U.S. stocks began the session higher, led by industrial shares, on news the Chinese government would inject nearly $600 billion into their economy through 2010. But the benchmark indices quickly reversed course as focus turned to the reality that the current quarter’s earnings figures will be less than auspicious, to put it mildly.
As you can see, industrial shares led the early session rally, up 3% from the get go, but also gave it back even though much of this group will benefit from China’s spending.
It is also impossible to currently gauge the duration and depth of the economic contraction that surely began in September, and this is also making it tough to hold rallies. However, we are down 42% from the peak, so it appears the market has priced this event in, even if we get something that compares to the significant 1982 downturn.
I don’t believe there as been such a rapid decline in confidence and economic data since at least 1973-1974, so we could be headed for a similar contraction – certainly the stock market activity of the past few months compares well to that period. That 1973-1974 economic downturn lasted roughly 18 months.
While the current earnings season (last quarter’s results) is shaping up quite well, sans the financial and consumer discretionary sectors, there is little doubt the current quarter will post some real weakness – earnings will be significantly affected by the shutdown in spending among consumers and an extreme level of caution among businesses that the stock-market decline and credit-market chaos wrought.
Senate Numbers
Another drag on confidence is the uncertainty regarding the filibuster power of the Senate. There are still three Senate seats that have yet to be decided – Minnesota and Alaska are in a recount and Georgia, which is still counting, appears headed for a runoff. (GA is like LA in that if there are three candidates in the race one fails to receive over 50%, then the top two head into a runoff election, which is roughly 20 days out)
This is a huge event. A Senate with filibuster ability – meaning Democrats hold less than 60 seats, currently it’s at 57 – is the only check and balance on an Obama/Pelosi/Reid legislative and executive branch agenda. We know the voting records of this three-some along with their statements of the past several months and the agenda is not exactly market friendly. So the fact that the Senate race remains undetermined seems to be a big market issue right now. (President-elect Obama will be out president and must be embraced. But one finds it hard to get past his voting record and associations. We should all hope those concerned over the direction he desires to take the country – myself included -- are dead wrong.)
China’s Stimulus
The Chinese government pledged to inject $586 billion into their economy, largely for infrastructure projects. The funds will be delivered by 2010, but the first tranche -- $100 billion – is scheduled for this quarter and to be spent on low-rent housing, roads, railways and airports. The government will also allow tax deductions for purchases of fixed assets like machinery, plants and electrical equipment – which is big news for U.S. firms that provide the Chinese economy with a good degree of these equipment and construction orders.
The degree of this stimulus is huge, amounting to nearly 20% of their GDP. For perspective, this would be equivalent to the U.S. spending $2.8 trillion – our own government is in the process of spending a lot, but we haven’t yet approached this percentage, thankfully.
Economic Data
We will be without a data release for a couple of days, but get back to it by the second-half of the week.
Thursday, we get the weekly jobless claims data and look for claims to remain elevated. The market will be watching to see if we hold below the 500k level. Most readers are familiar with the jobless claims chart, but I’ll post it again to illustrate.
We also get the trade balance for September, which will show meaningful declines for both export and import activity. Imports will decline to a larger extent than exports and thus the trade gap should narrow. On an inflation-adjusted basis, the trade gap will have narrowed to the lowest level since 2002.
Those who have yearned for a narrower trade gap are getting their wish, but it comes on the heels of slow growth, or economic contraction, which we have mentioned for several years now.
On Friday, we’ll get import prices (October) and business inventories (September).
On import prices, the market expects the figure to continue to ease from extreme readings of the first half of the year. The US dollar rallied 18% from July through October and this will naturally bring import prices lower. Further, the plunge in energy prices will also move the index lower.
That said, we expect the easing we’ve seen within the inflation gauges to reverse and turn up again as we look out over the next year -- the combination of fiscal stimulus (of which we haven’t yet seen the extent) and the massive liquidity the Fed has pumped into the system will cause the inflation gauges to shoot higher again. Currently, the financial press is focused on deflation, and most economists I’ll add. This is quite unlikely though with what the Fed has done. We’d watch for inflation to kick up after a multi-month respite. As you can see on the chart below, import price inflation has come off of extreme highs, but even excluding energy they remain dangerously high.
On the business inventories data, we expect the figure to fall as the manufacturing and wholesale figures have already offered evidence of this. Business sales have remained very upbeat over the past several months, but everything changed in late September and into October. There is no way sales will have advanced based on what’s occurred. The hope is that this decline will prove to be a two-month event. We shall see.
Veteran’s Day
Today is Veteran’s Day and the 90th anniversary of the symbolic end of WWI, signed on the 11th hour of the 11th day of the 11th month of the year 1918. The bond market will be closed, but stocks and currencies are open for business. Thank you veterans; thank you for all you endured and accomplished for the rest of us.
Corrections:
Yesterday I stated that $3.8 billion sits in money market funds as of the Fed’s latest report. It is actually $3.8 trillion. I’ve cited this figure before, so most of you likely assumed what I meant to type. A reader pointed the error out to me yesterday morning. Thank you.
Also, in terms of the mini nuclear reactor story, I noted that the $25 million initial cost for each reactor (able to power 10,000 homes) would come to only $250 per house – that number would actually be $2500. .
Starting today, we will not be including the tables or charts in the blog version of Daily Insights. If you would like the complete version, please send us your email information at info@acrinv.com.
Have a great day!
Brent Vondera, Senior Analyst
Tuesday, November 11, 2008
Monday, November 10, 2008
Fixed Income Recap
The benchmark curve steepness, usually measured by the difference in yield of the 2 year and 10 year Treasuries, reached 250 basis points for the first time since January 2004. Steeper yield curves have historically forecasted improving economic conditions in the past, but the validity of that correlation could be questioned this time around. Especially given the current state of the bond market overall and the current funding needs of the Treasury. These are things we will have to monitor closely.
Fannie Mae, who still has yet to receive a cent of help from the Treasury, reported a loss of $29 billion, or $13 a share today. The company said today that it may fall to negative net worth before the end of the year and the $100 billion facility established by the Treasury may not be enough. Delinquencies on their book of business did increase this month over last, but most of the losses resulted from a decreasing of a very large deferred tax asset that they have had on their books for years. Tax assets are only held at a significant value if they are expected to be realized in the foreseeable future through taxable profits, which doesn’t look likely to happen.
The treasury auction this morning was met with great demand driving treasury prices down and yields up. But yet again we saw them rally back as stocks lost their steam going into the afternoon, causing the curve to shift down about 8 basis points. We will wait to see if the thin balance sheets of dealers have the appetite for the 10 and 30 year auctions later this week.
The bond market is closed tomorrow in observance of Veterans Day.
Cliff J. Reynolds Jr.
Junior Analyst
Fannie Mae, who still has yet to receive a cent of help from the Treasury, reported a loss of $29 billion, or $13 a share today. The company said today that it may fall to negative net worth before the end of the year and the $100 billion facility established by the Treasury may not be enough. Delinquencies on their book of business did increase this month over last, but most of the losses resulted from a decreasing of a very large deferred tax asset that they have had on their books for years. Tax assets are only held at a significant value if they are expected to be realized in the foreseeable future through taxable profits, which doesn’t look likely to happen.
The treasury auction this morning was met with great demand driving treasury prices down and yields up. But yet again we saw them rally back as stocks lost their steam going into the afternoon, causing the curve to shift down about 8 basis points. We will wait to see if the thin balance sheets of dealers have the appetite for the 10 and 30 year auctions later this week.
The bond market is closed tomorrow in observance of Veterans Day.
Cliff J. Reynolds Jr.
Junior Analyst
Friday, November 7, 2008
Fixed Income Recap
The unexpected rate cuts by the Bank of England and European Central Bank on Thursday were a signal from Europe that economic growth is a pressing concern, yet the reaction in the US bond market was muted. Traders concentrated more on the employment report on Friday.
As expected, the employment data drove the direction of the treasury curve early in the day. Treasuries along all maturities were up slightly after the negative economic data, (-240k Change in Nonfarm Payrolls for October, a revision down for September to -284k from -159k and a rise in the Unemployment Rate to 6.5%). The rally in bonds prompted large investors to take profits going into the weekend, causing a sell off in the afternoon while traders await $55 billion of government auctions next week.
Interbank lending continues to be strong with overnight money costing well under the benchmark rates in both the U.S. and Europe. The improvement in liquidity has been felt in the market with spreads tightening but remaining very volatile as treasuries continue to trade all over the place day-to-day.
By Cliff Reynolds, Jr.
Junior Analyst
As expected, the employment data drove the direction of the treasury curve early in the day. Treasuries along all maturities were up slightly after the negative economic data, (-240k Change in Nonfarm Payrolls for October, a revision down for September to -284k from -159k and a rise in the Unemployment Rate to 6.5%). The rally in bonds prompted large investors to take profits going into the weekend, causing a sell off in the afternoon while traders await $55 billion of government auctions next week.
Interbank lending continues to be strong with overnight money costing well under the benchmark rates in both the U.S. and Europe. The improvement in liquidity has been felt in the market with spreads tightening but remaining very volatile as treasuries continue to trade all over the place day-to-day.
By Cliff Reynolds, Jr.
Junior Analyst
Daily Insight
U.S. stocks got clocked again yesterday, marking back-to-back 5% declines, after Cisco Systems reported its first revenue decline in five years and a reduction in outlook, increasing concerns over global growth and fourth-quarter earnings results. The two-day slide is the worst since 1987.
While the current earnings season (third-quarter) is shaping up better-than-expected, ex-financial profits are up a strong 16.3%. The problem now is this quarter’s results will show the effects of the economic deterioration that followed the Lehman Brothers collapse in mid September and the credit-market disturbance that ensued.
Putting additional pressure on stocks is the expectation that the October jobs report will show payrolls declined by 200,000 positions – and it may be as bad as 250,000. We believe current valuations already reflect these events, as the very broad NYSE Composite trades at 13 time trailing 12-month earnings, but in the current environment fundamentals have been thrown from the train. Hedge funds continue to deal with redemption calls and as they sell to raise cash mutual-fund investors bail, exacerbating the plunge.
Market Activity for November 6, 2008
Global Rate Cuts and the Dollar
Wow! The Bank of England (BOE) slashed their benchmark interest rate by 150 basis points (or 1.50 percentage points) and the ECB (European Central Bank) cut its rate by 50 basis points as they try to catch up to our Fed’s degree of rate cutting – good luck keeping up with that pace. The BOE rate reduction is the largest since 1992 and the current 3.00% level on what is called the Bank Rate is the lowest they’ve had it since 1955.
This is all part of the coordinated effort global central banks are now engaging in as they attempt to ease the credit-market disturbance that took hold last month. As a result, the US dollar is in rally mode again, rebounding from the recent pullback.
The Economy
On the economic front, the Labor Department reported initial jobless claims for the week ended November 1 fell 4,000 but remains elevated at 481,000. We’re likely to see this reading move above the 500,000 mark and thus surpass the level we saw during the 2001 downturn.
The states reporting an increase in claims relative to those reporting a decrease reversed course to return back to the ratio we saw two weeks ago – 40 stated and territories reported an increase/13 reported a decline.
The general theme was cuts in construction, manufacturing and transportation employment. Pennsylvania, California, Illinois and Ohio were the hardest hit. Texas and Tennessee bucked the trend as these states saw relatively large decreases in claims
Continuing claims rose to the highest level in 25 years, which shows laid off workers are having a more difficult time finding new employment. Of course, Congress keeps extending the period with which one can collect jobless benefits, so this has an effect as well.
While the continuing claims number is very elevated it is important to note that the labor force is much stronger today. For instance, back in 1983 the labor force stood at 112 million and by the 1990-1991 recession it was 126-million strong. Today the labor force is 154 million, so jobless and continuing claims of this magnitude are not what they used to be. The thing to focus on is whether or not we hit a number that is comparable to previous periods of weakness as we adjust for the rise in the workforce pool – we’d have to get to about 600,000 on initial claims and 4.5 million in continuing claims to match those previous levels.
This news is just another clear indication monthly payroll losses are going to be ugly over the next few months, but we’ll get through it assuming no major mistakes out of Washington that prolongs the situation – always a big if.
Proper Way to Stimulate
With all of this stimulus talk out there all we keep hearing about is the same old Keynesian-style rebate-check/public works/jobless benefit schemes that have proven to be nothing but feckless in the past. But this is no surprise as the current make-up of Washington, and certainly its structure after January 20, lives for this type of government spending. We hope they reconsider…oh, to dream.
What we need to do is implement polices that spur economic growth and the most efficient and lasting way to do this is by slashing marginal tax rates on income and capital. As has been true every time it’s implemented, this will kick start capital formation, which leads to more innovation, higher levels of productivity, increased competitiveness and more jobs.
Following the path of Keynesian-style “stimulus” is a clear sign Congress doesn’t get it. Engaging in the following proposal will get this economy rolling again as activity on the business and capital side more than offset the easing in debt ratios (and thus activity) for both consumers and the financial industry.
Besides leading to a lasting period of above-trend growth – assuming the Federal Reserve gets its act together; nothing can work if they don’t focus on price stability first and foremost over the next several years – the agenda below will result in a massive increase in federal tax revenue and allow us to meet the challenges of the future: (Even if few know it because the financial press has chosen not report it the broad-based tax cuts of 2003 resulted in the largest inflation-adjusted three-year explosion in tax receipts ever – up $785 billion for the fiscal years that ran 2005-2007.)
Move back to just two federal income tax brackets, ala 1986, this time 10% and 25% and make the current increased yearly allowance for business spending write-offs permanent (as of now this expires in January 2009) – you can bet on job creation to follow this change. (Slashing the top brackets down to 25% -- 75% of this make-up are small business taxpayers -- would be huge.
Cut the capital gains tax in half and watch the cost of capital fall, while the Treasury is inundated with tax receipts as investors unlock old investments for new.
- Cut the dividend tax rate further and – in addition to the new 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 taxation come home to provide billions in funds for R&D, equipment spending and stock buybacks.
