deal with as well. But for the long-term investor, this will prove to be a time that much wealth is created. For those with only a five-year time horizon, even if future policy halts a sustained rally, it is very likely we’ll see powerful short-term rallies from these levels. The S&P 500 is 30% below its 200-day moving average, and that doesn’t occur very often.


Friday’s Economic Data

On the economic front, the National Association of Realtors (NAR) reported existing home sales rose 5.5% in September (to 5.18 million at an annual rate from 4.91 million), led by a 16.8% jump in the West. Sales came at the expense of a foreclosure-driven decline in prices of 5.5% last month – down 8.6% over the past 12 months and 17% from the summer of 2006, the peak. .



The boost in sales may prove short-lived as the October reading will reflect the credit turmoil that occurred last month. (Existing home sales are counted when the contract closes as opposed to the new home sales figure, which are counted when signed – thus these September sales are the result of August lending)

Foreclosure-related sales accounted for 35% of last month’s sales, according to NAR. Of those, roughly 80% were for primary residences, higher than the average of 75% and suggesting investing (rather speculative purchases back when things were booming) were not the primary reason for the jump in foreclosures.

By region, sales jumped 16.8% in the West (which has witnessed the largest decline in prices), sales rose 4.4% in the Midwest, 2.2% in the South and fell 1.2% in the Northeast.

The supply of existing home – as a percentage of sales – did come down nicely, but still much room to make up.


Credit Markets

The credit-market indicators illustrate the freeze-up has thawed considerable, but seems to have taken a respite for now.


The TED Spread, an indication of risk aversion has leveled off as three-month T-bills have rallied (yield has fallen) due to another round of flight-to-safety trading – three-month LIBOR continues to tick lower, which is good. The spread has narrowed nicely, but there is more work to be done. Risk aversion will dissipate at some point and when it does the credit markets will flow again and stocks will rally, if not before.



Have a great day!

Brent Vondera, Senior Analyst

Afternoon Review

Earnings releases and management commentary all had a similar tone this week. The general consensus amongst firms reporting earnings this week is that the global economy is entering a recession that will last most of 2009. Most companies began to see weakening on a global scale in September, with the weakest demand in automotive, housing, and durable goods markets. Operations across all industries are tightening and capital expenditures are slowing as companies shift into cash preservation and build mode.

Companies seem to be encouraged by the coordinated response by governments and central banks around the world. While most statements showed confidence that government actions will ultimately restore global liquidity, there is a great deal of uncertainty regarding the depth and duration of economic decline as well as the timing and strength of a recovery.

These are obviously challenging times, and they are challenging for companies across all industries. Management statements this week acknowledged the importance of taking advantage of growth opportunities when they present themselves and position themselves for the future.

The market is beginning to distinguish between companies that will see modest growth and those where growth is going to fall off a cliff. In many cases it is easy to pick out the relatively stable businesses from the unstable ones. The companies that are holding up are doing so because they are very high quality companies.


Click here to read a summary of various earnings reports from this week.



Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stock activity exhibited another extremely volatile session on Thursday, but ended the day on the plus side as the broad-market rallied 5.5% in the final hour of trading. The Dow, which swung 555 points from the session’s peak to trough, jumped 5.2% in the final hour.

I was going to come in today and say it’s a good sign that we’re rallying at the end, but no one really knows in this market, the volatility is insane. Further, overseas markets were hammered last night, and into this morning for the European bourses. Stock-index futures are “limit down” – meaning trading curbs meant to keep things orderly have kicked in and prices cannot fall further prior to the bell. (Orderly, that would actually be nice) So, the fact that the market has rallied at the end of the prior two sessions is probably pretty meaningless right now.

Market Activity for October 23, 2008
We are fairly confident the market has poor earnings assumptions and a meaningful recession priced in at this point – although there are other factors that don’t exactly give the equity investors a great feeling, as touched on yesterday. (The government has pulled every trigger in its arsenal, except for its most powerful – a tax-rate response to this situation. This is beyond puzzling and proving to be a huge mistake)

The market is fundamentally oversold; everyone knows it, but it doesn’t matter right now as de-leveraging and fear continue to play out. We’re likely witnessing the most oversold market since October 1974, which proved to be the most awesome buying opportunity of all time – but just like that period 34 years ago to the month plenty of obstacles remain in the path of progress.

Even though fundamentals have been discarded, longer-term investors should not ignore the fact that multiples have compressed and the S&P 500 market cap-to-GDP ratio has dropped to a point that doesn’t properly reflect the actual size of the economy. To bring it back to a level that makes more sense, it is not unreasonable to expect that market cap to increase by $4-5 trillion, which would amount to a 50% jump in the index. Also, the broad market now trades at 2003 levels, yet after-tax corporate profits are higher by 115% since the S&P 500 last stood at this price.

