Treasuries continued their selloff today, especially in the longer end, as the curve steepened 10 basis points to +186. U.S. Treasury Secretary-nominee Timothy Geithner announced that the Obama administration believes China is manipulating its currency, and as a result could decrease their demand for U.S. Treasuries in the future. This along with supply concerns drove longer-dated Treasuries slower.
The New York Fed announced $19 billion in MBS purchases for the seven day period ending yesterday. Continuing to stick to 30-year product but making a slight adjustment toward Fannie Mae issued securities. The Fed’s previous buying had leaned more toward Freddie Mac. I’m not sure they truly have a preference. After taking over control of both agencies they act more like one entity than before, and since they are so early into the program, the Fed is more than likely just mopping up whatever they can find at this point.
What is spread?
Spread is the measure of yield differences between two securities. It is usually quoted in basis points, or one-hundredth of one percent, and is used in order to quantify relative risk and return.
Let’s use a simple example. Today you can purchase a 2-year Bank of America corporate bond around a 5.5% yield. Without knowing anything about the current rate environment there is no way of knowing what kind of deal you are getting here. It’s important to consider the return you are getting relative to the market.
We often use Treasuries in calculations of spread because they are the highest quality in terms of credit and liquidity. The goal of any benchmark is to eliminate as many variables as possible, and in bonds nothing is more “Plain Jane” than Treasuries.
A 2 year Treasury bond is currently yielding .72%. So if you were to purchase the BAC bond I mentioned earlier at 5.5% you would be earning 4.78% more than if you bought the Treasury. Therefore, you could say 2 year BAC debt is trading 478 basis points wide of comparable Treasuries (in bond talk). In other words 478 basis points is the “credit spread”.
Since the bonds mentioned here are both 2-year bonds credit worthiness of the issuers is the only major differentiator. According to the market Bank of America is more likely to default on their debt than the U.S. Government. The larger spread over Treasuries, or the higher relative yield, is how an investor is compensated for the added risk.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Friday, January 23, 2009
Thursday, January 22, 2009
Afternoon Review
Lockheed Martin (LMT) +6.31%
LMT said fourth quarter earnings increased three percent thanks to expanded sales of computer service and support to federal government agencies.
The company raised their 2009 sales forecast, which reflects decreasing expectations for cuts to the defense budget. However, Lockheed lowered its earnings guidance (first given last October) to reflect increased pension costs after declining stock markets eroded plan assets.
Information technology sales, which gained 16 percent last quarter, helped offset sluggish aeronautics revenue, which declined 4.6 percent. LMT expanded sales of computer service and support to federal government agencies.
UnitedHealth Group (UNH) +8.54%
UnitedHealth posted fourth quarter earnings that were in line with expectations and maintained full-year profit guidance. The company generated about $3.4 billion of free cash flow for shareholders in 2008, $2.7 billion of which was used for share repurchases.
Enrollment levels remained relatively stable, but commercial enrollment losses are likely to accelerate in 2009 as members who lost their jobs earlier in 2008 begin to run out of COBRA benefits. However, the company’s diversification paid off, with Medicaid and Medicare enrollment gains more than making up for the losses in the commercial business.
UnitedHealth expects meaningful growth in government-sponsored business in 2009. The company said there is strong interest in its Medicare market offerings and continued expansion from its state and public health program relationships.
The consolidated medical care ratio increased 90 basis points year-over-year to 80.8 percent. This ratio indicates the percentage of premium revenue that gets paid out in medical claims. For the full year, the medical cost ratio was 82 percent compared with 80.6 percent in 2007.
Realized investment losses remained minor, at $0.03 per share in the fourth quarter, which was primarily because of the write-down of a venture capital investment.
Raymond James Financial (RJF) +2.41%
Raymond James reported fiscal first quarter earnings that came in above analysts’ estimates. Although the outlook was grim for most of 2009, the company has been building its bank operations (Raymond James Bank). While many of its peers are cutting expenses, Raymond James has been looking to boost its market share by snagging brokers, traders and bankers from troubled firms.