- Double the child tax credit, which should help long-term demographic issues and in the meantime help the labor force keep more of its own earnings
This is the prescription that is needed. We can fiddle around with an agenda that offers short-term stimulus only to see the give back in the following quarter or we can get serious. It is time to get serious.
Have a great weekend!
Brent Vondera, Senior Analyst
Thursday, November 6, 2008
Afternoon Review
Cisco (CSCO) -2.59%
CSCO reported fiscal 1Q earnings after yesterday’s closing bell that were slightly lower than the average Bloomberg estimates and forecast the first revenue drop in five years because of the financial crisis. CEO John Chambers said the challenges in the U.S. have spread to Europe, emerging markets, and Asia. CSCO anticipates 2Q revenues will decline 5 to 10 percent versus a year ago. The forecast is based on a 9 percent drop in orders in October versus a year ago.
Although gross margins improved slightly in the quarter, the firm increased its R&D and selling expenses. This trend is likely to continue over the near term, as CSCO looks to gain market share at the expense of weaker competitors. The company generated $2.4 billion in free cash flow during the quarter, which gives them $19.9 billion in net cash. CSCO offered some details regarding its customer financing via its Cisco Capital unit, with the message that Cisco Capital represents a competitive advantage as opposed to a source of risk.
CSCO reiterated its target for long term revenue growth of 12 to 17 percent. In addition, the company plans to reduce capital spending by about $1 billion in fiscal 2009. Investors view CSCO as a technology industry barometer because it dominates the market for routers and switches, equipment that directs the flow of data over networks.
Transocean (RIG) -5.6%
RIG, the world’s largest offshore driller, reported earnings yesterday that just missed Bloomberg’s average estimates. We have reviewed a lot of drillers and RIG confirms a lot of what we already know at this point about the industry. Dayrates (the amount the company charges its customers who use their rigs) have held up nicely despite plunging oil prices and global economic turmoil because these deepwater projects (many of which have been planned out for years) will still be profitable with oil prices at their current levels. If oil were to drop below $50 a barrel, then we would likely see dayrates come down and an increase in producer cancelations.
RIG shareholders will vote next month on a proposal to move corporate headquarters to Geneva, which would allow the company to take advantage of a more stable tax regime and Switzerland’s broader network of tax treaties with countries where RIG has operations. Anheuser-Busch (BUD) +0.91%
InBev confirmed its takeover of Anheuser-Busch is still on track to close by the year’s end. BUD closed today at $64.58
CSCO reported fiscal 1Q earnings after yesterday’s closing bell that were slightly lower than the average Bloomberg estimates and forecast the first revenue drop in five years because of the financial crisis. CEO John Chambers said the challenges in the U.S. have spread to Europe, emerging markets, and Asia. CSCO anticipates 2Q revenues will decline 5 to 10 percent versus a year ago. The forecast is based on a 9 percent drop in orders in October versus a year ago.
Although gross margins improved slightly in the quarter, the firm increased its R&D and selling expenses. This trend is likely to continue over the near term, as CSCO looks to gain market share at the expense of weaker competitors. The company generated $2.4 billion in free cash flow during the quarter, which gives them $19.9 billion in net cash. CSCO offered some details regarding its customer financing via its Cisco Capital unit, with the message that Cisco Capital represents a competitive advantage as opposed to a source of risk.
CSCO reiterated its target for long term revenue growth of 12 to 17 percent. In addition, the company plans to reduce capital spending by about $1 billion in fiscal 2009. Investors view CSCO as a technology industry barometer because it dominates the market for routers and switches, equipment that directs the flow of data over networks.
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RIG, the world’s largest offshore driller, reported earnings yesterday that just missed Bloomberg’s average estimates. We have reviewed a lot of drillers and RIG confirms a lot of what we already know at this point about the industry. Dayrates (the amount the company charges its customers who use their rigs) have held up nicely despite plunging oil prices and global economic turmoil because these deepwater projects (many of which have been planned out for years) will still be profitable with oil prices at their current levels. If oil were to drop below $50 a barrel, then we would likely see dayrates come down and an increase in producer cancelations.
RIG shareholders will vote next month on a proposal to move corporate headquarters to Geneva, which would allow the company to take advantage of a more stable tax regime and Switzerland’s broader network of tax treaties with countries where RIG has operations.
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Wal-Mart (WMT) -1.18%
WMT reported October sales numbers that topped forecasts thanks to growth in their grocery division. Same-store sales (stores open at least a year) increased 2.4 percent as WMT is reducing prices weekly with an emphasis on “items families want and need most.” WMT has been more aggressive than ever with pricing, and it is starting to show that competitors can’t keep up. Other discount retailer results today include Costco (COST) who reported same-store sales decreased 1 percent, well below estimates of a 3.6 percent increase; and Target (TGT) said same-store sales fell 4.8 percent, worse than the estimate of a 2.8 percent decline.
WMT earnings are to be announced Nov. 13. It is possible WMT is definitely picking up market share in groceries, but may also being gaining share in clothing, home furnishing, and consumer electronics.
WMT is somewhat of a backdoor dollar play because most of its merchandise is purchased outside the country and then sold in the U.S. I would expect the WMT’s quarterly results to benefit from this since the dollar strengthened considerably during the quarter.
WMT reported October sales numbers that topped forecasts thanks to growth in their grocery division. Same-store sales (stores open at least a year) increased 2.4 percent as WMT is reducing prices weekly with an emphasis on “items families want and need most.” WMT has been more aggressive than ever with pricing, and it is starting to show that competitors can’t keep up. Other discount retailer results today include Costco (COST) who reported same-store sales decreased 1 percent, well below estimates of a 3.6 percent increase; and Target (TGT) said same-store sales fell 4.8 percent, worse than the estimate of a 2.8 percent decline.
WMT earnings are to be announced Nov. 13. It is possible WMT is definitely picking up market share in groceries, but may also being gaining share in clothing, home furnishing, and consumer electronics.
WMT is somewhat of a backdoor dollar play because most of its merchandise is purchased outside the country and then sold in the U.S. I would expect the WMT’s quarterly results to benefit from this since the dollar strengthened considerably during the quarter.
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InBev confirmed its takeover of Anheuser-Busch is still on track to close by the year’s end. BUD closed today at $64.58
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Whole Foods Market (WFMI) +1.65%
WFMI, the largest U.S. natural-foods grocer, received a $425 million equity investment from Leonard Green & Partners LP after reporting its eighth straight drop in profit and lowering its 2009 sales forecast. WFMI predicted sales would increase four percent in 2009, down from their previous sales forecast of six to ten percent sales growth. Increasing competition from mainstream supermarket chains that now carry organic products as well as pricing pressures on products are the main reasons for lower guidance.
United Natural Foods (UNFI), the largest U.S. distributor of natural and specialty foods, gained 1.5 percent today.
WFMI, the largest U.S. natural-foods grocer, received a $425 million equity investment from Leonard Green & Partners LP after reporting its eighth straight drop in profit and lowering its 2009 sales forecast. WFMI predicted sales would increase four percent in 2009, down from their previous sales forecast of six to ten percent sales growth. Increasing competition from mainstream supermarket chains that now carry organic products as well as pricing pressures on products are the main reasons for lower guidance.
United Natural Foods (UNFI), the largest U.S. distributor of natural and specialty foods, gained 1.5 percent today.
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Barr Pharmaceuticals (BRL) -0.03%
BRL, the generic drug maker being bought by Teva Pharmaceutical (TEVA), reported 3Q profit that beat analysts’ estimates on high sales of generic and name-brand contraceptives. BRL sees low risks to the deal closing by the end of the year. TEVA will control 23 percent of the generics market, according to research from IMS Health Inc.
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Dell (DELL) -5.79%
DELL’s restructuring efforts continue as they announced they will freeze hiring and offer workers one to five days of time off without pay. DELL has trimmed at least 8,800 jobs since last year, part of a program to eliminate $3 billion in annual costs by 2010.
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Peter Lazaroff, Junior Analyst
Daily Insight
Well, while Tuesday’s rally marked the best presidential Election Day performance since 1984, that bounce was followed by yesterday’s slide, a decline that marked the biggest plunge following a presidential election since the Dow’s inception.
The fact that four Senate seats remain undecided (and hence uncertainty continues over whether the Senate will have filibuster power or not) and the stimulus plans being discussed has not exactly inspired investors certainly didn’t help things. On this same note, as the market is eager to learn the make-up of the Obama economic team, the front runner for either Treasury Secretary or economic advisor is Larry Summers. This is someone who believes stimulus in the form of rebate checks and increased jobless benefits is the best thing since sliced bread, thus talk of the pick failed boost investor sentiment.
So, the market rallies one day and falters the next – the basic story continues.
The retreat halted an 18.5% rebound from the S&P 500’s five-year low reached on October 27 – a nearly uninterrupted snap-back over the previous six sessions.
Market Activity for November 5, 2008
Financial, consumer discretionary, basic materials and energy shares took the brunt of the damage – the same sectors that drove the rally the day prior. There is no way to rationalize this market, all you can do is invest in companies that are leaders in their respective industries, offer the most attractive valuations and diversify among asset classes. Oh, and of course, have patience.
Economy
On the economic front, the ADP employment report fell 157,000 for October – a larger-than-expected decline by 50,000. This is a preliminary report the market looks to for clues on how the official Labor Department’s monthly jobs figure turns out. ADP is often a good degree off base regarding the amount of change but worth reporting nevertheless as it’s direction is typically accurate.
(Our feel is the level of job losses ADP is suggesting is relatively accurate this time – even as the official numbers will be worse)
The ADP report noted its October reading did not reflect the strike of some 27,000 Boeing machinists. The Labor Department’s October Strike Report did note 27,000 were on strike last month, so this will be reflected in Friday’s jobs report and thus if ADP is close to accurate we’ll get the 200,000 decline in payrolls we believe is likely.
In terms of job segments, ADP showed a 126,000 decline in goods-producing employment – manufacturing down 85,000 and construction down 45,000. Service-sector jobs declined 31,000 in October, according to ADP.
In a separate report, the ISM Non-Manufacturing Index (service-sector survey) showed activity contracted after spending the past eight months hovering around the line that demarks expansion from contraction. This index -- which equally weights the business activity, employment, new orders and supplier delivery indexes – fell to the lowest reading on record, falling to 44.4 for October after 50.2 in September. (The data only goes back to 1997, so keep in mind not a lot of history here)
For some perspective, the index spent 57 straight months (68% of this run in robust territory) in expansion mode prior to the weakening that occurred this year. Beginning in January 2008 the service sector began to deteriorate, although remained somewhat upbeat. Last month as the credit event began to take hold, the degree of weakness became evident as all other economic data sets have indicated – fourth-quarter GDP will post a negative reading. This decline in real GDP will not be a tepid one such as the downturn of 2001 but a decline that is in line with the typical recession, roughly -3.00% at an annual rate.
The index’s employment survey hit 41.2, also the lowest on record. This corroborates the ADP survey that Friday’s jobs report is going to show significant decline. If we do get a decline of something like 200,000 it shouldn’t come as a surprise after these reports and thus the market may take the news with a degree of equanimity.
We’ll also note that the job losses for the first nine months of the year have been mild relative to the normal labor-market contraction. Tomorrow’s October jobs report will show the slash and burn has begun as we should see a string of monthly losses of at least 150,000. For context, the 1990-1991 recession saw five months of monthly job losses that totaled at least 150,000 with a 300,000 loss thrown in the mix. Thus far the current labor-market downturn has posted just one reading of 150,000 as the average monthly decline has been mild at 84,000.
Earnings
I do like to offer some bright side after negative remarks like the statements above, and there is optimism to speak of as third-quarter earnings have come in much better than expected.
Overall S&P 500 operating earnings fell 10.5% in the third-quarter, largely due to financial-sector profit losses – that’s with 80% of members reporting thus far. While the results will get worse for the current quarter, these are not large declines.
When we exclude the financial sector, S&P 500 profits are up 16.5% thanks to six of the 10 major industry groups posting positive income results (four of which grew profits at rates faster than the long-term average).
This is good news and illustrates the compression that has occurred in equity multiples (P/Es) – as stocks have been clobbered even as most earnings have held up well -- that make an abundance of stocks cheaper than anytime in the past 15 years. But we mustn’t make policy mistakes or that earnings growth will wane for far longer than just the next couple of quarters. This is the risk. If Washington plays if smart, we can get through this situation in quick order. If they do not, then trouble will drag on for longer.
For sure the unusual duration of earnings growth will help U.S. companies get past this period. There has been just one quarter over the last 25 in which either overall S&P 500 operating earnings or ex-financial profits has failed to grow at double-digit rates. That is extraordinary and leaves corporations with huge cash positions to weather the earnings storm that is about to hit.
Have a great day!
Brent Vondera, Senior Analyst
The fact that four Senate seats remain undecided (and hence uncertainty continues over whether the Senate will have filibuster power or not) and the stimulus plans being discussed has not exactly inspired investors certainly didn’t help things. On this same note, as the market is eager to learn the make-up of the Obama economic team, the front runner for either Treasury Secretary or economic advisor is Larry Summers. This is someone who believes stimulus in the form of rebate checks and increased jobless benefits is the best thing since sliced bread, thus talk of the pick failed boost investor sentiment.
So, the market rallies one day and falters the next – the basic story continues.
The retreat halted an 18.5% rebound from the S&P 500’s five-year low reached on October 27 – a nearly uninterrupted snap-back over the previous six sessions.
Market Activity for November 5, 2008
Financial, consumer discretionary, basic materials and energy shares took the brunt of the damage – the same sectors that drove the rally the day prior. There is no way to rationalize this market, all you can do is invest in companies that are leaders in their respective industries, offer the most attractive valuations and diversify among asset classes. Oh, and of course, have patience.Economy
On the economic front, the ADP employment report fell 157,000 for October – a larger-than-expected decline by 50,000. This is a preliminary report the market looks to for clues on how the official Labor Department’s monthly jobs figure turns out. ADP is often a good degree off base regarding the amount of change but worth reporting nevertheless as it’s direction is typically accurate.