Of course, if we get policy adjustments that fundamentally change our economy to one that involves more government action for the longer-term, then a jump of this magnitude will only be delayed.



On the economic front, the Labor Department reported jobless claims rose 15,000 to 478,000 in the week ended October 18 – this was double the expected increase, but remains below the peaks of the prior two job-market downturns.

The government stated that 12,000 of last week’s claims resulted from Hurricane Ike, which hit six weeks ago, as shutdowns from that weather-event continue to flow through to firings.

Nevertheless, we won’t be able to blame claims on that weather event from here and other areas of the report are showing weakness will continue – not that that’s a huge surprise based on what has developed over the past few weeks. The ratio of states reporting increased claims to those reporting a decrease is a meaningful sign of weakness – 39 states and territories reported an increase to 13 that reported a decrease. The credit-market freeze up of the past five weeks, and reactions to this occurrence such as an elevated level of caution and holding off, has damaged economic activity for at least the next two quarters.

The four-week average of jobless claims (chart below) fell 4,500 to 480,250. During the September employment survey this measure hit 445,750 – the October jobs report will be released on November 7 and this claims data suggests we’ll see another 100k-plus decline.


The economic deterioration from the credit-market event has occurred with amazing speed – it was just six weeks ago that economic data was suggesting the business side of the economy would offset weakness from consumer activity due to the housing and labor-market downturn. (Business spending on capital equipment was on the rebound, rising 7.0% at an annual rate April-August, but that trend will show a collapse when the September figure is released next week.)

Everything changed when Lehman went down on September 15 and the credit-market disturbance that resulted. Even firms that were not directly affected by this situation have become extremely cautious, which funnels down to job-market fundamentals.

In other economic news, the OFHEO Home Price index showed a decline of 0.6% for August – OFHEO stands for Office of Federal Housing Enterprise Oversight.

For the past 12 months, the index has home prices down 6.6%. As we explain each month, this is quite different from the S&P Case/Shiller Housing index (the index the press focuses on), which has prices down 16% over the past 12 months. This OFHEO index has its flaws, it does not include the high-end market, but it is much broader than the Case/Shiller reading, which includes only the 20 largest metro areas – several of which have endured the largest price declines due to heightened speculation during the boom.

Bottom line, weight Case/Shiller, OFHEO and the National Realtors Association existing home sales data equally and it suggests home prices are down 10% year-on–year. Probably very close to reality for the majority of U.S. regions.

A “Time for Choosing”

Over the past five weeks you all have certainly noticed the tone of the letter has grown negative – at least relative to my normal tone; the data along with thoughts of impending policy changes have that effect. Simply to provide a commentary on weak economic releases and market-specific data by definition leads to less-than-optimistic expression.

Taking a longer-term view though, the U.S. economy has so much going for it. Our entrepreneurial spirit, productive workforce, awesome ability to innovate, ability to attract capital, streamlined corporate structures, geographical breadth and track record of bouncing back from the most dangerous of scenarios are huge benefits that should not be forgotten.

However, we cannot have a Washington that stifles most of these benefits. To move to increased levels of regulation and onerous tax rates will smother our economic benefits like a python squeezing its prey (and I do have in mind Thomas Paine’s Rights of Man with this comment). The direction of policy over the next couple of years will shape whether we have the ability to continue along an economic trajectory that has raised living standards more in the past quarter century than possibly anytime in history or something more in line with Europe, a slow erosion that stifles the national spirit. We have indeed arrived at another “time for choosing.”

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

Round-tripper

U. S. stocks were pounded again yesterday and frankly I’m not buying the claim that this is because of poor earnings assumptions. Stocks have priced in these earnings assumptions and a substantial recession at this point. Yes, there is uncertainty over how badly profit results will be affected by this mess a quarter or two out, but heavens the broad market is down 42% from the peak – it’s priced in at this point. At least some of this move is about the election.

Credit markets are in the process of thawing, so we don’t have that to blame right now, certainly not to the degree we could a week ago. Uncertainty, or rather near certainty that market-sensitive tax rates will erode after-tax return expectations, is causing additional damage as a de-leveraging event may still be playing out.

Certainly, the economic damage locked up credit markets have wrought continues to pressure stocks. For each 5% move lower – and that’s not a scientific trigger point, I’m just throwing a figure out there – hedge funds and mutual funds receive additional redemption calls, and must sell stocks as a result.

Yet, the bounce off of the lows of the session yesterday does not suggest the move was due solely to this phenomenon. When redemption calls drive these sell offs we see erosion increase to the close, that didn’t occur on Wednesday.


Market Activity for October 22, 2008

The S&P 500 is back to levels not seen since April 2003, and June 1997 when the broad market hit this level for the first time – a round-tripper.