CEO Thomas James attributed the bank’s improved earnings to interest rate spreads that increased as a result of federal market intervention, a real estate and corporate loan portfolio that is outperforming industry benchmarks and a loan portfolio that was 36 percent larger at the end of December than a year earlier.
In November, the company applied to participate in the U.S. Treasury’s Troubled Asset Relief Program. Still, the company has yet to report write-downs related to subprime mortgages, a sign the company’s balance sheet is relatively strong.
Noble Corporation (NE) -0.82%
Noble’s earnings exceeded expectations with profits growing 20 percent in the fourth quarter thanks to long-term service contracts.
Despite oil declining 35 percent in the fourth quarter, Noble had contracts in place for some time. We are unlikely to see a decline in earnings for a few quarters simply because they have everything locked up near-term. Nevertheless, there are several uncertainties surrounding drillers in 2009 including low commodity prices, weakness in the capital markets, high contract turnover and the expected deliveries of several uncontracted newbuild jack-ups.
CEO David Williams said in the statement, “While we believe the long-term fundamentals of our industry are sound, the condition of the global economic environment is clearly a cause of concern and a reason for caution.”
Spending by companies around the world on oil and natural-gas exploration is expected to drop 12 percent in 2009 to $400 billion, according to a Dec. 19 report by Barclays analysts.
Quick Hits
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks recovered most of Tuesday’s losses, rebounding off of a two-month low as a 14.6% jump in financial shares led the broad market higher. The major indices began the session higher, gaining momentum mid-morning as it seemed clear Treasury Secretary Nominee Timothy Geithner wasn’t going to be grilled too badly over his tax return issues – the street appears to like Geithner, largely because they don’t want to see time taken to hunt for a new nominee.
After the close it was reported that Bank of America CEO Ken Lewis and five directors bought 500,000 shares and JP Morgan CEO Jamie Dimon purchased 500,000 JPM shares. That’s a big confidence booster, let’s hope it holds.
Technology stocks also jumped yesterday after IBM issued a 2009 profit forecast that topped estimates. Last night’s strong profit release from Apple should help the NASDAQ again today -- at least at the open, from there it’s anyone’s guess.
Energy shares gained good ground as oil prices jumped 12.42% yesterday. This is part of the contango trade, as the February contract expired on Tuesday and crude for March delivery traded higher. There seems to be some flow through there if I gauging things properly.
Looking over the next couple of weeks this trade should wane and crude prices will likely revisit the $30 handle as it’s all about global growth right now. We’ll get some really ugly GDP readings and that’s going to affect demand expectations and thus the price of crude. (Looking out a bit longer, say six months, I wouldn’t be surprised to see oil settle in around $50-$60 as demand rebounds a bit.)
Market Activity for January 20, 2009
Treasury Nominee
While the street seems to like Geithner, after reading his prepared text for testimony before the Senate yesterday, I’m not terribly impressed. What we have hear is another Keynesian, and the economy really needs better than that. He’s certainly very smart, you don’t become President of the New York Federal Reserve Bank (and by definition a permanent member of the FOMC – the monetary policy committee) without real knowledge of financial intermediation. But then this also reinforces the fact that he is a Keynesian, or demand side thinker, as it is tough for those with opposing views to gain high Federal Reserve posts.
His comments involved too mention of what the world thinks of us and the typical utopian view that regulations can make sure the U.S and global economy “never again face a crisis of this severity.”
On the first, this is completely unrealistic, crises are a fact of life. Further, maybe he should look inward, as it was years of Fed monetary policy mistakes that encouraged the event of over-leverage that the market is now working to correct.
On the international view, he mentions caring what the world thinks of our “ideas and actions” from a regulatory standpoint. A Treasury Secretary needs to focus on making sure his/her country welcomes and treats capital well – nothing more.
Look, we are the engine of global growth. The sooner we get back to being the place where capital seeks to reside (this means higher returns and a stable currency), the rest will take care of itself. Let’s not worry what Europe – economies that are smothered by a massive public sector due to their cradle-to-grave entitlement system and therefore higher rates of unemployment and lower rates of growth – thinks of us. We’ll lead and they will follow if they desire to.)