(Our feel is the level of job losses ADP is suggesting is relatively accurate this time – even as the official numbers will be worse)
The ADP report noted its October reading did not reflect the strike of some 27,000 Boeing machinists. The Labor Department’s October Strike Report did note 27,000 were on strike last month, so this will be reflected in Friday’s jobs report and thus if ADP is close to accurate we’ll get the 200,000 decline in payrolls we believe is likely.
In terms of job segments, ADP showed a 126,000 decline in goods-producing employment – manufacturing down 85,000 and construction down 45,000. Service-sector jobs declined 31,000 in October, according to ADP.
In a separate report, the ISM Non-Manufacturing Index (service-sector survey) showed activity contracted after spending the past eight months hovering around the line that demarks expansion from contraction. This index -- which equally weights the business activity, employment, new orders and supplier delivery indexes – fell to the lowest reading on record, falling to 44.4 for October after 50.2 in September. (The data only goes back to 1997, so keep in mind not a lot of history here)
For some perspective, the index spent 57 straight months (68% of this run in robust territory) in expansion mode prior to the weakening that occurred this year. Beginning in January 2008 the service sector began to deteriorate, although remained somewhat upbeat. Last month as the credit event began to take hold, the degree of weakness became evident as all other economic data sets have indicated – fourth-quarter GDP will post a negative reading. This decline in real GDP will not be a tepid one such as the downturn of 2001 but a decline that is in line with the typical recession, roughly -3.00% at an annual rate.
The index’s employment survey hit 41.2, also the lowest on record. This corroborates the ADP survey that Friday’s jobs report is going to show significant decline. If we do get a decline of something like 200,000 it shouldn’t come as a surprise after these reports and thus the market may take the news with a degree of equanimity.
We’ll also note that the job losses for the first nine months of the year have been mild relative to the normal labor-market contraction. Tomorrow’s October jobs report will show the slash and burn has begun as we should see a string of monthly losses of at least 150,000. For context, the 1990-1991 recession saw five months of monthly job losses that totaled at least 150,000 with a 300,000 loss thrown in the mix. Thus far the current labor-market downturn has posted just one reading of 150,000 as the average monthly decline has been mild at 84,000.
Earnings
I do like to offer some bright side after negative remarks like the statements above, and there is optimism to speak of as third-quarter earnings have come in much better than expected.
Overall S&P 500 operating earnings fell 10.5% in the third-quarter, largely due to financial-sector profit losses – that’s with 80% of members reporting thus far. While the results will get worse for the current quarter, these are not large declines.
When we exclude the financial sector, S&P 500 profits are up 16.5% thanks to six of the 10 major industry groups posting positive income results (four of which grew profits at rates faster than the long-term average).
This is good news and illustrates the compression that has occurred in equity multiples (P/Es) – as stocks have been clobbered even as most earnings have held up well -- that make an abundance of stocks cheaper than anytime in the past 15 years. But we mustn’t make policy mistakes or that earnings growth will wane for far longer than just the next couple of quarters. This is the risk. If Washington plays if smart, we can get through this situation in quick order. If they do not, then trouble will drag on for longer.
For sure the unusual duration of earnings growth will help U.S. companies get past this period. There has been just one quarter over the last 25 in which either overall S&P 500 operating earnings or ex-financial profits has failed to grow at double-digit rates. That is extraordinary and leaves corporations with huge cash positions to weather the earnings storm that is about to hit.
Have a great day!
Brent Vondera, Senior Analyst
Wednesday, November 5, 2008
Afternoon Review
With an overwhelmingly different look to the U.S. political system, this seems like an appropriate time for me to provide an in depth look at the effects the political landscape will have on different industries. Today, I am starting with healthcare because it is the sector that has the greatest chance of being significantly altered during the next four years (outside of financials of course).
The obvious obstacle to any changes to U.S. healthcare will be budgetary pressures from the government’s involvement in the financial crisis. If there is any time or money left over from dealing with the economy in the next four years, then we can expect to see healthcare reform that favors government solution over private market solutions.
The impact is mostly negative for managed care and health insurers.
Democrats are likely to increase regulation over the managed care industry and make cuts to Medicare Advantage to fund other healthcare priorities such as universal coverage and/or SCHIP (State Children’s Health Insurance Program) expansion. Expanding SCHIP and possibly Medicaid, however, is positive for insurers that run the plans (e.g. UNH, WLP) because they would benefit from subsidies and access to 46 million uninsured Americans. Insurers and managed care would benefit from more pricing power for drugs and medical devices.
The impact on major and specialty pharma is negative.
Democrats support drug reimportation (from Canada or other countries), direct negotiation of Medicare drug pricing, comparative effectiveness, and increased generics. All of these things significantly weaken pricing power for pharmaceutical companies (e.g. PFE, MRK, BMY, LLY), which in turn lowers these companies returns.
A Democratic-appointed FDA commissioner could provide a positive impact by speeding up the new drug approval process. The vast majority of congressional allegations of FDA mishandling of drug-related issues is coming from Democratic leadership. With a Democratic-Congress, there ought to be more reluctance from the FDA to question and interrogate FDA officials under a Democratic-appointed FDA commissioner.
However, the speed in which companies can get new drugs on the marketplace may be negated if government pricing of drugs leads to lower profits and, thus, lower R&D budgets. If this scenario plays out, then the positive impact regarding the FDA is less important.
The impact on biotech companies is relatively neutral.
Generic biologic legislation may be passed in the next four years, but biotech companies are less exposed to the pricing pressures generics create than other drug companies. This is because the complexity of biologic products would likely require an approval pathway to include clinical studies to demonstrate equivalent efficacy and safety. This creates higher barriers to entry and lower returns on investment for the generic biologic industry, which in turn decreases generic competition and the price differential between branded and generic biologics.
Direct negotiation of Medicare drug pricing could, however, have a slightly negative impact.
The impact is negative for medical devices.
Medicare reform would certainly affect cardiovascular devices (e.g. STJ, MDT) and orthopedic devices (e.g. ZMH, SYK) since these devices are largely paid for through the Medicare. Changes to Medicare payments could lead to less-favorable pricing and less favorable mix. Democrats also favor comparative effectiveness and greater regulation of sales and marketing practice. This too would put more pressure on pricing and mix, which in turn would lower the long-term secular growth of medical device companies.
The impact is neutral for medical supplies.
Medical supplies (e.g. COV, TMO) have lower exposure to U.S. healthcare reform owing to their low prices and international diversification. Universal healthcare could be a slight benefit should the volume of healthcare services increase.
The impact on labs and diagnostics is positive.
Universal health coverage could benefit the lab and diagnostics industry (e.g. DGX) since Democratic-led healthcare changes would likely stress preventative care measures. Lab testing is viewed to be cost-effective and able to offer early detection/prevention.
The impact is positive for generics, which in turn is slightly positive for the PBMs and drug distributors.
With both Republicans and Democrats pushing for generics to come to the market faster, we are likely to see generics (e.g. MYL) gain a larger share of the overall prescription market, which also benefits PBMs (e.g. ESRX) who profit more from generic drugs than branded drugs. Any expansion of health benefits (expanding SCHIP and possibly Medicaid) is beneficial to PBMs and distributors, as the number of individuals having insurance increases, so should the number of scripts being written.
The impact on Healthcare IT is positive.
Obama wants to spend $50 billion a year for five years on computerized health records (e.g. CERN); technology that both Republicans and Democrats believe can save money.
To read more about potential winners and losers of the new political landscape, check out this Bloomberg article.
--
Peter Lazaroff, Junior Analyst
The obvious obstacle to any changes to U.S. healthcare will be budgetary pressures from the government’s involvement in the financial crisis. If there is any time or money left over from dealing with the economy in the next four years, then we can expect to see healthcare reform that favors government solution over private market solutions.
The impact is mostly negative for managed care and health insurers.
Democrats are likely to increase regulation over the managed care industry and make cuts to Medicare Advantage to fund other healthcare priorities such as universal coverage and/or SCHIP (State Children’s Health Insurance Program) expansion. Expanding SCHIP and possibly Medicaid, however, is positive for insurers that run the plans (e.g. UNH, WLP) because they would benefit from subsidies and access to 46 million uninsured Americans. Insurers and managed care would benefit from more pricing power for drugs and medical devices.
The impact on major and specialty pharma is negative.
Democrats support drug reimportation (from Canada or other countries), direct negotiation of Medicare drug pricing, comparative effectiveness, and increased generics. All of these things significantly weaken pricing power for pharmaceutical companies (e.g. PFE, MRK, BMY, LLY), which in turn lowers these companies returns.
A Democratic-appointed FDA commissioner could provide a positive impact by speeding up the new drug approval process. The vast majority of congressional allegations of FDA mishandling of drug-related issues is coming from Democratic leadership. With a Democratic-Congress, there ought to be more reluctance from the FDA to question and interrogate FDA officials under a Democratic-appointed FDA commissioner.
However, the speed in which companies can get new drugs on the marketplace may be negated if government pricing of drugs leads to lower profits and, thus, lower R&D budgets. If this scenario plays out, then the positive impact regarding the FDA is less important.
The impact on biotech companies is relatively neutral.
Generic biologic legislation may be passed in the next four years, but biotech companies are less exposed to the pricing pressures generics create than other drug companies. This is because the complexity of biologic products would likely require an approval pathway to include clinical studies to demonstrate equivalent efficacy and safety. This creates higher barriers to entry and lower returns on investment for the generic biologic industry, which in turn decreases generic competition and the price differential between branded and generic biologics.
Direct negotiation of Medicare drug pricing could, however, have a slightly negative impact.
The impact is negative for medical devices.
Medicare reform would certainly affect cardiovascular devices (e.g. STJ, MDT) and orthopedic devices (e.g. ZMH, SYK) since these devices are largely paid for through the Medicare. Changes to Medicare payments could lead to less-favorable pricing and less favorable mix. Democrats also favor comparative effectiveness and greater regulation of sales and marketing practice. This too would put more pressure on pricing and mix, which in turn would lower the long-term secular growth of medical device companies.
The impact is neutral for medical supplies.
Medical supplies (e.g. COV, TMO) have lower exposure to U.S. healthcare reform owing to their low prices and international diversification. Universal healthcare could be a slight benefit should the volume of healthcare services increase.
The impact on labs and diagnostics is positive.
Universal health coverage could benefit the lab and diagnostics industry (e.g. DGX) since Democratic-led healthcare changes would likely stress preventative care measures. Lab testing is viewed to be cost-effective and able to offer early detection/prevention.
The impact is positive for generics, which in turn is slightly positive for the PBMs and drug distributors.
With both Republicans and Democrats pushing for generics to come to the market faster, we are likely to see generics (e.g. MYL) gain a larger share of the overall prescription market, which also benefits PBMs (e.g. ESRX) who profit more from generic drugs than branded drugs. Any expansion of health benefits (expanding SCHIP and possibly Medicaid) is beneficial to PBMs and distributors, as the number of individuals having insurance increases, so should the number of scripts being written.
The impact on Healthcare IT is positive.
Obama wants to spend $50 billion a year for five years on computerized health records (e.g. CERN); technology that both Republicans and Democrats believe can save money.
To read more about potential winners and losers of the new political landscape, check out this Bloomberg article.
--
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks rallied yesterday, marking the largest presidential Election Day rally since 1984 as it seems the market rejoiced over the fact that the uncertainty of the event has ended. Policy implications will develop over time but with all that’s occurred, the anticipation of removing an additional unknown was a welcome thought.
I do think investors had a sense that the Senate would not give the current majority a two-thirds stance so in that way there is a check against the untoward, even if is it is a fairly weak one – the ability to filibuster may prove a big market plus over time. (This is not yet official as four Senate seats are still too close to call – the seat Al Franken is running for is still up in the air – are we serious in these challenging times? The answer is obvious.)
Energy shares led the advance; the S&P 500 index that tracks these shares gained 6.39% as oil futures jumped nearly 10% advance during Tuesday’s session. Basic material, financial and industrial shares also performed very well, up 5.69%, 5.50% and 5.45%, respectively.
Market Activity for November 4, 2008
Crude-Oil
While stocks liked the fact that the election has finally arrived, the dollar took a decent beating as there was talk of another “stimulus” package – this one totaling $500 billion. Of course, what’s being discussed isn’t simulative at all – food stamp and jobless benefit increases, even infrastructure projects, offer nothing in the way of an economic kick start. I love the infrastructure talk. Anyone who has even a minimal understanding of this form of government action knows it takes years to get off the ground as states must approve and you have the typical environmental lawsuit activity that arises. This stuff takes 12-18 months to implement, not to mention the private sector activity it crowds out.
Anyway, talk of such a plan – especially the size -- sent the dollar down and may have been behind a rally in commodity prices as traders search for an inflation hedge. I’m not saying a trend has begun, but the $500 billion number definitely worried a lot of people. Spending plans of this size, in addition to the $700 billion TARP and trillions in spending President-elect Obama has promised will not treat the dollar well. When the dollar falls this allows inflation to ramp – as everyone has spent the last year learning first hand, specifically with regard to import prices. Add in trillions of dollars the Fed has pumped into the system and you’ve got a snap back in inflation rates down the road. Oil jumped 9.26% as a result. Commodities in general were up 5.34%.
The Credit Markets
Credit spreads/indicators continue to improve. We’ve talked at length on this topic for a month now so there’s not much more to say other than letting the charts (LIBOR and TED Spread) speak for themselves.
For new readers, LIBOR is a rate charged for inter-bank lending. As this rate spiked, it showed banks were unwilling to lend to one another. This has intensive implications to the flow of credit and is a key reason the markets and economic data have taken a turn for the worse lately. Now that things have eased, the stock market has bounced back – up 18.5% from the closing low hit on October 27 – but it will be a while until the economic data shakes this event off.