However, we are holding above the 849 intra-day low in terms of the S&P 500 and 7890 for the Dow, which were hit on October 10. I’m not going to pretend to be a technician, but the longer we hold above those levels the better.

It isn’t fun going no where for a decade. But multiples continue to compress and history shows after round-trippers of this duration, the Great Depression being the exception, it isn’t long before a sustained rally takes hold. This multiple compression action is an important one.

When we hit this level for the first time back in 1997 the broad market traded at a P/E of 23 times earnings and after-tax profits were about to go flat (many don’t know this but after-tax corp. profits declined Q3 1997 to the end of the decade). When we touched this level again in 2003, the index was trading at 30 times, after-tax corporate profits were in the process of an extraordinary five year growth run. Currently, the S&P 500 trades at 18 times trailing profits. Based on profit expectations for the next four quarters, the index trades at just 11 times – assuming profit growth expectations are off the mark by a huge 50%, you still have a forward P/E of just 14.

Problem is we may have some policies that aren’t exactly market-friendly to deal with. Further, a President Obama will be tested by our enemies (which Senator Biden has now warned us of, was he privy to a recent intelligence report suggesting this?), which could delay that sustained rally we’re all hoping far. It’s unfortunate we must rely on hope, but when no one is going to step up with a sensible fiscal policy response, that’s all you’ve got.

This is where the current administration takes the blame. With all that has been said, what got us here is hardly Bush’s fault; plain and simple the origin of this situation is Federal Reserve monetary policy mistakes – keeping rates too low for too long. (What were they thinking as they continued to cut fed funds to 1.00% in June 2003 even as the economy began to come back in 2002 and was rolling by the spring of 2003?) In fact, the Bush tax cuts (on income, dividends, capital gains, repatriated income and business write-off allowances) helped us withstand a 178% jump in the price of oil (mid 2003-mid 2005) – even before the super-spike occurred two years later – and housing’s drag on the economy that has lasted for 2 ½ years now.

However, for the administration to ignore a tax-rate policy response to the current troubles is mind-boggling. We’ve thrown everything at this issue – and for sure much of this does not have an immediate effect, but will in time – yet to hold back on the most powerful policy tool there is strange. So President Bush fears he doens’t have the numbers to get it through Congress, what does it hurt to try your darnedest?

On to better thoughts -- The Greenback

Wow! The dollar continues to soar. Wonder if Giselle is ready to accept US dollars as compensation again?


Another Congressional Lashing

Ratings agency executives were on Capitol Hill attempting to defend yet another berating by those who hold themselves up to be as pure as the wind-driven snow yesterday.

Funny how regulators never come under attack. For instance when the SEC’s regulatory division head (Annette Nazareth) decided it was a good idea to switch from fixed capital ratio standards to “sophisticated” Basel II mathematical models in the middle of a housing boom it didn’t’ turn out to be an award-winning idea. But few are talking about that terrible mistake. Doing so when housing was on fire, thanks to Greenspan’s recklessly easy money policy – effectively subsidizing debt –, meant that highly rated mortgage–backed securities were treated as if they were nearly as safe as cash. This meant less capital was required – a major source of the current problem. I don’t recall those now pointing the finger at the private sector questioning this regulatory move back then.

No doubt the ratings agencies are guilty as charged, but it’s not like moronic regulatory decisions have not played a major role. The next time someone sells you on something because of its sophistication, run!

This morning we get back to data. It’s Thursday, so we’ll be watching the jobless claims release for the week ended October 18– it’s not likely to be pretty but will hold below the peaks of the past two labor-market downturns.

Have a great day!

Brent Vondera, Senior Analyst

Afternoon Review

Following up on the dividend discussion from yesterday, this post on the WSJ.com blog MarketBeat commented on the S&P 500’s unusually high dividend yield and suggests that the yields is likely to come down.

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Earnings reports have been mixed the last few days, but almost all companies are projecting lower profits in the coming quarters. I will provide a summary of earnings in Friday's post.

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Standard and Poor’s, Fitch, and Moody’s Investors Service are under intense scrutiny for putting profit gain before accuracy. These articles (here and here) are must reads for insight into the underlying problems in these ratings agency.

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A study by Bernstein Research showed that U.S. sales of store-brand household and personal products rose 8.9 percent in the four weeks ended Oct. 4. By contrast, sales of similar products increased by 2.3 percent at Procter & Gamble (PG) and 1.3 percent at Colgate (CL). In the year-earlier period, sales of private-label products increased 2.4 percent, according to Bernstein.

• Private-label brands increased market share in 15 out of the top 20 household and personal-products categories, according to a study by Bernstein Research.
• Consumer-products makers increased prices by as much as 16 percent this year to cover higher expenses for oil used in plastic packaging and pulp used for toilet paper, tissues, and paper towels.
• Shoppers are more likely to “trade down” when it comes to diapers and anything made of paper. That disproportionately hurts Kimberly-Clark (KMB), which specializes in paper products.
• Interesting Bloomberg article on the subject.