The soon-to-be Treasury Secretary gave no specifics on what needs to be a plan to house “troubled” assets and no mention of mark-to-market. (The reason we have so many “troubled” assets is not because the vast majority fail to produce cash flow, but because of this insane accounting rule.)
Geithner acknowledged that one of the major issues right now is a lack of confidence, but seems to believe that more regulation is what will bring confidence back. This is a huge mistake.
I know, people these days believe we need more regulation. I’d submit, maybe the Fed should have been engaged in the financial-sector oversight for which they are responsible. If our goal is to add on more overlapping regulation for the sake of it, it will only curtail growth and force business to escape this grip – such as off balance sheet entities that banks used to avoid the current regulatory regime. More regulation results in opacity; less, but enforced regulation, means transparency.
With regard to confidence, we need a bold tax-rate response to deal with this issue. You want a higher level of confidence? Give the market a real sense economic growth will have a chance to flourish and higher after-tax return expectations. That’s what gets confidence rolling.
In any event, we wish him luck with getting the economy back on its feet. But I do not wish him luck with regard to demand-side spending initiatives that create work, instead of longer-run job creation, and a level of budget deficits that help tax hikers sell their agenda to the public.
Today’s Economic Data
It’s been a very quiet week but we get back to it this morning with weekly jobless claims, mortgage applications and housing starts.
The claims data is expected to show a rise for the week ended November 17; we’ll be watching to see if the reading holds below 550k.
Claims moved below the 500k level in the previous couple of readings, reversing a trend that had approached 600k just before Christmas. That move lower was due to poorly adjusted seasonal factors (result of the holidays), which was evident by the 54,000 jump in the week ended January 10. It will be important to hold below that 600k mark over the next several weeks, as it may show the major labor market damage has already occurred. Today’s data will give a good indication – holding below 550k will be helpful for stocks.
On housing starts, residential construction plunged 18.9% in November, to a record low of 625,000 units at an annual rate. On an unadjusted basis, only 29,800 single-family homes were started for the month (the average is roughly 130,000). Building permits – a gauge of future activity – dropped 15.8% in November, which is a good indication we’ll make another new record low when the December starts figure is released today.
Mortgage applications for the week ended January 16 are already out this morning. The Mortgage Bankers Association stated total apps fell 9.8% after a 15.8% rise in the previous week. Purchases rose 2.5% and refinancing was down 12.4%, but that does follow a big 25.6% jump in the previous week.
Have a great day!
Brent Vondera, Senior Analyst
After the close it was reported that Bank of America CEO Ken Lewis and five directors bought 500,000 shares and JP Morgan CEO Jamie Dimon purchased 500,000 JPM shares. That’s a big confidence booster, let’s hope it holds.
Technology stocks also jumped yesterday after IBM issued a 2009 profit forecast that topped estimates. Last night’s strong profit release from Apple should help the NASDAQ again today -- at least at the open, from there it’s anyone’s guess.
Energy shares gained good ground as oil prices jumped 12.42% yesterday. This is part of the contango trade, as the February contract expired on Tuesday and crude for March delivery traded higher. There seems to be some flow through there if I gauging things properly.
Looking over the next couple of weeks this trade should wane and crude prices will likely revisit the $30 handle as it’s all about global growth right now. We’ll get some really ugly GDP readings and that’s going to affect demand expectations and thus the price of crude. (Looking out a bit longer, say six months, I wouldn’t be surprised to see oil settle in around $50-$60 as demand rebounds a bit.)
Market Activity for January 20, 2009
Treasury Nominee
While the street seems to like Geithner, after reading his prepared text for testimony before the Senate yesterday, I’m not terribly impressed. What we have hear is another Keynesian, and the economy really needs better than that. He’s certainly very smart, you don’t become President of the New York Federal Reserve Bank (and by definition a permanent member of the FOMC – the monetary policy committee) without real knowledge of financial intermediation. But then this also reinforces the fact that he is a Keynesian, or demand side thinker, as it is tough for those with opposing views to gain high Federal Reserve posts.
His comments involved too mention of what the world thinks of us and the typical utopian view that regulations can make sure the U.S and global economy “never again face a crisis of this severity.”