And…the TED Spread is a measure of risk aversion. The index measures the spread between three-month LIBOR and three-month T-bills. A rising LIBOR, as stated above, means banks become more cautious and a plunging T-bill rate is indication investors flee to the safety of the Treasury market – hence risk aversion is heightened. When the spread narrows, obviously, risk aversion wanes. We still have a pretty high level of the safety trade occurring, but when this eases (T-bill rates rise), TED Spread will come back down to 1.00-1.50. When this occurs it will be a good sign that investors are willing to take on more risk and both corporate bonds and stocks should rally hard.
The Economy
On the economic front, the Commerce Department reported factory orders fell 2.5% in September after a large 4.3% decline for August. While this data is fairly out-dated (this is for September and we’ve already seen what’s occurred for this segment of the economy with the durable goods orders we received last week and manufacturing data for October yesterday), it does offer additional clues, specifically regarding the energy industry.
The weakness really came from the non-durables side of the report as durables were boosted by large increases in aircraft and other transportation equipment, something we discussed last week after the October durables goods report came out. Non-durables, which were hurt by the plunge in commodity prices, showed a significant decline of 5.5% in September – the second month of meaningful weakness. Of course, weakened demand has something to do with this decline as well.
We’ll add that refinery shut-downs due to Hurricane Ike, which hit Galveston on September 13, also played havoc with the figure. Point is the September decline in orders probably overstates the weakness the economy endured for the month due to this transitory event. However, we are pretty sure the October reading will be down big and will be a good measure of the fundamental weakness that took hold last month.
Inventories (specifically the inventory-to-sales ratio) has spiked a bit, although remains historically low. We should expect this figure to rise to 1.40 months’ worth of supply, but it should prove to be a low enough level to spur a ramp up in production when things normalize.
This morning we’ll see what occurred in the service sector last month by way of the ISM Non-Manufacturing Composite. The reading should come in below 50, which will indicate service-sector activity contracted in October. The index has averaged 50.3 over the past 12 months
The big news of the week will come on Friday as the October jobs report is due out. This will be a big hurdle for the market to get past; although, we think it is likely the market has already priced in an ugly number, and that we will get as we’ll see at least 175,000 payroll jobs were lost – and quite possibly a number closer to 200,000. A decline of this magnitude is more in line with the typical labor market contraction. We’ve heard a lot about the weak job market over the past nine months, but the losses were mild. We are about to see what a labor-market downturn really looks like – pay attention financial press, so at least you’ll know the difference next time around.
Have a great day!
Brent Vondera, Senior Analyst
I do think investors had a sense that the Senate would not give the current majority a two-thirds stance so in that way there is a check against the untoward, even if is it is a fairly weak one – the ability to filibuster may prove a big market plus over time. (This is not yet official as four Senate seats are still too close to call – the seat Al Franken is running for is still up in the air – are we serious in these challenging times? The answer is obvious.)
Energy shares led the advance; the S&P 500 index that tracks these shares gained 6.39% as oil futures jumped nearly 10% advance during Tuesday’s session. Basic material, financial and industrial shares also performed very well, up 5.69%, 5.50% and 5.45%, respectively.
Market Activity for November 4, 2008
Crude-OilWhile stocks liked the fact that the election has finally arrived, the dollar took a decent beating as there was talk of another “stimulus” package – this one totaling $500 billion. Of course, what’s being discussed isn’t simulative at all – food stamp and jobless benefit increases, even infrastructure projects, offer nothing in the way of an economic kick start. I love the infrastructure talk. Anyone who has even a minimal understanding of this form of government action knows it takes years to get off the ground as states must approve and you have the typical environmental lawsuit activity that arises. This stuff takes 12-18 months to implement, not to mention the private sector activity it crowds out.
Anyway, talk of such a plan – especially the size -- sent the dollar down and may have been behind a rally in commodity prices as traders search for an inflation hedge. I’m not saying a trend has begun, but the $500 billion number definitely worried a lot of people. Spending plans of this size, in addition to the $700 billion TARP and trillions in spending President-elect Obama has promised will not treat the dollar well. When the dollar falls this allows inflation to ramp – as everyone has spent the last year learning first hand, specifically with regard to import prices. Add in trillions of dollars the Fed has pumped into the system and you’ve got a snap back in inflation rates down the road. Oil jumped 9.26% as a result. Commodities in general were up 5.34%.
The Credit Markets
Credit spreads/indicators continue to improve. We’ve talked at length on this topic for a month now so there’s not much more to say other than letting the charts (LIBOR and TED Spread) speak for themselves.
For new readers, LIBOR is a rate charged for inter-bank lending. As this rate spiked, it showed banks were unwilling to lend to one another. This has intensive implications to the flow of credit and is a key reason the markets and economic data have taken a turn for the worse lately. Now that things have eased, the stock market has bounced back – up 18.5% from the closing low hit on October 27 – but it will be a while until the economic data shakes this event off.
And…the TED Spread is a measure of risk aversion. The index measures the spread between three-month LIBOR and three-month T-bills. A rising LIBOR, as stated above, means banks become more cautious and a plunging T-bill rate is indication investors flee to the safety of the Treasury market – hence risk aversion is heightened. When the spread narrows, obviously, risk aversion wanes. We still have a pretty high level of the safety trade occurring, but when this eases (T-bill rates rise), TED Spread will come back down to 1.00-1.50. When this occurs it will be a good sign that investors are willing to take on more risk and both corporate bonds and stocks should rally hard.
The Economy
On the economic front, the Commerce Department reported factory orders fell 2.5% in September after a large 4.3% decline for August. While this data is fairly out-dated (this is for September and we’ve already seen what’s occurred for this segment of the economy with the durable goods orders we received last week and manufacturing data for October yesterday), it does offer additional clues, specifically regarding the energy industry.
The weakness really came from the non-durables side of the report as durables were boosted by large increases in aircraft and other transportation equipment, something we discussed last week after the October durables goods report came out. Non-durables, which were hurt by the plunge in commodity prices, showed a significant decline of 5.5% in September – the second month of meaningful weakness. Of course, weakened demand has something to do with this decline as well.
We’ll add that refinery shut-downs due to Hurricane Ike, which hit Galveston on September 13, also played havoc with the figure. Point is the September decline in orders probably overstates the weakness the economy endured for the month due to this transitory event. However, we are pretty sure the October reading will be down big and will be a good measure of the fundamental weakness that took hold last month.
Inventories (specifically the inventory-to-sales ratio) has spiked a bit, although remains historically low. We should expect this figure to rise to 1.40 months’ worth of supply, but it should prove to be a low enough level to spur a ramp up in production when things normalize.
This morning we’ll see what occurred in the service sector last month by way of the ISM Non-Manufacturing Composite. The reading should come in below 50, which will indicate service-sector activity contracted in October. The index has averaged 50.3 over the past 12 months
The big news of the week will come on Friday as the October jobs report is due out. This will be a big hurdle for the market to get past; although, we think it is likely the market has already priced in an ugly number, and that we will get as we’ll see at least 175,000 payroll jobs were lost – and quite possibly a number closer to 200,000. A decline of this magnitude is more in line with the typical labor market contraction. We’ve heard a lot about the weak job market over the past nine months, but the losses were mild. We are about to see what a labor-market downturn really looks like – pay attention financial press, so at least you’ll know the difference next time around.
Have a great day!
Brent Vondera, Senior Analyst
Tuesday, November 4, 2008
Afternoon Review
Principal Financial Group (PFG) +22.82%
PFG reported earnings after yesterday’s close that were slightly better than expected with profit declining 59 percent from the year before. The results were primarily attributable to lower earnings from the company’s US. Asset Accumulation and Global Asset Management segments, which was partially offset by slightly higher earnings from its Life and Health Insurance segment and International Asset Management and Accumulation.
In the U.S. Asset Accumulation segment, assets under management (AUM) fell to $161 billion at the end of 3Q2008 from $179 billion in 3Q2007. PFG’s total AUM decreased 6 percent from a year ago to $287.4 billion. Strong net cash flows offset a substantial portion of the impact of equity market declines thanks to continued strong sales of each of their three key retirement and investment products during 3Q.
PFG is among life insurers that are trying to strengthen their capital position after investments they hold to pay claims declined in value. PFG cut its dividend in half on 10/13/2008. In addition, the company has been limiting the size of variable annuities with guaranteed living benefits. The decline in the value of securities cost $230.6 million before tax, including a total of $82 million in losses tied to Lehman Brothers and Washington Mutual.
PFG said last week it favors including life insurers in the U.S. Treasury Department’s $250 billion program to invest in financial companies. Although PFG did not directly confirm they would participate, a spokesperson said “we would certainly evaluate our options” if they were allowed to participate.
PFG has gained 40.72 percent in the last two days.
JEC reported 4Q earnings that increased 36.3 percent from a year ago on strong demand for its services. The company said that it expects to earn between $3.55 and $4.05 a share in 2009, which was lower than the consensus estimate. The outlook represents a growth range of 6 percent to 21 percent (midpoint of 13.5 percent). JEC’s guidance is normally conservative, but they normally forecast 15 percent growth and usually does better than that in stronger markets. At the end of the quarter, JEC’s order backlog totaled $16.7 billion compared to $13.6 billion in the previous year, representing a 23 percent increase year-over-year.
JEC attributes their success to their business model that depends less on transactional projects – which JEC defined as “big events, large jobs in far away places, or giant lump sum turnkey events around the world” – than their competitors. Instead they work on developing long-term customer relationships and its process-management capabilities. This improves visibility on contract flow, which helps reduce revenue volatility, and better contract terms, which provides some margin stability. Their business model also allows them to more effectively utilize its assets, which helps contribute to solid returns on invested capital. Competitors who focus on transactional projects, on the other hand, are constantly moving assets from one project to another, which leads to inefficiencies.
JEC’s business model and long track record of solid project execution and good management should help them remain a strong player in the industry.
This Bloomberg story examines AMGN’s potential to snatch up distressed biotechnology companies. While AMGN will be competing with other large drugmakers like Pfizer (PFE), their experience in biotechnology and massive cash position may give AMGN advantages in the acquisition arena. Here is another article covering the story.
PFG reported earnings after yesterday’s close that were slightly better than expected with profit declining 59 percent from the year before. The results were primarily attributable to lower earnings from the company’s US. Asset Accumulation and Global Asset Management segments, which was partially offset by slightly higher earnings from its Life and Health Insurance segment and International Asset Management and Accumulation.
In the U.S. Asset Accumulation segment, assets under management (AUM) fell to $161 billion at the end of 3Q2008 from $179 billion in 3Q2007. PFG’s total AUM decreased 6 percent from a year ago to $287.4 billion. Strong net cash flows offset a substantial portion of the impact of equity market declines thanks to continued strong sales of each of their three key retirement and investment products during 3Q.
PFG is among life insurers that are trying to strengthen their capital position after investments they hold to pay claims declined in value. PFG cut its dividend in half on 10/13/2008. In addition, the company has been limiting the size of variable annuities with guaranteed living benefits. The decline in the value of securities cost $230.6 million before tax, including a total of $82 million in losses tied to Lehman Brothers and Washington Mutual.
PFG said last week it favors including life insurers in the U.S. Treasury Department’s $250 billion program to invest in financial companies. Although PFG did not directly confirm they would participate, a spokesperson said “we would certainly evaluate our options” if they were allowed to participate.
PFG has gained 40.72 percent in the last two days.
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Emerson Electric (EMR) +10.14%
EMR reported quarterly profit rose 10 percent, bolstered by cost cuts and overseas sales of its tools used in a range of industrial goods and household appliances. EMR also boosted its quarterly dividend 10 to 33 cents from 30 cents.
Net Sales for fiscal 2008 rose 12 percent to $24.8 billion as global demand pushed the company’s total sales from outside the U.S. to a record 54 percent of total sales. FY2008 operating cash flow was a record $3.3 billion, a 9 percent increase from 2007 and 13.3 percent of reported sales. In FY2008, EMR returned 63 percent of operating cash flows to shareholders through $940 million in dividends and $1.1 billion in share repurchases.
Free cash flow increased 10 percent to a record $2.6 billion. Free cash flow as a percentage of net earnings was 107 percent for 2008, the eighth consecutive year in excess of 100 percent. This is a sign of very high earnings quality.
EMR continues to be a well-managed, financially-sound company and their balance sheet is a testament to that. CEO David Farr said “the Company is well positioned for more challenging times ahead in 2009 and 2010, as we have spent $265 million in best cost restructuring actions in the last three years, of which $70 million was incurred in the last six months. We will continue to make smart growth investments in our businesses and maintain our focus on significant cash returns to shareholders.”
EMR reported quarterly profit rose 10 percent, bolstered by cost cuts and overseas sales of its tools used in a range of industrial goods and household appliances. EMR also boosted its quarterly dividend 10 to 33 cents from 30 cents.
Net Sales for fiscal 2008 rose 12 percent to $24.8 billion as global demand pushed the company’s total sales from outside the U.S. to a record 54 percent of total sales. FY2008 operating cash flow was a record $3.3 billion, a 9 percent increase from 2007 and 13.3 percent of reported sales. In FY2008, EMR returned 63 percent of operating cash flows to shareholders through $940 million in dividends and $1.1 billion in share repurchases.
Free cash flow increased 10 percent to a record $2.6 billion. Free cash flow as a percentage of net earnings was 107 percent for 2008, the eighth consecutive year in excess of 100 percent. This is a sign of very high earnings quality.
EMR continues to be a well-managed, financially-sound company and their balance sheet is a testament to that. CEO David Farr said “the Company is well positioned for more challenging times ahead in 2009 and 2010, as we have spent $265 million in best cost restructuring actions in the last three years, of which $70 million was incurred in the last six months. We will continue to make smart growth investments in our businesses and maintain our focus on significant cash returns to shareholders.”
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Jacob Engineering Group (JEC) +16.46%JEC reported 4Q earnings that increased 36.3 percent from a year ago on strong demand for its services. The company said that it expects to earn between $3.55 and $4.05 a share in 2009, which was lower than the consensus estimate. The outlook represents a growth range of 6 percent to 21 percent (midpoint of 13.5 percent). JEC’s guidance is normally conservative, but they normally forecast 15 percent growth and usually does better than that in stronger markets. At the end of the quarter, JEC’s order backlog totaled $16.7 billion compared to $13.6 billion in the previous year, representing a 23 percent increase year-over-year.