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks gave some of the recent rally back yesterday as investors’ concern over the state of the global economy grows. The Dow, for instance, jumped 400 points last week and added another 413 on Monday as credit market indicators have improve, but yesterday the index gave back one-third of that bounce and if futures offer any guidance we may just give back another 200 points today.

Credit markets are thawing – the Ted spread has narrowed another 30 basis points this morning – but the market now seems to be focused on corporate-profit guidance and stocks are under some pressure again as a result. That said ex-financial S&P 500 profit numbers look quite good thus far, up 8.1% with 25% of members reporting to this point. But when we enter such a scenario, the market chooses to look at only the negatives, of which there are plenty – but that will change.


Market Activity for October 21, 2008

No matter what occurs over the near term valuations are very attractive here. I said that a couple of months ago, but it’s truer today. There are many really good companies trading at the cheapest multiples in a very long time, I heard someone state this morning that 40% of S&P 500 members are trading at 8 times earnings -- haven’t had time to look that up yet, seems a bit of an exaggeration, but for sure there’s an abundance of names trading at 10 times or lower and even if 2009 profit results come in 25% below expectations stocks will remain cheap. It’s just going to take patience, but when a sustained rally occurs, it will be powerful.

The Dollar and Commodity Prices

The U.S. dollar has bounced back strong and commodity prices have gotten clocked from the fed-induced peak in July.

A combination of the flight-to-safety trade and expectations of a series of ECB rates cuts has sent the dollar soaring from the low hit in April.


De-leveraging trades and concerns the credit-market freeze-up will damage global growth have combined to fully whack commodity prices.


Both of these develops are good for the consumer and they can be added to realities such as strong corporate balance sheets and low inventory levels to assist in a recovery once we progress from this current weakness. (We’ll note commodity prices are likely not down for the count. We will have an inflation issue to deal with over the next couple of years due to the massive liquidity the Fed has pumped into the system, but for now the objective is to deal with credit-market disturbances. Some will say we should just let things fall where they may, for it is the Fed’s easy money policy that got us into this situation to begin with, but that’s not going to happen, not the way the world works.)

And speaking of which, the Federal Reserve rolled out another lending facility, about the sixth if memory serves. This one will provide liquidity to the U.S. money markets – the program will be termed the Money Market Investor Funding Facility (MMIFF) and will purchase assets from money-market mutual funds to stave off any difficulties meeting redemptions. This program is authorized under section 13(3) of the Federal Reserve Act.

Under the MMIFF, the New York Fed will provide senior secured funding to facilitate an industry-supported private-sector initiative to finance the purchase of eligible assets from eligible investors. (Eligible assets will include certificates of deposits and commercial paper issued by highly rated financial institutions with maturities of 90 days or less.) JP Morgan will be one of the firms running the program.

This facility is an extension of the commercial paper (CP) program the Fed rolled out last week – some had commented that that CP facility was insufficient because it did not include CDs – a major source of funding for banks. This program is expected to ease strains in the bank funding market and assist in pushing LIBOR rates lower, which has occured.

Let’s hope the worst of the credit-market disturbance is behind us – developments of the past few days suggest this is the case. We’ll be keeping an eye on LIBOR, TED Spread and commercial paper spreads.

Moving On

The WSJ ran an article last night on how big bets in domestic currencies are hammering the emerging market economies, specifically the Latin American regions, but within Asia too. Many countries with which many investors believed offered nearly unstoppable growth prospects are showing trouble related to their own speculative bubbles – namely currency bubbles. As the U.S. dollar enjoys a powerful rally all of those betting against the greenback are paying dearly for that trade.

And there is no glee in these comments pointed at those who have believed in the decoupling theory – the view that emerging-market growth would not be affected by what occurs in the U.S. If the emerging markets are going to endure substantial weakness it makes it that much more difficult for global growth to withstand this period.

This is the time for the U.S. to take the lead – which has been our role no matter the situation for the past 70 years. Congress can call their plans to extend employment benefits and food stamps “stimulus” all they want but any serious person understands these programs are nothing but socialism in disguise. Broad-based tax cuts are needed here and will provide the correct prescription for pulling us out of the weakness clogged up credit markets has delivered. We itemized what needs to be done yesterday, so I won’t repeat the bullet points.

There are some that say you can’t get the bang for your buck in growth from cutting rates from current levels. Certainly when Reagan cut the top income tax rate from 70% a powerful incentive effect was delivered. But let’s not kid ourselves. We have a top income rate of 36%; a corporate tax rate of 35%; dividend and capital gains tax rates of 15% and a terribly onerous repatriated tax of 35%. We can still enjoy huge incentive effects by reducing from these levels and this will spark a stock market rally that gets optimism flowing again. From there, everything else will fall into place.