On the first, this is completely unrealistic, crises are a fact of life. Further, maybe he should look inward, as it was years of Fed monetary policy mistakes that encouraged the event of over-leverage that the market is now working to correct.
On the international view, he mentions caring what the world thinks of our “ideas and actions” from a regulatory standpoint. A Treasury Secretary needs to focus on making sure his/her country welcomes and treats capital well – nothing more.
Look, we are the engine of global growth. The sooner we get back to being the place where capital seeks to reside (this means higher returns and a stable currency), the rest will take care of itself. Let’s not worry what Europe – economies that are smothered by a massive public sector due to their cradle-to-grave entitlement system and therefore higher rates of unemployment and lower rates of growth – thinks of us. We’ll lead and they will follow if they desire to.)
The soon-to-be Treasury Secretary gave no specifics on what needs to be a plan to house “troubled” assets and no mention of mark-to-market. (The reason we have so many “troubled” assets is not because the vast majority fail to produce cash flow, but because of this insane accounting rule.)
Geithner acknowledged that one of the major issues right now is a lack of confidence, but seems to believe that more regulation is what will bring confidence back. This is a huge mistake.
I know, people these days believe we need more regulation. I’d submit, maybe the Fed should have been engaged in the financial-sector oversight for which they are responsible. If our goal is to add on more overlapping regulation for the sake of it, it will only curtail growth and force business to escape this grip – such as off balance sheet entities that banks used to avoid the current regulatory regime. More regulation results in opacity; less, but enforced regulation, means transparency.
With regard to confidence, we need a bold tax-rate response to deal with this issue. You want a higher level of confidence? Give the market a real sense economic growth will have a chance to flourish and higher after-tax return expectations. That’s what gets confidence rolling.
In any event, we wish him luck with getting the economy back on its feet. But I do not wish him luck with regard to demand-side spending initiatives that create work, instead of longer-run job creation, and a level of budget deficits that help tax hikers sell their agenda to the public.
Today’s Economic Data
It’s been a very quiet week but we get back to it this morning with weekly jobless claims, mortgage applications and housing starts.
The claims data is expected to show a rise for the week ended November 17; we’ll be watching to see if the reading holds below 550k.
Claims moved below the 500k level in the previous couple of readings, reversing a trend that had approached 600k just before Christmas. That move lower was due to poorly adjusted seasonal factors (result of the holidays), which was evident by the 54,000 jump in the week ended January 10. It will be important to hold below that 600k mark over the next several weeks, as it may show the major labor market damage has already occurred. Today’s data will give a good indication – holding below 550k will be helpful for stocks.
On housing starts, residential construction plunged 18.9% in November, to a record low of 625,000 units at an annual rate. On an unadjusted basis, only 29,800 single-family homes were started for the month (the average is roughly 130,000). Building permits – a gauge of future activity – dropped 15.8% in November, which is a good indication we’ll make another new record low when the December starts figure is released today.
Mortgage applications for the week ended January 16 are already out this morning. The Mortgage Bankers Association stated total apps fell 9.8% after a 15.8% rise in the previous week. Purchases rose 2.5% and refinancing was down 12.4%, but that does follow a big 25.6% jump in the previous week.
Have a great day!
Brent Vondera, Senior Analyst
Wednesday, January 21, 2009
Afternoon Review
International Business Machines Corp. (IBM) +11.51%
IBM reported another quarter of solid earnings and issued an outlook for 2009 that exceeds current estimates. Even after adjusting for special items such as lower tax rate and fewer shares, IBM’s profit beat expectations.
While revenues slipped across all geographic regions for a total decline of six percent year-over-year, IBM managed to improved gross margins by generating a larger share of its business from high-profit software and services. Even in its hardware business, solid sales of high-margin mainframe computers helped offset disappointing sales of commodity-type servers and a 34 percent sales drop in its semiconductor division.
IBM ended 2008 with $12.9 billion of cash on hand and generated free cash flow of $14.3 billion, up $1.9 billion year-over-year.
This positive earnings release comes as fellow tech-bellwether Intel’s CEO raises the possibility of a loss in the first quarter, ending its more than 21-year run of profitability.