JEC attributes their success to their business model that depends less on transactional projects – which JEC defined as “big events, large jobs in far away places, or giant lump sum turnkey events around the world” – than their competitors. Instead they work on developing long-term customer relationships and its process-management capabilities. This improves visibility on contract flow, which helps reduce revenue volatility, and better contract terms, which provides some margin stability. Their business model also allows them to more effectively utilize its assets, which helps contribute to solid returns on invested capital. Competitors who focus on transactional projects, on the other hand, are constantly moving assets from one project to another, which leads to inefficiencies.
JEC’s business model and long track record of solid project execution and good management should help them remain a strong player in the industry.
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Cisco (CSCO) +6.57%
Shares of CSCO traded higher in anticipation of their earnings report tomorrow. The company’s outlook and thoughts on the technology spending environment are likely to determine the tech market’s moves tomorrow. Investors will be paying particularly close attention to CSCO’s international outlook since many larger companies derive a sizeable portion of their earnings overseas.
Shares of CSCO traded higher in anticipation of their earnings report tomorrow. The company’s outlook and thoughts on the technology spending environment are likely to determine the tech market’s moves tomorrow. Investors will be paying particularly close attention to CSCO’s international outlook since many larger companies derive a sizeable portion of their earnings overseas.
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General Electric (GE) +7.62%
GE traded higher on news that the U.S. Treasury may broaden the scope of its $700 billion rescue package and take equity stakes in bond insurers and specialty finance firms.
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Boeing (BA) +1.46%
BA will delay the first test flight of the new 787 Dreamliner beyond the fourth quarter because of the just-ended machinists strike, but did not speculate when the test flight might occur. The 787 had been already delayed three times and was 15 months late before an eight week long machinists’ strike. Earlier delays were due to parts shortages and problems with the new production process, which uses suppliers around the world to build large sections of the plane for assembly in Everett, Washington.
BA will delay the first test flight of the new 787 Dreamliner beyond the fourth quarter because of the just-ended machinists strike, but did not speculate when the test flight might occur. The 787 had been already delayed three times and was 15 months late before an eight week long machinists’ strike. Earlier delays were due to parts shortages and problems with the new production process, which uses suppliers around the world to build large sections of the plane for assembly in Everett, Washington.
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Amgen (AMGN) -1.59%This Bloomberg story examines AMGN’s potential to snatch up distressed biotechnology companies. While AMGN will be competing with other large drugmakers like Pfizer (PFE), their experience in biotechnology and massive cash position may give AMGN advantages in the acquisition arena. Here is another article covering the story.
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Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stock market activity was a boring as anytime in the past couple of months as traders wait for the election to play out before making short-term bets at this point. Actually to call it boring is a bit inaccurate, but everything’s relevant, right? For normal times the 1.7% move from peak to trough in the S&P 500 yesterday would have been something to talk about, but not these days.
While the indices ended pretty much flat we did see energy, basic materials and consumer discretionary shares record meaningful losses of 2.03%, 1.54% and 0.96%, respectively. The very weak manufacturing data, which we’ll discuss below, drove these sectors lower as recession concerns hit these stocks the hardest.
Health-care, financial and utility names – two of which are traditional safe-havens – were the best performers up 0.68%, 0.29% and 0.29%, respectively.
Market Activity for November 3, 2008
Economy
On the economic front, the index that tracks nationwide manufacturing activity confirmed what the Chicago factory index illustrated on Friday; manufacturing is showing the effect of the credit freeze-up, halt in business spending and slow-down in global growth.
The Institute for Supply Management’s (ISM) manufacturing survey fell to the lowest level in 26 years, breaking through (but just barely) the bottom it hit during the 1990-1991 recession and touching a reading not seen since the 1982 contraction – although the index posted lower readings than this during that tough period back in the early 1980s.
The ISM reading came in at 38.9 for October after an already weak 43.5 in September – the sub-indices also show the economic downturn has intensified. We’ll have to wait for the next two readings to see whether this level of weakness was a transitory event due to the credit disturbance that took place last month or if this is a more lasting condition.
As stated, this is the lowest reading since the 1981-82 recession (a downturn that was significant as the Federal Reserve jacked fed funds to 15%-plus to quash double-digit inflation). ISM spent 13 straight months below 40 during that period, so by comparison, we haven’t seen anything close to that just yet.
Both the production and new orders indices within the report showed meaningful weakness – actually lower readings than the 1981-82 recession -- moving back to the 1980 contraction.
A decline of this magnitude for new orders is a pretty clear indication the November reading will be equally abysmal.
Export orders hit the lowest level on record, but this segment was just added to the ISM index in 1988 (back then ISM was the NAPM index) so we can’t see how it stacks up to the 1980 or 1981-82 contractions.
In a separate report, the Commerce Department showed construction spending fell in September; however, the 0.3% decline was better than expected. Residential construction continues to weigh on the figure, down 1.3% for the month and by 27.7% over the past year. Residential construction combines single and multi-family dwellings; separating single-family homes out, the figure is down 41.3% past 12 months! While harsh, this is simply a reality that needs to play out as the inventory-to-sales ratio of new homes remains elevated.
That said, we have seen the number of homes available for sale (which is not in relation to sales) plunge over the past year; so, much work as been done. Let’s hope we’ll have this behind us within 9-12 months and housing can once again contribute to GDP growth – or at least flatten out and thus no longer weigh on GDP, which has been a 2 ½ year occurrence.
On the bright side, non-residential construction rose 0.1%, halting a two-month decline. This rise – albeit mild – was all due to the private sector, which rose 1.2% in September and is up 11% over the past year. Public-sector non-residential construction fell 1.3% for the month – up 3.7% past 12 months. Over the next couple of years we should expect a significant increase in public-sector construction if we get an Obama/Pelosi/Reid (OPR) government, which won’t be the only thing to rise if you know what I mean.
Auto Sales Plummet
October auto sales came in very weak for October, hitting a 17-year low – yet another data set that matches up well with the last traditional recession. (I say traditional because the 2001 downturn was not a traditional recession, as so many continue to call it – the last traditional recession we endured was 1990-1991 no matter what the NBER says, sorry) The comparisons to the 1990-1991 recession have come quick, as the data took a dramatic and quick turn for the worse in the past eight weeks.
Auto sales came in at 10.6 million last month, which is seasonally adjusted at an annual pace; this is down by one-third since December 2007. When adjusted for population increases, October marked the worst month in the post WWII-era, according to a GM spokesperson. And it wasn’t much better for the Asian-based automakers either as sales were down 25% from the year-ago period for both Toyota and Honda.
The Election
A large uncertainty will have been removed by tomorrow. Policy implications will develop over time, and we may not even know the results of the Presidential race for a couple of days (who knows after the last two elections) but we will know the make-up of the Senate and that is what the market is focused on right now. If everything else goes the way expected, large advances for Democrats in the House and an Obama White House, it will be important that Republicans hold 41 seats in the Senate – currently the count stands 49-49 with two independents – and probably will need 43 to be safe from the possibility of flippers.
If the Senate holds as the only blocking point to what the track records of OPR would lead one to believe will be their way of governance, stocks should rally big time. If not, it’s my personal view we may get a rally, but its sustainability is doubtful.
Have a great day!
Brent Vondera, Senior Analyst
While the indices ended pretty much flat we did see energy, basic materials and consumer discretionary shares record meaningful losses of 2.03%, 1.54% and 0.96%, respectively. The very weak manufacturing data, which we’ll discuss below, drove these sectors lower as recession concerns hit these stocks the hardest.
Health-care, financial and utility names – two of which are traditional safe-havens – were the best performers up 0.68%, 0.29% and 0.29%, respectively.
Market Activity for November 3, 2008
EconomyOn the economic front, the index that tracks nationwide manufacturing activity confirmed what the Chicago factory index illustrated on Friday; manufacturing is showing the effect of the credit freeze-up, halt in business spending and slow-down in global growth.
The Institute for Supply Management’s (ISM) manufacturing survey fell to the lowest level in 26 years, breaking through (but just barely) the bottom it hit during the 1990-1991 recession and touching a reading not seen since the 1982 contraction – although the index posted lower readings than this during that tough period back in the early 1980s.
The ISM reading came in at 38.9 for October after an already weak 43.5 in September – the sub-indices also show the economic downturn has intensified. We’ll have to wait for the next two readings to see whether this level of weakness was a transitory event due to the credit disturbance that took place last month or if this is a more lasting condition.
As stated, this is the lowest reading since the 1981-82 recession (a downturn that was significant as the Federal Reserve jacked fed funds to 15%-plus to quash double-digit inflation). ISM spent 13 straight months below 40 during that period, so by comparison, we haven’t seen anything close to that just yet.
Both the production and new orders indices within the report showed meaningful weakness – actually lower readings than the 1981-82 recession -- moving back to the 1980 contraction.
A decline of this magnitude for new orders is a pretty clear indication the November reading will be equally abysmal.
Export orders hit the lowest level on record, but this segment was just added to the ISM index in 1988 (back then ISM was the NAPM index) so we can’t see how it stacks up to the 1980 or 1981-82 contractions.
In a separate report, the Commerce Department showed construction spending fell in September; however, the 0.3% decline was better than expected. Residential construction continues to weigh on the figure, down 1.3% for the month and by 27.7% over the past year. Residential construction combines single and multi-family dwellings; separating single-family homes out, the figure is down 41.3% past 12 months! While harsh, this is simply a reality that needs to play out as the inventory-to-sales ratio of new homes remains elevated.
That said, we have seen the number of homes available for sale (which is not in relation to sales) plunge over the past year; so, much work as been done. Let’s hope we’ll have this behind us within 9-12 months and housing can once again contribute to GDP growth – or at least flatten out and thus no longer weigh on GDP, which has been a 2 ½ year occurrence.
On the bright side, non-residential construction rose 0.1%, halting a two-month decline. This rise – albeit mild – was all due to the private sector, which rose 1.2% in September and is up 11% over the past year. Public-sector non-residential construction fell 1.3% for the month – up 3.7% past 12 months. Over the next couple of years we should expect a significant increase in public-sector construction if we get an Obama/Pelosi/Reid (OPR) government, which won’t be the only thing to rise if you know what I mean.
Auto Sales Plummet
October auto sales came in very weak for October, hitting a 17-year low – yet another data set that matches up well with the last traditional recession. (I say traditional because the 2001 downturn was not a traditional recession, as so many continue to call it – the last traditional recession we endured was 1990-1991 no matter what the NBER says, sorry) The comparisons to the 1990-1991 recession have come quick, as the data took a dramatic and quick turn for the worse in the past eight weeks.
Auto sales came in at 10.6 million last month, which is seasonally adjusted at an annual pace; this is down by one-third since December 2007. When adjusted for population increases, October marked the worst month in the post WWII-era, according to a GM spokesperson. And it wasn’t much better for the Asian-based automakers either as sales were down 25% from the year-ago period for both Toyota and Honda.
The Election
A large uncertainty will have been removed by tomorrow. Policy implications will develop over time, and we may not even know the results of the Presidential race for a couple of days (who knows after the last two elections) but we will know the make-up of the Senate and that is what the market is focused on right now. If everything else goes the way expected, large advances for Democrats in the House and an Obama White House, it will be important that Republicans hold 41 seats in the Senate – currently the count stands 49-49 with two independents – and probably will need 43 to be safe from the possibility of flippers.
If the Senate holds as the only blocking point to what the track records of OPR would lead one to believe will be their way of governance, stocks should rally big time. If not, it’s my personal view we may get a rally, but its sustainability is doubtful.
Have a great day!
Brent Vondera, Senior Analyst
Monday, November 3, 2008
Afternoon Review
October 2008 market performance can be summed up in two words: sell off. Approximately $9.5 trillion from the value of stocks worldwide were erased this month, which is almost one-third of the total value lost this year. With this number in mind, the $700 billion government bailout program (TARP) doesn’t seem quite so big, especially when you consider that global governments have committed more than $5 trillion in guarantees and capital injections.
The S&P 500 Large Cap Index lost 16.8 percent, the S&P 400 Mid Cap Index declined 21.74 percent, and the S&P 600 Small Cap Index fell 20.15 percent. Small cap stocks had beaten larger companies for most of the year as the U.S. subprime-mortgage collapse took a steeper toll on bigger banks and brokerages, while surging energy and materials prices benefited smaller producers more.
Investor sentiment for small cap stocks was hurt because they likely to be weighed down more than large cap stocks by their significant exposure to weakening domestic demand. Also hurting their performance in October was the swiftness and severity of redemptions and fallout in the hedge fund community certainly exacerbated the trend. According to Bloomberg data, hedge funds own an average of 13 percent of shares in the Russell 2000.
Consumer staples held up its reputation as a defensive sector as companies that manufacture and sell food/beverages, tobacco, and household products reported healthy earnings. Healthcare, telecoms, and utilities benefited from investors seeking safety in defensive companies with high-yields.
On the other end of the performance spectrum, consumer discretionary stocks suffered from weakening consumer spending, while energy and material stocks suffered from commodity prices worst decline in half a century.
International markets continued to tumble with MSCI EAFE Index declining more than 20 percent and down more than 42 percent on the year. Despite surging more than 20 percent in three days during the last week of the month, the emerging market stocks still lost over 20 percent in October and are off nearly 50 percent in 2008.
Market performance as of 10/31/2008.
The S&P 500 Large Cap Index lost 16.8 percent, the S&P 400 Mid Cap Index declined 21.74 percent, and the S&P 600 Small Cap Index fell 20.15 percent. Small cap stocks had beaten larger companies for most of the year as the U.S. subprime-mortgage collapse took a steeper toll on bigger banks and brokerages, while surging energy and materials prices benefited smaller producers more.
Investor sentiment for small cap stocks was hurt because they likely to be weighed down more than large cap stocks by their significant exposure to weakening domestic demand. Also hurting their performance in October was the swiftness and severity of redemptions and fallout in the hedge fund community certainly exacerbated the trend. According to Bloomberg data, hedge funds own an average of 13 percent of shares in the Russell 2000.