We’ll find which direction the country chooses in 13 days – a philosophy that believes public works programs will deliver the growth we need; or private-sector inspiring tax cuts that moves the government out of the way of American innovation and its natural entrepreneurial spirit.

Have a great day!

Brent Vondera, Senior Analyst

Afternoon Review

The dividend yield on the S&P 500 is over 3 percent for the first time since 1992. However, Standard and Poor cut its estimate for 2008 dividend payments by the members of its S&P 500 index and project fourth-quarter dividends falling as much as 10 percent, which would be the worst quarterly drop in 50 years.

It is easy to get excited about the very high yields we are seeing today; however, there is a lot of pressure on balance sheets today and we could start to see many of these high dividends cut or suspended.

In spirit of this headline, this is a good opportunity to explain some basic ways to evaluate dividend payments. Our general stance is that there is no hurry to jump into a stock in fear that you are missing out on a high yield. Instead of jumping into a stock just because of a high dividend yield, investors should wait until it is more certain that the dividend payment is safe.

For example, if you were in a hurry to buy Bank of America soley for its 8 percent dividend earlier this year, then you were probably disappointed to see the dividend cut in half and the stock valuation decline.

With all of this in mind, here are a few ways to determine the health of a company's dividend.

Dividend Yield

• A company with a low dividend yield compared to the industry is either (1) a result of a high stock price that reflects the company’s impressive prospects and ability to make the dividend payment, or (2) the company cannot afford to pay a reasonable dividend because its business model is not as strong as its industry peers.
• At the same time, however, a high dividend yield can signal a sick company with a depressed share price (e.g. C, PFG, BAC, GE).

Dividend Growth

• Dividend growth is one of the simplest ways for companies to communicate the financial well-being and shareholder value. They send a clear, powerful message about future prospects and performance. Obviously double-digit dividend growth great, but something that at least surpasses inflation is nice to see.
• While a history of steady or increasing dividend is certainly reassuring, it is generally a bad practice for companies to rely on borrowings to finance those payments.
• Watch out for companies with debt-to-equity ratios greater than 60%. Higher debt levels often lead to pressure from Wall Street as well as debt-rating agencies. That, in turn, can hamper a company’s ability to pay its dividend.

Dividend Payout Ratio

• In general, the lower the payout ratio, the more secure the dividend because smaller dividends are easier to pay out.
• What is a high dividend payout ratio depends on the industry. Retail stocks tend to have ratios under 30 percent (retail is a terrible cash flow business); mature technology stocks (e.g. IBM) tend to be around 20 percent (they need cash for R&D); bank stocks are historically in the 30 to 45 percent range (the current payout ratios are not representative of historical ratios); consumer staples tend to be around 40 percent
• Anything above 45 percent or that is not the industry-norm means there may not be enough cash to weather hard times or raise the dividend.

Dividend Coverage Ratio

• This ratio is used to gauge whether earnings are sufficient to cover dividend obligations. The ratio is calculated by dividing EPS by the dividend per share.
• When coverage is getting thin, odds are that there will be a dividend cut, which usually hurts the stock price too.
• In general, a coverage ratio of 2 or 3 is considered safe. In practice, the coverage ratio becomes a pressing indicator when coverage slips below about 1.5, at which point prospects start to look risky. If the ratio is under 1, the company is using its retained earnings from last year to pay this year’s dividend.
• At the same time, if the payout gets very high, say above 5, investors should ask whether management is withholding excess earnings, not paying enough cash to shareholders. Companies that raise their dividends are telling investors that business over the coming 12 months or more will be stable.

There are obviously other variables that need to be considered, but this is a great starting point for evaluating dividends...Introduction to Dividends or Dividends 101, if you will.

Because there are so many earnings reports out this week, I will forgo earnings analysis until Friday.

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks rose as credit markets continue to thaw and earnings reports illustrate there will be some bright spots even if overall profit results are weighed down by the financial sector, for the fourth straight quarter. The Dow and S&P 500 both gained more than 4.5%; the NASDAQ Composite added 3.4%.

Energy shares led the gains, bouncing 11.15%, as measured by the S&P 500 Energy Index; these stocks have gotten crushed as oil prices have been cut in half from the fed-induced peak hit back in July and some bargain hunters are coming back in. Basic material and utility shares also enjoyed a huge day, jumping 8.15% and 8.06%, respectively.

The big news of the day is the continued thawing in the credit markets. It’s too early to get terribly excited, but the market has to feel much better as inter-bank lending becomes a bit more open (as illustrated by the decline in three-month LIBOR) and investors are not seeking out the ultra-safe investments to the extreme degree that was the case just a week back (as illustrated by three-month T-bills). The TED Spread shows the narrowing between these two rates – a very very good sign but it must continue.