United Technologies (UTX) -0.22%
United Technologies reported results that met expectations and reaffirmed its outlook for 2009. Earnings did include six cents per share in one-time gains, which are typically not included when comparing to the consensus.
Revenues fell 1.3 percent year-over-year to $14.5 billion (consensus called for revenues of $14.8 billion). The company said that solid margin expansion at its aerospace units and at UTC Fire & Security offset the impact of a sharp decline at its Carrier HVAC unit and declines in its Otis elevator unit.
Aggressive share buybacks (over $3 billion worth in 2008 alone) alleviate some of the 2008 headwinds. Looking into 2009, the company expects the global recession to continue through most of this year, but expects a “modest recovery” in the second half.
Wal-Mart Stores (WMT) -2.81%
Wal-Mart was downgraded by several analysts today in response to the company’s December same-store-sales release and guidance revision.
Wal-Mart’s sales fell short of expectations in all three business divisions, illustrating that even Wal-Mart is not immune to the economic slowdown. The company may not realize any benefits in 2009 from consumers trading down as they did in 2008. In addition, price increases drove the majority of Wal-Mart’s sales growth in 2008, not unit growth.
As CreditSuisse notes, Target is focusing on reducing prices to gain market share, which presents an added competitive threat to Wal-Mart. Longer term, Wal-Mart’s sheer size and fewer stores in peak productivity stage (3-5 years after opening) are likely to challenge sales growth expectations.
Bank of America (BAC) +30.98%, J.P. Morgan Chase (JPM) +25.1%
Bank shares soared after regulatory filings showed that Bank of America CEO Kenneth Lewis and five directors bought more than 500,000 shares yesterday. In addition, Bloomberg reported that JPMorgan CEO Dimon bought $11.5 Million of JPM shares last week. Some view this as an act of confidence, while others see this as no more than an expensive PR move.
Bank of America also announced more job cuts.
First Cash Financial Services (FCFS) -4.64%
First Cash reaffirmed its 2009 earnings guidance today, but still saw selling pressure after competitor Cash America International (CSH) reduced its 2009 earnings forecast citing the faltering economy and the effects of store closings.
First Cash has far greater economies of scale than their competitors, plus their growing exposure to Mexico is helping offset weakness in the U.S. First Cash also has a stronger balance sheet than its competitors, which is allowing them to buyback shares and open new stores in Mexico.
Quick Hits
Peter Lazaroff, Junior Analyst
January 2009 Portfolio Insights
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The January 2009 issue of Portfolio Insights has arrived! This expanded addition includes:- Strategic Reflections
- Madoff
- Inside the Economy
- Equity Markets Activity
- Fixed Income Strategy
- 2008 Review
- Ask Acropolis
Click here or the cartoon to view the issue.
Daily Insight
U.S. stocks failed to abide by the script, we’re supposed to feel a sense of optimism with the changing of the guard, focusing on reality instead as stocks got clocked. The damage done to overall earnings as the fourth-quarter was hit hard by the credit-market chaos is hammering sentiment again. Uncertainty over the direction of government policy is also roiling the market.
The decline on Tuesday added to the market’s worst week (last week) since November and has lopped off two-thirds of the late-November/December rally that shot the NYSE Composite 28% from the November 20 low – we’re now just 8.75% above that mark. Talk of nationalizing banks, while this would be a last resort, is also causing major concern.
Financials led the broad-market’s decline after the largest money manager for institutions – State Street Corp. – announced unrealized bond losses nearly doubled last quarter; the stock tumbled 59%.
Telecoms, utilities and consumer staples were relative winners; none of the 10 major industry groups were positive, as the chart below shows.
Decliners trounced advancers by a 17-to-1 margin on average volume.
Market Activity for January 20, 2009
Mark-to-Disaster
We made mention yesterday of how the Treasury’s decision to guarantee, or backstop, loans at Citigroup and Bank of America was smart by half. If they’re going to do something, they need to remove these assets from balance sheets. The idea of backstopping increases the odds that institutions with this guarantee in place may now dump this trouble at even lower prices, which reverberates throughout the sector. It appears there was significant deterioration in asset-backed securities in December even as some of the credit indicators managed to improve a bit.