Consumer staples held up its reputation as a defensive sector as companies that manufacture and sell food/beverages, tobacco, and household products reported healthy earnings. Healthcare, telecoms, and utilities benefited from investors seeking safety in defensive companies with high-yields.
On the other end of the performance spectrum, consumer discretionary stocks suffered from weakening consumer spending, while energy and material stocks suffered from commodity prices worst decline in half a century.
International markets continued to tumble with MSCI EAFE Index declining more than 20 percent and down more than 42 percent on the year. Despite surging more than 20 percent in three days during the last week of the month, the emerging market stocks still lost over 20 percent in October and are off nearly 50 percent in 2008.
Market performance as of 10/31/2008.
Daily Insight
U.S. stocks finished the week up roughly 11% -- capping the best weekly performance since 1974, adding yet another similarity to that bear market – as investors brushed aside weak-to-absymal economic data to focus on better-than-expected profits and thawing credit markets.
Stock-market activity was volatile again on Friday, but the swings occurred above the plus-line for most of the session – which is quite different from what we’ve seen lately, huge moves between gain and loss.
Credit markets appear to be returning to normal – great progress was made last week as LIBOR rates came down big time and commercial paper issuance rolled again.
Another bright spot is earnings as third-quarter profits look much better than expected – ex-financial operating profits are up 16.1% with 70% of members reporting. Overall earnings are down just 10.5%, which is pretty darn good considering the financial sector has endured another quarter of losses.
The economic data was surely ugly last week, and Friday’s releases were no exceptions as we’ll touch on below, but the market has this weakness priced in currently, in our view. From here we’ll see if October marked the worse of it or not; an almost completely frozen credit situation last month did some major damage.
Market Activity for October 31, 2008
Credit Market Indicators
Three-month LIBOR has moved to its lowest level since Lehman Brothers went down.
The TED Spread – an indication of investors’ willingness to take risk – has narrowed significantly as well. There is still a large degree of risk aversion out there, which is why the spread has not narrowed more considering how fast LIBOR has come down. The flight to safety trade has kept T-bills rates low, otherwise this spread would be much narrower.
Friday’s Economic Data
On the economic front, the Commerce Department released personal income and spending figures for September. The income data is holding up, but spending tanked.
Personal income rose 0.2% in September and is up roughly 4% from the year-ago period.
Looking through the various sources of income the slow down in dividend income sticks out as a really nice run for this segment has hit a wall due to the financial-sector slashing payouts. Dividend income growth is down for three-straight months now and on a year-over-year basis has gone from up 9.1% back in March to just 4.1% as of September.
In total personal income is holding up well, up 3.9% from the year-ago period, even as the labor market becomes weaker by the month. Disposable income (after-tax income) is up a solid 4.2% year-over-year, which is a good nominal reading but in real terms it is flat as inflation continues to run 4%-plus.
As the chart below shows (the PCE Deflator is the inflation gauge within the personal spending data) inflation remains sticky, which is always the case. Inflation rates don’t historically come down until several months after an economic downturn as played out. This time we expect inflation to come down significantly for a few months (the combination of weak activity and the plunge in energy prices will be the driving force) but then ramp back up as the Fed has pumped in massive amounts of liquidity – liquidity they will be very hesitant to remove once the economy bounces back as they will make sure a recovery has taken hold.
Spending is a different story as the consumer has definitely run into trouble, we’ve discussed this for a couple of months now as declines in home and stock prices along with a weak labor market prove too much to handle. Even those with the means hold back in a spate of caution.
Personal spending fell 0.3% in September, marking the largest monthly decline in four years. This comes off of two straight quarters in which spending was unchanged, and explains why personal consumption fell the most since the 1990-1991 recession in the third-quarter GDP report.
This consumer weakness is going to be with us for several months. However, the 60% decline in wholesale gasoline will continue to work through to the pump price (which is down just 41% from its peak). Further, the plunge in all energy prices will offer nice relief this winter. The large declines in energy prices will have an incremental effect on consumer behavior.
In another release, the Chicago Purchasing Manager’s Index (PMI) came in at an abysmally weak level in October, falling by the largest degree on record. The main sub-indices within the report – production and new orders – plummeted.
The PMI-Chicago’s Business Index (factory activity within that region) was slammed, falling to 37.8 last month after a strong reading of 56.7 in September. October was really hit by the credit-market freeze-up, not just in a direct way but also from the caution that took over the business community simply for fear of the affects such a disturbance can have.
A reading this low is a clear sign of recession. Even though we’ll need another couple of months of data to gauge the duration of this event, it is crystal clear the events of the past two months have done significant economic damage. If this number remains below 45 for the remainder of the quarter, Q4 GDP is going to be weaker than we currently expect. Right not we’re looking for this quarter’s GDP reading to post -3.0% -- a level that is in line with the typical recession – a reading we haven’t seen since 1990.
The Chicago PMI’s production index came crashing down, posting a reading of 30.9 in October after 71.4 in September. Again, a reading above 50 marks expansion so production moved from a hot pace to very cold in a month’s time.
New orders plunged to 32.5 from 53.9.
This morning we get the national look at the manufacturing sector and you can bet it’s going to be very weak as it is not possible to buck what occurred in the Chicago region.
In fact, we’ll have to prepare for a week of very soft data as construction spending and factory orders will not be pretty. We’ll round out the week with the October jobs data, which will likely show the largest decline yet, possible a decline of 200,000 payroll positions – a number that is also in line with the typical recession. To this point during the nine-month labor-market downturn, monthly job losses have averaged 84,000. This is about to get worse.
The bright side is that it certainly appears the stock market has priced in a nasty recession – either that or the deleveraging event has moved values beyond fundamentals. If we get something that is more like the 1990-1991 contraction (meaningful but pretty short), stocks could rally big time from these levels. Looking out over the next several months it gets more difficult to gauge as the direction of the economy and stocks will depend on the direction of tax and trade policy.
Have a great day!
Brent Vondera, Senior Analyst
Stock-market activity was volatile again on Friday, but the swings occurred above the plus-line for most of the session – which is quite different from what we’ve seen lately, huge moves between gain and loss.
Credit markets appear to be returning to normal – great progress was made last week as LIBOR rates came down big time and commercial paper issuance rolled again.
Another bright spot is earnings as third-quarter profits look much better than expected – ex-financial operating profits are up 16.1% with 70% of members reporting. Overall earnings are down just 10.5%, which is pretty darn good considering the financial sector has endured another quarter of losses.
The economic data was surely ugly last week, and Friday’s releases were no exceptions as we’ll touch on below, but the market has this weakness priced in currently, in our view. From here we’ll see if October marked the worse of it or not; an almost completely frozen credit situation last month did some major damage.
Market Activity for October 31, 2008
Credit Market IndicatorsThree-month LIBOR has moved to its lowest level since Lehman Brothers went down.
The TED Spread – an indication of investors’ willingness to take risk – has narrowed significantly as well. There is still a large degree of risk aversion out there, which is why the spread has not narrowed more considering how fast LIBOR has come down. The flight to safety trade has kept T-bills rates low, otherwise this spread would be much narrower.
Friday’s Economic Data
On the economic front, the Commerce Department released personal income and spending figures for September. The income data is holding up, but spending tanked.
Personal income rose 0.2% in September and is up roughly 4% from the year-ago period.
Looking through the various sources of income the slow down in dividend income sticks out as a really nice run for this segment has hit a wall due to the financial-sector slashing payouts. Dividend income growth is down for three-straight months now and on a year-over-year basis has gone from up 9.1% back in March to just 4.1% as of September.
In total personal income is holding up well, up 3.9% from the year-ago period, even as the labor market becomes weaker by the month. Disposable income (after-tax income) is up a solid 4.2% year-over-year, which is a good nominal reading but in real terms it is flat as inflation continues to run 4%-plus.
As the chart below shows (the PCE Deflator is the inflation gauge within the personal spending data) inflation remains sticky, which is always the case. Inflation rates don’t historically come down until several months after an economic downturn as played out. This time we expect inflation to come down significantly for a few months (the combination of weak activity and the plunge in energy prices will be the driving force) but then ramp back up as the Fed has pumped in massive amounts of liquidity – liquidity they will be very hesitant to remove once the economy bounces back as they will make sure a recovery has taken hold.
Spending is a different story as the consumer has definitely run into trouble, we’ve discussed this for a couple of months now as declines in home and stock prices along with a weak labor market prove too much to handle. Even those with the means hold back in a spate of caution.
Personal spending fell 0.3% in September, marking the largest monthly decline in four years. This comes off of two straight quarters in which spending was unchanged, and explains why personal consumption fell the most since the 1990-1991 recession in the third-quarter GDP report.
This consumer weakness is going to be with us for several months. However, the 60% decline in wholesale gasoline will continue to work through to the pump price (which is down just 41% from its peak). Further, the plunge in all energy prices will offer nice relief this winter. The large declines in energy prices will have an incremental effect on consumer behavior.
In another release, the Chicago Purchasing Manager’s Index (PMI) came in at an abysmally weak level in October, falling by the largest degree on record. The main sub-indices within the report – production and new orders – plummeted.
The PMI-Chicago’s Business Index (factory activity within that region) was slammed, falling to 37.8 last month after a strong reading of 56.7 in September. October was really hit by the credit-market freeze-up, not just in a direct way but also from the caution that took over the business community simply for fear of the affects such a disturbance can have.
A reading this low is a clear sign of recession. Even though we’ll need another couple of months of data to gauge the duration of this event, it is crystal clear the events of the past two months have done significant economic damage. If this number remains below 45 for the remainder of the quarter, Q4 GDP is going to be weaker than we currently expect. Right not we’re looking for this quarter’s GDP reading to post -3.0% -- a level that is in line with the typical recession – a reading we haven’t seen since 1990.
The Chicago PMI’s production index came crashing down, posting a reading of 30.9 in October after 71.4 in September. Again, a reading above 50 marks expansion so production moved from a hot pace to very cold in a month’s time.
New orders plunged to 32.5 from 53.9.
This morning we get the national look at the manufacturing sector and you can bet it’s going to be very weak as it is not possible to buck what occurred in the Chicago region.
In fact, we’ll have to prepare for a week of very soft data as construction spending and factory orders will not be pretty. We’ll round out the week with the October jobs data, which will likely show the largest decline yet, possible a decline of 200,000 payroll positions – a number that is also in line with the typical recession. To this point during the nine-month labor-market downturn, monthly job losses have averaged 84,000. This is about to get worse.
The bright side is that it certainly appears the stock market has priced in a nasty recession – either that or the deleveraging event has moved values beyond fundamentals. If we get something that is more like the 1990-1991 contraction (meaningful but pretty short), stocks could rally big time from these levels. Looking out over the next several months it gets more difficult to gauge as the direction of the economy and stocks will depend on the direction of tax and trade policy.
Have a great day!
Brent Vondera, Senior Analyst
Friday, October 31, 2008
Afternoon Review
Express Scripts (ESRX) +5.28%
After yesterday’s closing bell, ESRX reported earnings guidance that surpassed analyst expectations and raised guidance for 2008. ESRX is not very economically sensitive, as pharmaceutical demand (especially generics) tends to hold up in any environment. Increasing their generic utilization rate to 66.2 percent from 62.2 percent last year led to operating margin improvement of 110 basis points.
ESRX’s 2009 outlook is higher than Bloomberg’s average estimates. The company expects economically stressed consumers to switch to generic drugs or mail-order pharmacies to save money, both of which generate higher margins for the company. Both presidential candidates have supported greater use of generic drugs to help lower healthcare costs in the U.S.
Chevron (CVX) +0.57%
CVX, the second-largest U.S. oil company, said 3Q profit doubled. JPMorgan Chase & Co (JPM) +9.65%
After yesterday’s closing bell, ESRX reported earnings guidance that surpassed analyst expectations and raised guidance for 2008. ESRX is not very economically sensitive, as pharmaceutical demand (especially generics) tends to hold up in any environment. Increasing their generic utilization rate to 66.2 percent from 62.2 percent last year led to operating margin improvement of 110 basis points.
ESRX’s 2009 outlook is higher than Bloomberg’s average estimates. The company expects economically stressed consumers to switch to generic drugs or mail-order pharmacies to save money, both of which generate higher margins for the company. Both presidential candidates have supported greater use of generic drugs to help lower healthcare costs in the U.S.
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CVX, the second-largest U.S. oil company, said 3Q profit doubled.
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JPM said it will modify terms on the $110 billion of mortgages and delay foreclosures (see story here). None of its customers will face foreclosure in the next 90 days while it finds ways to make payments easier. JPM also said it issued $25 billion of preferred stock and warrants to the U.S. Treasury as part of the government’s plan to shore up lenders and thaw credit markets.
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Recently, the market has been making big moves (both up and down) in the last 30 minutes of trading. WSJ.com blog MarketBeat tries to provide some logic to the late-day insanity.
Happy Halloween!!!
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks gained good ground yesterday and actually held onto just about all of the early-session gains. It appeared we were in the process of a Wednesday-session redux (a plunge at the end) but spiked in the final half-hour.
The press advanced the notion that stocks rallied due to the latest GDP reading (third-quarter), which wasn’t as bad as expected; however, the market’s concern has not been what occurred last quarter, but the damage that has been done in the current period. More likely, additional signs the credit markets are returning to something that looks more normal is what helped investor sentiment yesterday.
Market Activity for October 30, 2008
Energy stocks led the benchmarks higher – the index that tracks these shares is up 19% over the last three days – adding another 4% yesterday. Utility, consumer discretionary and industrial shares also performed well – all higher by at least 3%.
The Credit Markets
The credit markets continue to move back to normal, which should give stock-market investors some solace. As we’ve touched on nearly each day lately, three-month LIBOR (inter-bank lending rate for this term and tied to ARMs) continues to decline. Also, the TED Spread, which is a measure of risk-aversion (a wider spread means aversion to risk is high), has narrowed. Although, we’ve seen some flight to the safety of T-bills the past couple of days, thus the spread has halted its decline. But the trend on LIBOR means that this should begin to narrow again.