Market Activity for October 20, 2008

Substantial economic damage has been done as the credit markets locked up for a full month, but stocks should get juiced if these spreads continue to narrow, as this is what will determine the extent and degree of the downturn. Sure there are other factors weighing on growth and investor expectations, but this is at the heart of the issue.

On the earnings front, things are looking pretty good, at this point. Thus far roughly 20% of S&P 500 members have reported and ex-financial profit results are up 8.8%. Financial profits are down 119% with 30% of the group reporting. (How can something fall more than 100%? It’s called profit losses.) But we do have four of the 10 major industry posting double-digit earnings growth (consumer discretionary, energy, tech and basic materials). Expect this ex-financial figure to ease as earnings season progresses, but for now things are looking pretty good.

On the economic front, the Conference Board’s Leading Economic Indicators (LEI) index rose 0.3% for September, marking the first increase since April. Nevertheless, this is not an accurate indicator – at least it hasn’t been over the past few years. We usual refrain from touching on this figure, but since it was yesterday’s only economic release, I thought it was worth mentioning.

The index got a boost from money supply growth (added 0.45%), interest rate spreads (slope of yield curve, up 0.19%) and consumer expectations (up 0.26%). The drag came from stock prices (down 0.20%), building permits (down 0.23%) and jobless claims (0.23%).

The index is designed to forecast the direction of the economy over the next six months, but that has not been the case. For instance, the LEI posted negative readings in half of the 36 months that ran January 2005 through December 2007. During that period GDP advanced at a real annual rate of 2.5% (and that’s with a major housing drag during half of that period), certainly better than the LEI was forecasting.

From here, the index will continue to get a boost from money supply growth (which will surge as the Fed pumps cash into the system to unfreeze credit markets), interest rate spreads (very positively sloped yield curve) and consumer expectations – not that consumer’s are going to be feeling great over the next couple of months, but from currently low levels, there’s really only one direction for this component to go.) The index will not take into account the harm credit-market disturbances have had on the economy over the past month, and sends the wrong signal as the short end of the curve is benefiting from the “safety” trade, making the yield curve more positively sloped than would otherwise be the case.

Moving On

I see Fed Chairman Bernanke is endorsing a second “stimulus” plan – oh, boy; here we go. Sure he states any stimulus package needs to “promote economic growth and job creation,” but in the current political environment – Bush hesitant to offer the right prescription, thus leaving it to Speaker Pelosi and Senate Majority Leader Reid to mold their variety of a “stimulant” – such words mean he is giving them the green light to say the Fed Chairman is behind their hand-out schemes.

That scheme, as I believe it is appropriate to term the proposal, involves increased unemployment benefits, food stamps and aid to cash-strapped states. (Cash-strapped stated, eh? They can’t reduce spending? It’s not like they haven’t received billions from the Federal government over the past few years. It’s not like revenue growth wasn’t huge during the previous three years. They should not be cash-strapped.) And someone please explain to me how increases in food stamps and unemployment benefits stimulate the broad economy?

Heck, the last “stimulus” plan sent checks out to most everyone ($168 billion worth) – unless of course you made “too much” as defined by those omniscient actors in Congress – and it did nothing. The personal consumption segment of the second-quarter GDP reading rose 1.2% at an annual rate – weak. You can expect a proposal that extends jobless benefits and food stamps to be even weaker, which means it adds nothing to growth but does substantial damage to the budget. This is pathetic.

When Washington wants to get serious, they can cut tax rates in a broad-based way – this actually has incentive effects and at the same time delivers increased tax receipts to the Treasury. Here’s what works:

• Cut the top two income tax brackets (small business taxpayers) and make the current increased allowance for business spending write-offs permanent (as of now this expires in January 2009) -- you’ll get job creation.
• Cut the capital gains tax and watch the cost of capital fall, while the Treasury is inundated with tax receipts as investors unlocked old investments for new.
• Cut the dividend tax rate further and – in addition to the capital gains tax rate – the stock market will get on its horse.
• Cut the corporate tax rate and remove all doubt that the U.S. is the greatest place in the world to headquarter. You’ll get a two for one benefit as corporate profits rise and prices fall – corporate taxation is ultimately passed on to the consumer.
• Eliminate the dead-weight loss which is the repatriated tax and watch capital that is currently hiding overseas to escape this tax come home to provide billions in funds for R&D.

This is real stimulus. When Washington wants to get serious, you’ll know it. Right now, outside of some recent steps from Treasury that have reduced credit-market disturbances, everyone understands they are not.

Have a great day!