It’s important to mention, State Street said none of these securities that are taking write-downs are in default, but that doesn’t matter with mark-to-market; this is why it’s so damaging. My fear is as we continue to watch this insane accounting standard wrought its destruction, it will continue to lead to additional government decisions that bring their own consequences. We’re trying nine-gazillion things (in typical government Rube Goldberg machine fashion) with all of the unintended consequences that result when we could have simply ended an accounting standard that was just put in place a mere14 months ago. This is not just insane, it’s an exhibition in self-flagellation.
And on bank nationalization, no one in Washington has the skills to run the banking system – we only need to look at Fannie and Freddie for evidence of that, or most other government programs for that matter. Nationalization is not an option, such a decision would be ruinous. What needs to be done is elimination of pro-cyclical accounting standards. This will stop the bleeding and buy time for private money to eventually flow in.
This is not a bankrupt society, even if a bevy of government action is doing its best to make it so. Corporate America is as streamlined as ever and flush with cash. On the consumer side, the vast majority of people are not broke, let’s not act like the situation is reversed.
The private sector is the savior here, we mustn’t forget that. Nor should we forget that it has been mistaken Fed policy (keeping real rates negative for two years) and a regulatory regime that put in place mark-to-market that has done the most damage. This country has built a level of prosperity the world had never seen, and done so in a very short time from a historical perspective – it hasn’t been accomplished by regulating the hell out of private industry.
Crude-Oil
Oil futures continue to plunge as the spot price closed in on $30 per barrel yesterday morning. Just two weeks ago crude looked ready to move past $50, but had tumbled in the last 10 sessions as global economic concerns crush demand expectations. The price on the February contract rose mid-day (after falling to $33 early morning) as traders covered their short positions or be forced to take delivery of product as the contract expired yesterday.
Crude is higher today as the market is in contango, meaning subsequent-month contracts trade higher. At this rate, however, it should come down to the mid-$30s within a couple of days.
While oil and stocks trade in tandem for now (yesterday notwithstanding due to the contract expiration) this makes the decline tough to deal it. However, a huge benefit to consumers has resulted
Real incomes have received a large boost over the past six months, something in the neighborhood of $300 billion. This will not be enough to completely offset the deterioration in labor-market conditions, certainly this event is weighing on confidence along with the rout in stock prices, but it is helping consumers rebuild cash savings – something they have been focused on as their two main savings vehicles (stocks and homes) fall in value. The sooner cash savings are rebuilt, the sooner consumer activity can engage in a rebound.
That said, for now the economic picture continues to get worse. However, with production horrendously weak, inventories are being drawn down in a manner that will set the stage for a rebound in output – but we must get past this period of full blown pessimism and caution first. Once we do the combination of a small boost in consumer activity along with higher business spending and production should drive GDP higher two quarters down the road. But we’re also at the whim of government, so gauging things is even more difficult than usual.
Futures Higher
IBM and United Technologies – both Dow components – have posted some decent results since the close of trading yesterday, this is helping to boost stock-index futures. However, the relatively good results were a function of cost cutting, fourth-quarter revenue declined for both firms.
But this is what economic downturns do, they force the strong to become more efficient and weed out the weak, setting the stage for a stronger business cycle upswing. Government meddling will curtail the next expansion – all they need to concentrate on is removing toxic assets from bank balance sheets and eliminating mark-to-market to replace it with cash-flow accounting. If they engaged in nothing more from this point, we could really be onto something six months out. That’s a big if.
Have a great day!
Brent Vondera, Senior Analyst
The decline on Tuesday added to the market’s worst week (last week) since November and has lopped off two-thirds of the late-November/December rally that shot the NYSE Composite 28% from the November 20 low – we’re now just 8.75% above that mark. Talk of nationalizing banks, while this would be a last resort, is also causing major concern.
Financials led the broad-market’s decline after the largest money manager for institutions – State Street Corp. – announced unrealized bond losses nearly doubled last quarter; the stock tumbled 59%.
Telecoms, utilities and consumer staples were relative winners; none of the 10 major industry groups were positive, as the chart below shows.
Decliners trounced advancers by a 17-to-1 margin on average volume.