Further, the Fed’s commercial paper (CP) facility – which they rolled out on Monday – is working well as the CP market is rolling again. U.S. commercial paper outstanding rose $100.6 billion, or 6.9%, to a seasonally adjusted $1.55 trillion for the week ended yesterday. This was the first gain in seven weeks and reverses a 20% decline over the past six weeks.
The Economy
On the economic front, the Labor Department reported initial jobless claims for the week ended October 25 came in unchanged from an upwardly revised reading in the previous week. Claims for unemployment benefits were 479,000 and the number of people remaining on the dole, known as continuing claims, fell 12,000 to 3.715 million.
The four-week moving average – a less volatile measure as it smoothes out weekly disruptions – fell to 475,000 from 480,000.
While the jobless claims figures remain elevated, it is nice to see we’re holding below the 2001 peak. It was also nice to see the ratio of states reporting an increase to those reporting a decrease in claims reversed course. Forty states and territories reported a decrease in claims, with only 13 reporting an increase. This is the inverse of what we saw in the previous week.
Still the October jobs report, which we get in a week, is going to show the largest amount of monthly job losses we’ve seen yet during this 10-month labor-market downturn. The losses for the first eight months of the year were mild, but kicked up in September. We should expect another 100,000-plus loss when that data is released on November 7. If the October data shows a decline of 150,000 payroll jobs, we’ll have lost roughly 10% of the eight million created September 2003-December 2007.
In a separate report, the Commerce Department’s initial estimate on third-quarter GDP showed the economy contracted at 0.3% real annual rate, better than the expected 0.5% contraction.
A positive contribution in inventories added 0.56 percentage point and net exports added 1.13 percentage points partially offseting weakness from residential fixed investment (subtracted 0.72 percentage point) and a large contraction in personal consumption (subtracted a huge 2.25 percentage points).
Take the inventories figures out – what’s known as real final sales – and GDP contacted at 0.8% annual pace. That followed a 4.4% rise in the second quarter. (We were hardly in a recession prior to the credit-market event)
The big news was the 3.1% decline in personal consumption – the most powerful component of GDP. (Don’t confuse this with the number in the previous paragraph. The number above just states the percentage points personal consumption subtracted from the GDP number. This 3.1% figure is the annual rate at which consumption declined) This marks the first contraction in personal consumption since the 1990-1991 recession and is the largest drop since the 1981-1982 recession.
Residential fixed investment (housing) plunged 19.1% in the third-quarter, and marks the 10th straight quarter in which housing has weighed on GDP.
Business spending on equipment and software, which began the quarter strong, shut down as the credit-market disturbance hit – the figure fell 5.5% in the quarter. This more than offset an increase in non-residential structures.
Real imports fell 1.9% and real exports jumped 5.9%, which is why real net exports added nicely to the report. This will not buoy the current (Q4) quarter’s GDP report though as global weakness will hit export orders.
The fourth-quarter GDP report will be the doozie as global weakness will hit exports, inventories will likely contract (inventory levels are low but firms will remain very cautious), consumer activity may remain weak and housing construction will continue to pull-back. Some of these realties are not new, what’s changed since the credit-markets went into chaos in mid-September is the global weakness, likely inventory pull-back and weaker consumer activity. When the current quarter’s GDP number is reported it will likely show a contraction of 3.0-4.0% in real terms at an annual rate – this is in line with the typical economic contraction.
Have a great weekend!
Brent Vondera, Senior Analyst
The press advanced the notion that stocks rallied due to the latest GDP reading (third-quarter), which wasn’t as bad as expected; however, the market’s concern has not been what occurred last quarter, but the damage that has been done in the current period. More likely, additional signs the credit markets are returning to something that looks more normal is what helped investor sentiment yesterday.
Market Activity for October 30, 2008
Energy stocks led the benchmarks higher – the index that tracks these shares is up 19% over the last three days – adding another 4% yesterday. Utility, consumer discretionary and industrial shares also performed well – all higher by at least 3%.
The Credit Markets
The credit markets continue to move back to normal, which should give stock-market investors some solace. As we’ve touched on nearly each day lately, three-month LIBOR (inter-bank lending rate for this term and tied to ARMs) continues to decline. Also, the TED Spread, which is a measure of risk-aversion (a wider spread means aversion to risk is high), has narrowed. Although, we’ve seen some flight to the safety of T-bills the past couple of days, thus the spread has halted its decline. But the trend on LIBOR means that this should begin to narrow again.
Further, the Fed’s commercial paper (CP) facility – which they rolled out on Monday – is working well as the CP market is rolling again. U.S. commercial paper outstanding rose $100.6 billion, or 6.9%, to a seasonally adjusted $1.55 trillion for the week ended yesterday. This was the first gain in seven weeks and reverses a 20% decline over the past six weeks.
The Economy
On the economic front, the Labor Department reported initial jobless claims for the week ended October 25 came in unchanged from an upwardly revised reading in the previous week. Claims for unemployment benefits were 479,000 and the number of people remaining on the dole, known as continuing claims, fell 12,000 to 3.715 million.
The four-week moving average – a less volatile measure as it smoothes out weekly disruptions – fell to 475,000 from 480,000.
While the jobless claims figures remain elevated, it is nice to see we’re holding below the 2001 peak. It was also nice to see the ratio of states reporting an increase to those reporting a decrease in claims reversed course. Forty states and territories reported a decrease in claims, with only 13 reporting an increase. This is the inverse of what we saw in the previous week.
Still the October jobs report, which we get in a week, is going to show the largest amount of monthly job losses we’ve seen yet during this 10-month labor-market downturn. The losses for the first eight months of the year were mild, but kicked up in September. We should expect another 100,000-plus loss when that data is released on November 7. If the October data shows a decline of 150,000 payroll jobs, we’ll have lost roughly 10% of the eight million created September 2003-December 2007.
In a separate report, the Commerce Department’s initial estimate on third-quarter GDP showed the economy contracted at 0.3% real annual rate, better than the expected 0.5% contraction.
A positive contribution in inventories added 0.56 percentage point and net exports added 1.13 percentage points partially offseting weakness from residential fixed investment (subtracted 0.72 percentage point) and a large contraction in personal consumption (subtracted a huge 2.25 percentage points).
Take the inventories figures out – what’s known as real final sales – and GDP contacted at 0.8% annual pace. That followed a 4.4% rise in the second quarter. (We were hardly in a recession prior to the credit-market event)
The big news was the 3.1% decline in personal consumption – the most powerful component of GDP. (Don’t confuse this with the number in the previous paragraph. The number above just states the percentage points personal consumption subtracted from the GDP number. This 3.1% figure is the annual rate at which consumption declined) This marks the first contraction in personal consumption since the 1990-1991 recession and is the largest drop since the 1981-1982 recession.
Residential fixed investment (housing) plunged 19.1% in the third-quarter, and marks the 10th straight quarter in which housing has weighed on GDP.
Business spending on equipment and software, which began the quarter strong, shut down as the credit-market disturbance hit – the figure fell 5.5% in the quarter. This more than offset an increase in non-residential structures.
Real imports fell 1.9% and real exports jumped 5.9%, which is why real net exports added nicely to the report. This will not buoy the current (Q4) quarter’s GDP report though as global weakness will hit export orders.
The fourth-quarter GDP report will be the doozie as global weakness will hit exports, inventories will likely contract (inventory levels are low but firms will remain very cautious), consumer activity may remain weak and housing construction will continue to pull-back. Some of these realties are not new, what’s changed since the credit-markets went into chaos in mid-September is the global weakness, likely inventory pull-back and weaker consumer activity. When the current quarter’s GDP number is reported it will likely show a contraction of 3.0-4.0% in real terms at an annual rate – this is in line with the typical economic contraction.
Have a great weekend!
Brent Vondera, Senior Analyst
Thursday, October 30, 2008
Afternoon Review
Harris Corporation (HRS) +4.32%
HRS reported earnings that beat estimates after yesterday’s closing bell. The company reported that revenue during its first quarter of fiscal 2009 increased 11 percent and net income rose 18 percent. Double-digit organic revenue and earnings growth was a result of rapidly expanding international sales. Additionally, the company ended their first quarter in excellent financial position with $345 million in cash, no long-term debt maturing until 2016, and a new five-year $750 million revolving credit facility.
Highlighting the earnings release was the RF Communications segment, which makes military and law enforcement radios, increasing revenue 31 percent thanks to successful new products and new markets. International revenue growth accelerated and represented over 35 percent of total revenue in the quarter, compared to 27 percent of revenue for all of fiscal 2008. International revenue growth is expected to remain strong throughout fiscal 2009 and beyond, as U.S. allies implement defense communications modernization programs.
HRS reconfirmed its earnings guidance for fiscal 2009, with revenues increasing by 8 to 10 percent.
HRS reported earnings that beat estimates after yesterday’s closing bell. The company reported that revenue during its first quarter of fiscal 2009 increased 11 percent and net income rose 18 percent. Double-digit organic revenue and earnings growth was a result of rapidly expanding international sales. Additionally, the company ended their first quarter in excellent financial position with $345 million in cash, no long-term debt maturing until 2016, and a new five-year $750 million revolving credit facility.
Highlighting the earnings release was the RF Communications segment, which makes military and law enforcement radios, increasing revenue 31 percent thanks to successful new products and new markets. International revenue growth accelerated and represented over 35 percent of total revenue in the quarter, compared to 27 percent of revenue for all of fiscal 2008. International revenue growth is expected to remain strong throughout fiscal 2009 and beyond, as U.S. allies implement defense communications modernization programs.
HRS reconfirmed its earnings guidance for fiscal 2009, with revenues increasing by 8 to 10 percent.
******
Harsco Corporation (HSC) +12.70%
HSC earnings beat expectations as 3Q sales increased 13 percent to a record 1.04 billion.
Solid 3Q number were a result of improved results in the Middle East, Asia-Pacific and North America, more than offsetting weaker performance in Europe. Double-digit organic growth drove fantastic sales number across all business segments. Higher than expected production cuts by steel mill across the globe led to declining margins in HSC’s Mill Services segment, particularly in September. HSC expects steel production to begin to return to more normalized levels in the later quarters of 2009.
The company announced a number of measures to reinforce 2009 performance in the face of “enormous uncertainty and anxiety throughout the world.” HSC is accelerating cost reduction actions, which will result in a restructuring chare of approximately $0.17 a share in 4Q, but will save $30 million annually. The reduction to be realized in 2009 is about $0.25 per share. The company is also significantly reducing growth capital expenditure in 2009 by approximately $150 million from 2008 with the intention of using this discretionary cash for share repurchases and targeted acquisitions. In addition, HSC is redeploying equipment from slowing markets to new projects in such strategically important areas as the Middle East and Africa, India, China, and several other key countries.
HSC lowered its full-year 2008 guidance, but this should be viewed as a positive because they are taking many restructuring charges in their 4Q to insure they hit the ground running in 2009.
HSC repurchased approximately 1.1 million shares since the beginning of the year, including close to 755,000 shares in 3Q. Approximately 5 million shares remain under HSC’s share repurchase authorization.
The company’s balance sheet is very health and should have no difficulties maintaining their dividend (which as of now yields 3.38 percent).
******
Curtiss-Wright (CW) +6.42%
CW beat earnings estimates despite the Boeing strike, delays on the Eclipse and Boeing 787 programs, and foreign exchange losses associated with the VMetro acquisition.
Sales growth of 10 percent in 3Q was generated by solid organic growth across all segments. Higher operating margins were realized in all three of CW’s segments. The increase in both organic operating income and margin was largely due to higher sales volumes, improved profitability on several long-term contracts, and reduced R&D costs.
Defense programs continue to show growth and CW’s commercial markets remain strong, specifically the commercial nuclear power market, which CW expects to continue growing at a rapid rate. CW lowered its 2008 guidance, citing dilutive effects of the VMetro acquisition, build-up of inventory due to program delays and the Boeing strike, and build-up of inventory in CW’s oil and gas market for anticipated orders that have shifted into 2009.
Record backlog of $1.7 billion indicates continuing success of CW’s products and programs.
******
Mylan (MYL) +17.05%
MYL, the biggest U.S. maker of generic drugs, reported 3Q profit before one-time items that was more than double the average analyst estimate, according to Bloomberg data. MYL said profit gained on the sale of blood pressure drug Bystolic and revenue from acquisitions. The economic crisis has so far had little impact on the underlying demand for MYL’s generic products.
MYL paid more than its own market value for Merck KGaA’s generics business last year to increase manufacturing capacity and reach fast-growing European markets. The unit contributed more than half of net revenue, which doubled.
MYL increased its forecast for 2008 earnings to the range of $0.64 to $0.67, from $0.47 to $0.53.
******
Alliant Techsystems (ATK) +2.33%
ATK said quarterly earnings rose 27 percent, which exceed expectations, and announced full-year profit will be higher than their original forecast. Increased sales of commercial and military ammunition drove sales thanks to strong demand from law enforcement and international markets.
Sales and profit rose at ATK’s armament and mission systems groups, but declined at the space division. Space revenue declined on reduced work on the Minuteman II missile program and delays on the launch abort system being developed for the new Orion spacecraft. Armament group sales gained 19 percent lifted by ammunition demand and the mission systems group boosted sales 2.5 percent on military rocket motors.
******
ExxonMobil (XOM) +0.54%
XOM said 3Q profit jumped 58 percent, exceeding analyst estimates, as record crude prices made up for the largest drop in output in at least a decade. Earnings from oil and gas wells alone were higher than XOM’s total profit a year earlier, even as output fell 8.2 percent, the most since at least 1997. Spending on drilling rigs, refinery expansions, and new gas plants may jump to $30 billion annually in the next five years – a 20 percent increase from their March estimate.
Oil and gas output will increase in 2009, in part because of a new liquefied-gas project in Qatar.