Brent Vondera, Senior Analyst

Afternoon Review

News pertaining to Acropolis securities was relatively light on Friday…

IBM confirmed 3Q EPS increased 22 percent to $2.05 per share, in line with last week’s pre-announcement, and the company said it sees “very strong opportunities” in developing markets over the next six months. It has had no problems issuing commercial paper, liquidity is very strong, and short-term signings picked up in September. Services and software were solid, but very weak hardware numbers show a clear industry slowdown. In this environment, I think it is safe to assume that no technology business segment is immune to macro pressures.

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Russian stocks continued their steep slide (on Friday) as the Financial Times reported modest runs on medium-sized banks. The near collapse in commodity prices, including the more than 50 percent drop in oil in recent months, is also darkening the outlook. Central Europe and Russia Fund (CEE) is down 47.99 percent since 8/28/2008.

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What happened today…

China’s economic growth (9.0 percent in 3Q) slowed more than expected. This data is likely to prompt Beijing to shift to looser monetary policy and step up fiscal spending (especially as inflation concerns cool). It is unclear to what extent Olympic-related factory closures and transport disruptions affected GDP, but it is no surprise that export growth took a hit considering the state of other developed economies. All in all, China’s economy is in a good place compared to the U.S. and Europe. There is confidence in their financial system, no liquidity problems or risk of bank insolvency, low levels of external debt and very minor exposure to foreign mortgage-related investments.

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Energy related stocks rallied on the earnings release from Halliburton (HAL) who said that unconventional activity throughout the U.S. and Canada accelerated. HAL said a worldwide recession would have negative short-term implications for demand, but current prices still support most projects under way. International business has not yet been impacted by economic troubles and the drop in commodity prices, the CEO said.

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One of the biggest news stories today may be Fed Chief Ben Bernanke’s support for a second fiscal stimulus package. Bernanke said that because the economy is “likely to be weak for several quarters,” including the risk of a “protracted slowdown,” a fiscal stimulus package seems appropriate. Bernanke would not provide a specific dollar amount but said any potential package should be “significant.” However, he did suggest that fiscal package should include “measures to help improve access to credit by consumers, homebuyers, businesses, and other borrowers.”

Commentary as well as video of Bernanke’s address to the House Budget Committee can be accessed by clicking here.

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The upcoming election has highlighted some major obstacles for U.S. coal stocks. Coal powers half of the U.S. electricity supply, but also is the country’s largest source of carbon dioxide emissions. This article on WSJ.com examines how politicians are responding to the coal industries concerns.

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At this point, it’s hard to put any credence into analyst estimates on housing prices (look where that got us today). That being said, Fitch Ratings projected prices will start to stabilize after falling 10 percent more.

“Fitch’s analysis shows that the 29 percent rise in prices realized between 2004 and 2006, representing one of the largest price growth periods ever recorded, has been reversed. With prices returning to early 2004 levels, Fitch believes that most of the additional 10 percent decline, which will bring prices back to levels seen in 2003, will occur over the next eighteen months. Fitch then expects declines thereafter to moderate.”

In case you missed it, WSJ.com posted a great interactive graph that shows the housing pains in the U.S.

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139 of the S&P 500 companies are reporting earnings this week, so we should get a pretty good idea of which sectors are best suited to weather the storm. Companies reporting tomorrow that are of interest to Acropolis clients: Lockheed Martin (LMT), Pfizer (PFE), 3M (MMM), Quest Diagnostics (DGX), DuPont (DD), Caterpillar (CAT), Cerner (CERN), Raymond James Financial (RJF), and First Cash Financial (FCFS).

Prepared by:

Peter Lazaroff, Junior Analyst

Stock Market Volatility

You don’t need us to tell you that the market has been volatile, but I thought these statistics were interesting at the very least:

Year to date through Sept. 15, the average daily change in the Dow Jones Industrial Average (DJIA) was 122 points. Since that time, the average daily change is 348 points per day.

Prior to Sept 15, there were no moves greater than 500 points, but since then we have had six days where the DJIA moved in excess of 500 points. We have also had 10 trading days with intra-day movements of more than 750 points.
This graphic from NYTimes.com last week gives some perspective on the scale of stock market volatility.

October 2008 Portfolio Insights

The highly anticipated October 2008 edition of Portfolio Insights has arrived!

This expanded edition focuses on:

• The History of Past Down Markets
• Are Your Investments Safe?
• Fixed Income Strategy
• Equity Markets Activity
• Inside the Economy
• Ask Acropolis

Click here or on the cartoon to view the issue.

3Q 2008 Participant Insights

Another fantastic issue of Participant Insights is available for your viewing. In this issue of our 401(k) participant newsletter, Mona Gooden reviews some key rules for 401(k) investing and Debra Moran provides some commentary on how to view the market's recent volatility in regards to your retirement savings accounts.

Click here to view 3Q 2008 Participant Insights.