Market Activity for January 20, 2009
Mark-to-Disaster
We made mention yesterday of how the Treasury’s decision to guarantee, or backstop, loans at Citigroup and Bank of America was smart by half. If they’re going to do something, they need to remove these assets from balance sheets. The idea of backstopping increases the odds that institutions with this guarantee in place may now dump this trouble at even lower prices, which reverberates throughout the sector. It appears there was significant deterioration in asset-backed securities in December even as some of the credit indicators managed to improve a bit.
It’s important to mention, State Street said none of these securities that are taking write-downs are in default, but that doesn’t matter with mark-to-market; this is why it’s so damaging. My fear is as we continue to watch this insane accounting standard wrought its destruction, it will continue to lead to additional government decisions that bring their own consequences. We’re trying nine-gazillion things (in typical government Rube Goldberg machine fashion) with all of the unintended consequences that result when we could have simply ended an accounting standard that was just put in place a mere14 months ago. This is not just insane, it’s an exhibition in self-flagellation.
And on bank nationalization, no one in Washington has the skills to run the banking system – we only need to look at Fannie and Freddie for evidence of that, or most other government programs for that matter. Nationalization is not an option, such a decision would be ruinous. What needs to be done is elimination of pro-cyclical accounting standards. This will stop the bleeding and buy time for private money to eventually flow in.
This is not a bankrupt society, even if a bevy of government action is doing its best to make it so. Corporate America is as streamlined as ever and flush with cash. On the consumer side, the vast majority of people are not broke, let’s not act like the situation is reversed.
The private sector is the savior here, we mustn’t forget that. Nor should we forget that it has been mistaken Fed policy (keeping real rates negative for two years) and a regulatory regime that put in place mark-to-market that has done the most damage. This country has built a level of prosperity the world had never seen, and done so in a very short time from a historical perspective – it hasn’t been accomplished by regulating the hell out of private industry.
Crude-Oil
Oil futures continue to plunge as the spot price closed in on $30 per barrel yesterday morning. Just two weeks ago crude looked ready to move past $50, but had tumbled in the last 10 sessions as global economic concerns crush demand expectations. The price on the February contract rose mid-day (after falling to $33 early morning) as traders covered their short positions or be forced to take delivery of product as the contract expired yesterday.
Crude is higher today as the market is in contango, meaning subsequent-month contracts trade higher. At this rate, however, it should come down to the mid-$30s within a couple of days.
While oil and stocks trade in tandem for now (yesterday notwithstanding due to the contract expiration) this makes the decline tough to deal it. However, a huge benefit to consumers has resulted
Real incomes have received a large boost over the past six months, something in the neighborhood of $300 billion. This will not be enough to completely offset the deterioration in labor-market conditions, certainly this event is weighing on confidence along with the rout in stock prices, but it is helping consumers rebuild cash savings – something they have been focused on as their two main savings vehicles (stocks and homes) fall in value. The sooner cash savings are rebuilt, the sooner consumer activity can engage in a rebound.
That said, for now the economic picture continues to get worse. However, with production horrendously weak, inventories are being drawn down in a manner that will set the stage for a rebound in output – but we must get past this period of full blown pessimism and caution first. Once we do the combination of a small boost in consumer activity along with higher business spending and production should drive GDP higher two quarters down the road. But we’re also at the whim of government, so gauging things is even more difficult than usual.
Futures Higher
IBM and United Technologies – both Dow components – have posted some decent results since the close of trading yesterday, this is helping to boost stock-index futures. However, the relatively good results were a function of cost cutting, fourth-quarter revenue declined for both firms.
But this is what economic downturns do, they force the strong to become more efficient and weed out the weak, setting the stage for a stronger business cycle upswing. Government meddling will curtail the next expansion – all they need to concentrate on is removing toxic assets from bank balance sheets and eliminating mark-to-market to replace it with cash-flow accounting. If they engaged in nothing more from this point, we could really be onto something six months out. That’s a big if.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries traded wildly today as the curve steepened 7 basis points to +166 basis points. The 2-year ended the day yielding .705% and the 10-year sold off three-quarters of a point to yield 2.38%. The 30-year, traded as low as 127.5 around 8:30 a.m., before rallying back to 130. This volatility in the Treasury market depicts investor’s true uncertainty towards risk
Mortgages
Mortgages underperformed Treasuries today, with 30-year MBS widening out about 6 basis points to the benchmark curve.