XOM’s ratio of market value to crude and gas reserves is the highest among the world’s 10 largest oil companies. XOM trades at about $16 per barrel of oil-equivalent reserves, 60 percent above the average for its peers.
******
In news outside of earnings reports…
Emerging market stocks climbed out of a bear market after surging more than 20 percent in three days, as the U.S. agreed to pump as much as $90 billion into Brazil, Mexico, and South Korea and the International Monetary Fund approved an emergency loan program. A 20 percent gain in a stock index is the common definition of a bull market. Emerging markets rally was boosted further by a jump in the price of commodities that sustain many nations. Crude oil rose above $70 a barrel for the first time in a week.
******
With Procter & Gamble, Kellogg, Kraft, Colgate, and other consumer product companies reporting strong earnings due to price hikes, it is not surprising to see that grocery chains are resisting any further price hikes. The Wall Street Journal ran this interesting article today on the topic.
--
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks declined on Wednesday, failing to expand upon the prior day’s powerful rally as investors dismissed the Fed’s latest move. While the market bounced between gain and loss (what’s become a normal occurrence lately), it looked as though we’d close higher, but the market erased 4.2% in the final 10 minutes of trading to close roughly 1% to the downside. The NASDAQ Composite bucked the trend, as did mid and small-cap indices, closing to the plus side.
A better-than-expected durable goods report – which we’ll discuss below – helped buoy stocks in the morning session and investors then waited for the Fed rate decision. When that decision to cut fed funds by one-half a percentage point was announced volatility spiked. With 30 minutes left in the session, the S&P 500 was higher by 3.2%, but that all evaporate, and then some, in the final minutes. Was this due to mutual fund redemptions? I don’t know, but it sure looks like it.
Market Activity for October 29, 2008
The Rate Cut
The FOMC went ahead with what the market called for and cut their target rate on fed funds by 50 basis points to 1.00%. Of course, like so many government actions of late, the market expects it, the government delivers and… BAM! it sells off.
However, the many facilities and programs the Fed has rolled out are helping the credit markets to thaw as three-month LIBOR continues to move lower, the TED Spread narrows (although not yesterday due to flight to T-bills) and the commercial paper market is showing early signs of life. So, it’s not accurate to say there hasn’t been some degree of efficacy regarding what the Fed has done, but stock-market traders sure enjoy slapping Bernanke around.
The vote to cut was unanimous (the FOMC is made up of 12 members – seven Fed governors (including the Chairman) and five rotating spots involving the 12 regional Federal Reserve Bank presidents) to move the target down to 1.00%; “a return to the scene of the crime,” as our Senior Fixed Income Analyst Ryan Craft puts it.
Now, the effective fed funds rate is actually trading below that 1.00% target rate (as discussed yesterday) due to the massive amount of liquidity the Fed has pumped in. That effective rate should trade closer to the interest rate at which the Fed is now paying on deposits at the central bank (fed funds minus 35 basis points, or 0.65%) – which is what’s referred to as quantitative easing, I believe, and why the target fed funds rate is not nearly as important as the growth in the Fed’s balance sheet right now, which makes the other programs they’re engaged in possbile.
In the statement that accompanies the rate decision, the FOMC mentioned coordinated actions with other central banks, which should presage what the Japanese central bank does tomorrow and Europe does next week, which will be a cut of 50 basis points.
One should not expect this latest reduction back to 1.00% fed funds to stimulate from here. What it should do is help to lower three-month LIBOR, which many adjustable rate mortgages are pegged to. It was also a PR move, as the Fed does not want to disappoint the market and touch off anything that may cause stocks to plunge from here. As mentioned yesterday, I don’t agree with this and wish Fedhead Bernanke would have been more forceful with the market a few months back. If that had occurred they may not be at the whim of the stock market right now. Who knows?
Yesterday’s Economic Data
The Commerce Department reported durable goods orders for September were much better-than-expected, although it did follow a downward revision to the August figure.
Orders for durable goods rose 0.8% last month, which was considerably better than the expected 1.1% decline; this followed a large 5.5% decline in August. Orders were boosted by defense and commercial aircraft orders. Electrical equipment orders also rose nicely, up 1.5% last month, after two months of weakness for this segment. However, outside of these components orders were weak, as witnessed by the ex-transportation reading, which fell 1.1%.
Defense orders jumped 19.6% in September and commercial aircraft was up a huge 29.7%. As the Boeing strike appears to be coming to an end aircraft shipments may offer some economic boost than would otherwise be the case – unfilled orders aircraft orders are up 20% over the past 12 months.
The component we watch most closely within the durable report is orders for non-defense capital good ex-aircraft – this is a proxy for business capital spending. Business spending had been on the rise, up at a 10% annual rate in the five months ended July, but things changed quickly as the credit market freeze-up began to take hold. Firms have the resources to engage in these orders but hold off in caution due to the effects and uncertainty that the credit disturbance will have on global growth. As of this latest report, capital spending declined at an 8% annual rate since July – a serious reversal.
That said, shipments of business equipment rose 2.0% in September – which results from the healthy orders a couple of months back – will help the third-quarter GDP report as this component funnels directly into that report, but it won’t nearly be enough to offset other weakness.
We will need to get past this credit market disturbance, which seems to be incrementally thawing, before durable goods orders begin to trend higher again. The problem even as we get beyond this event is the tax policy that had spurred a rebound in capital spending three months back (higher current-year write-down allowances and bonus depreciation) will end in January. It would be a fabulous idea for the administration to demand that this policy is extended through 2009 – the McCain campaign has this in there agenda, but it appears unlikely they’ll get the chance to implement it.
It’s Thursday, so this morning we get initial jobless claims, which will remain elevated. We’ll also get the initial estimate to third-quarter GDP, which will mark the beginning of a traditional recession, which began when Lehman went down in September and the credit markets froze up. Prior to that point, many had stated the U.S. was in recession – and certainly the job market was weak and the consumer side was showing trouble – but recession was not true as the business side was upbeat, as business spending and sales were moving higher. That has changed.
We should expect a reading of -0.5%, maybe even something close to -1.0%. The fourth quarter reading will be the big one, as we’ll probably see a reading of -3.0%, possibly as high as -4.0%. Those are negative figures we haven’t seen since the 1990-1991 recession – a traditional recession.
Moving to Policy
We hear a lot about what’s caused the current economic situation, unfortunately, the much talked about “causes” are not the causes at all and miss exactly that which has delivered this state of affairs.
If we are to blame historically low tax rates, free trade, flexible labor markets and entertain the de-regulation myth, as some have, we’re in for deep trouble. The origins of this crisis are monetary policy mistakes (keeping rates too low for too long), congressional demands to offer credit to less than creditworthy consumers and an insane decision to switch to Basel II banking standards (and mark-to-market accounting) in the midst of the housing bubble – which has caused capital ratios to look much worse than would be the case under the former, more stable, standards.
To ignore the true origins of this situation, and instead kill the fundamentals of a relatively free economy the next few years are not likely to offer the optimal economic outcome. Eventually, we will choose the correct policy, but to raise taxes, eliminate trade pacts and regulate everything under the sun (specifically overlapping regulation) will spell economic death, at least a coma, especially in the current environment – I believe much of the damage in the stock market has been a pricing in of this scenario.
If we are to lower after-tax returns (by raising tax rates) on those that provide the capital for innovation, business start-ups and overall financing for the economy everyone else is not made better-off, but just the opposite.
Low tax rates on capital drives the formation of capital; capital funds (and thus drives) innovation; innovation drives productivity; higher levels of productivity drives competitiveness; increased competitiveness drives jobs. Period.
Remember these economic axioms the next time you run into a politician claiming to raise taxes on the “rich,” for it is the rest of society that will pay.
Have a great day!
Brent Vondera, Senior Analyst
A better-than-expected durable goods report – which we’ll discuss below – helped buoy stocks in the morning session and investors then waited for the Fed rate decision. When that decision to cut fed funds by one-half a percentage point was announced volatility spiked. With 30 minutes left in the session, the S&P 500 was higher by 3.2%, but that all evaporate, and then some, in the final minutes. Was this due to mutual fund redemptions? I don’t know, but it sure looks like it.
Market Activity for October 29, 2008
The Rate Cut
The FOMC went ahead with what the market called for and cut their target rate on fed funds by 50 basis points to 1.00%. Of course, like so many government actions of late, the market expects it, the government delivers and… BAM! it sells off.
However, the many facilities and programs the Fed has rolled out are helping the credit markets to thaw as three-month LIBOR continues to move lower, the TED Spread narrows (although not yesterday due to flight to T-bills) and the commercial paper market is showing early signs of life. So, it’s not accurate to say there hasn’t been some degree of efficacy regarding what the Fed has done, but stock-market traders sure enjoy slapping Bernanke around.
The vote to cut was unanimous (the FOMC is made up of 12 members – seven Fed governors (including the Chairman) and five rotating spots involving the 12 regional Federal Reserve Bank presidents) to move the target down to 1.00%; “a return to the scene of the crime,” as our Senior Fixed Income Analyst Ryan Craft puts it.
Now, the effective fed funds rate is actually trading below that 1.00% target rate (as discussed yesterday) due to the massive amount of liquidity the Fed has pumped in. That effective rate should trade closer to the interest rate at which the Fed is now paying on deposits at the central bank (fed funds minus 35 basis points, or 0.65%) – which is what’s referred to as quantitative easing, I believe, and why the target fed funds rate is not nearly as important as the growth in the Fed’s balance sheet right now, which makes the other programs they’re engaged in possbile.
In the statement that accompanies the rate decision, the FOMC mentioned coordinated actions with other central banks, which should presage what the Japanese central bank does tomorrow and Europe does next week, which will be a cut of 50 basis points.
One should not expect this latest reduction back to 1.00% fed funds to stimulate from here. What it should do is help to lower three-month LIBOR, which many adjustable rate mortgages are pegged to. It was also a PR move, as the Fed does not want to disappoint the market and touch off anything that may cause stocks to plunge from here. As mentioned yesterday, I don’t agree with this and wish Fedhead Bernanke would have been more forceful with the market a few months back. If that had occurred they may not be at the whim of the stock market right now. Who knows?
Yesterday’s Economic Data
The Commerce Department reported durable goods orders for September were much better-than-expected, although it did follow a downward revision to the August figure.
Orders for durable goods rose 0.8% last month, which was considerably better than the expected 1.1% decline; this followed a large 5.5% decline in August. Orders were boosted by defense and commercial aircraft orders. Electrical equipment orders also rose nicely, up 1.5% last month, after two months of weakness for this segment. However, outside of these components orders were weak, as witnessed by the ex-transportation reading, which fell 1.1%.
Defense orders jumped 19.6% in September and commercial aircraft was up a huge 29.7%. As the Boeing strike appears to be coming to an end aircraft shipments may offer some economic boost than would otherwise be the case – unfilled orders aircraft orders are up 20% over the past 12 months.
The component we watch most closely within the durable report is orders for non-defense capital good ex-aircraft – this is a proxy for business capital spending. Business spending had been on the rise, up at a 10% annual rate in the five months ended July, but things changed quickly as the credit market freeze-up began to take hold. Firms have the resources to engage in these orders but hold off in caution due to the effects and uncertainty that the credit disturbance will have on global growth. As of this latest report, capital spending declined at an 8% annual rate since July – a serious reversal.
That said, shipments of business equipment rose 2.0% in September – which results from the healthy orders a couple of months back – will help the third-quarter GDP report as this component funnels directly into that report, but it won’t nearly be enough to offset other weakness.
We will need to get past this credit market disturbance, which seems to be incrementally thawing, before durable goods orders begin to trend higher again. The problem even as we get beyond this event is the tax policy that had spurred a rebound in capital spending three months back (higher current-year write-down allowances and bonus depreciation) will end in January. It would be a fabulous idea for the administration to demand that this policy is extended through 2009 – the McCain campaign has this in there agenda, but it appears unlikely they’ll get the chance to implement it.
It’s Thursday, so this morning we get initial jobless claims, which will remain elevated. We’ll also get the initial estimate to third-quarter GDP, which will mark the beginning of a traditional recession, which began when Lehman went down in September and the credit markets froze up. Prior to that point, many had stated the U.S. was in recession – and certainly the job market was weak and the consumer side was showing trouble – but recession was not true as the business side was upbeat, as business spending and sales were moving higher. That has changed.
We should expect a reading of -0.5%, maybe even something close to -1.0%. The fourth quarter reading will be the big one, as we’ll probably see a reading of -3.0%, possibly as high as -4.0%. Those are negative figures we haven’t seen since the 1990-1991 recession – a traditional recession.
Moving to Policy
We hear a lot about what’s caused the current economic situation, unfortunately, the much talked about “causes” are not the causes at all and miss exactly that which has delivered this state of affairs.
If we are to blame historically low tax rates, free trade, flexible labor markets and entertain the de-regulation myth, as some have, we’re in for deep trouble. The origins of this crisis are monetary policy mistakes (keeping rates too low for too long), congressional demands to offer credit to less than creditworthy consumers and an insane decision to switch to Basel II banking standards (and mark-to-market accounting) in the midst of the housing bubble – which has caused capital ratios to look much worse than would be the case under the former, more stable, standards.
To ignore the true origins of this situation, and instead kill the fundamentals of a relatively free economy the next few years are not likely to offer the optimal economic outcome. Eventually, we will choose the correct policy, but to raise taxes, eliminate trade pacts and regulate everything under the sun (specifically overlapping regulation) will spell economic death, at least a coma, especially in the current environment – I believe much of the damage in the stock market has been a pricing in of this scenario.
If we are to lower after-tax returns (by raising tax rates) on those that provide the capital for innovation, business start-ups and overall financing for the economy everyone else is not made better-off, but just the opposite.
Low tax rates on capital drives the formation of capital; capital funds (and thus drives) innovation; innovation drives productivity; higher levels of productivity drives competitiveness; increased competitiveness drives jobs. Period.
Remember these economic axioms the next time you run into a politician claiming to raise taxes on the “rich,” for it is the rest of society that will pay.
Have a great day!
Brent Vondera, Senior Analyst
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