Daily Insight

U.S. stocks engaged in another day of wild fluctuations on Friday as the broad market was higher by 4% just after lunch, but we lost it all in the final two hours of trading to close in negative territory. Nevertheless, it was a good week, the first in four, as the benchmark indices closed higher by nearly 5%.

The Dow Jones Industrial Average gained 4.75% over the past five sessions, following the worst week in the index’s history – down 18.15%. Despite the 400-point rebound last week, the Dow remains 2,570 points lower since Lehman Brothers went down on September 15. That marked the point the credit markets became disturbed, to put it lightly.

Market Activity for October 17, 2008
As of the past few days though, the credit markets do appear to be thawing – hopefully the trend continues, but one should not expect to accurately extrapolate based on the trend of the past week – the ride lower will probably not be straight down.

Below are two key indicators the market has been watching, and we’ve spent much time mentioning.

The first is three-month LIBOR, which shows the inter-bank lending rate for the specified period. While it shows banks remain unwilling to lend to one another, or charge a high rate to do so, it’s come down nicely over the past three sessions.


The next is the TED Spread, which illustrates the level of risk aversion in the marketplace. This spread is the difference between the rate on three-month LIBOR and three-month T-bills. The spread shows people continue to run to the safety of the Treasury market. That is, short-term Treasury yields remain very low due to huge demand for these securities. Once this fear wanes, rising T-bill rates will combine with falling LIBOR and this will, obviously, cause the spread to narrow – a clear sign things are normalizing.


Rates for one-month commercial paper also fell to a three-week low.

Friday’s Economic Releases

On the economic front, U.S. housing starts fell more than expected in September as construction of single-family homes plunged to the lowest level in more than 25 years, indicating the slump intensified and will be a larger drag on GDP – residential investment has weighed on economic growth for 10 quarters now; that drag eased in the second quarter, but will get worse again with regard to the final two GDP reports of this year due to the chaotic state of the credit markets.


The only time in the history of this data, which goes back to 1959, single-family starts were this low was in the middle of the 1981-1982 recession.

While this development hurts for now, it is a necessary condition for bringing the housing market back. Inventory levels as a percentage of sales remain at an extreme elevation and a serious reduction in supply is needed. That said, the homes available for sale data (not adjusted for the current sales pace) has plunged. So, when the sales numbers do begin to pick up again, the inventory-to-sales ratio (the supply figure that remains elevated) will come down fast.

It will take some time still, especially as the labor market has deteriorated. Further, demand will not improve substantially until the perception that prices have bottomed takes hold. And obviously, tighter credit conditions – rather, all but frozen credit markets – delay the rebound as well. We do believe though that the next chart illustrates some very important work has been accomplished.


We will have to see the permits reading bounce before housing begins to flatten out.


Digressing

Capitalism is certainly under assault after what’s occurred over the past month – referring to the plunge in stock prices --, but we should be very careful not to throw the baby out with the bathwater. Capitalism, for all of its flaws, remains the best of all of man’s inventions with which to allocate scarce capital, goods and services in order to fulfill unlimited wants. Period. Choose something else and you get lower growth, less prosperity and less choice – such as in Europe for instance. From the perspective of an individual country, tax capital more and it will simply go elsewhere as it seeks out the places where it is most welcome and best treated – to paraphrase the words of the late Walter Wriston.

Policy proposals to raise taxes are harmful. The claim that such an endeavor is necessary to punish the rich is perverse. While it may punish some in the upper class, it truly punishes those attempting to climb the economic ladder. The rich and well-off can shelter their income from onerous tax rates. What it does to other achievers is close the door to wealth – making it more difficult to walk through that door. We should not forget also that the majority of those that make up the top tax brackets are small businesses – the most prolific job creators in our economy.

It is no coincidence why rich Europeans are those that have been wealthy for generations. Conversely, in the U.S. you can run into a multi-millionaire today who didn’t have anything but good ideas and a strong work-ethic 10 years back. This is the key difference between the U.S. and Europe (this is just not a cultural difference but one of tax rates) and those that have the desire to move to the European model are actually punishing those they claim to help far more than those they claim to punish.

And on this claim that de-regulation is what brought us to this point, a topic we spent some time dispelling last week explaining that Congress has net increased regulations over the past several years coming out of the tech bubble and bust, there were two excellent Op/Eds in the WSJ on Saturday. One – the first link below -- explains the regulatory changes that helped deliver us down this path. The other – an interview with the brilliant Anna Schwartz – explains was put us on this path. For those with WSJ subscriptions, these are worth the read.

http://online.wsj.com/article/SB122428201410246019.html?mod=todays_us_opinion

http://online.wsj.com/article/SB122428279231046053.html?mod=todays_us_opinion

Have a great day!

Brent Vondera, Senior Analyst