The story with mortgages continues to be the same. Reports of banks beginning to see activity in the refi market is most likely contributing to the underperformance of mortgages. Very few in the market are anticipating a refi boom like that of 2003, but even if we see just a small fraction of that activity, mortgages will behave very differently in 2009.
Fannie and Freddie
Herbert Allison, the CEO of Fannie Mae, was quoted in this morning’s Wall Street Journal as saying, "We're not out to maximize profits… We want to promote responsible homeownership.” These are dangerous words coming from the Chief Executive of a publically traded company. A sign that full nationalization doesn’t seem too far off.
The new surcharges introduced by Fannie and Freddie in 2008 in order to cushion losses taken on non-conforming loans they purchased have now been retracted, in favor of further subsidizing home ownership through artificially lower costs.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Mortgages
Mortgages underperformed Treasuries today, with 30-year MBS widening out about 6 basis points to the benchmark curve.
The story with mortgages continues to be the same. Reports of banks beginning to see activity in the refi market is most likely contributing to the underperformance of mortgages. Very few in the market are anticipating a refi boom like that of 2003, but even if we see just a small fraction of that activity, mortgages will behave very differently in 2009.
Fannie and Freddie
Herbert Allison, the CEO of Fannie Mae, was quoted in this morning’s Wall Street Journal as saying, "We're not out to maximize profits… We want to promote responsible homeownership.” These are dangerous words coming from the Chief Executive of a publically traded company. A sign that full nationalization doesn’t seem too far off.
The new surcharges introduced by Fannie and Freddie in 2008 in order to cushion losses taken on non-conforming loans they purchased have now been retracted, in favor of further subsidizing home ownership through artificially lower costs.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Tuesday, January 20, 2009
Afternoon Review
Johnson & Johnson (JNJ) -1.20%
JNJ topped earnings estimates for the fourth quarter, but their revenues and outlook for 2009 were below expectations.
The economic recession, unfavorable currency exchange rates and generic drug competition hurt fourth quarter revenue and factored into the 2009 outlook, which left open the possibility of a decline from 2008 earnings.
The sales decline was led by a drop of 11.1 percent for prescription drugs, in which cheaper copycat pills displaced Risperdal (its top-selling antipsychotic) and Topamax (migraine pill). Also hurting the U.S. pharmaceuticals market was increasing layoffs that left more people without drug-benefit plans.
JNJ noted that consumers and patients are becoming more frugal. Hospitals are chopping purchases and JNJ has seen sales slow on products ranging from contact lenses to diabetes test strips.
The company’s diversified business model has served it well in comparison to rivals more concentrated in the pharmaceutical industry, and the company will exploit cheap market valuations to make acquisitions. CEO William Weldon identified two areas where JNJ are more likely to be acquisitive: health information-technology companies and companies that specialize in wellness and disease prevention.
JNJ’s strength lies in innovation and diversification. JNJ’s strength across diverse health care niches should offset head winds in pharmaceuticals.
Bank of America (BAC) -28.97%, J.P. Morgan Chase (JPM) -20.73%
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks rallied in the afternoon session on Friday to erase what was a 1.6% decline just before lunch. A very weak industrial production report, which followed an outsized decline for November, was said to have driven stocks lower in the morning session.
We don’t agree with that assessment as the production data, even as it was worse than expected, is hardly a surprise after all other data sets have clearly shown a shutdown occurred last quarter. Rather, the market doesn’t know what to do as investors are attempting to gauge government action instead of focusing on fundamentals. The government is capricious, and thus trading will continue to exhibit quick fluctuations as well.
It was talk that the FDIC and Treasury are going back to the future, as we’ll touch on below, by removing troubled assets from banks’ balance sheets that got things rolling in the back-half of trading.
Market Activity for January 16, 2009
Advancers ended up beating decliners by a two-to-one margin on the NYSE. Roughly 1.5 billion shares were traded, in line with the three-month daily average.
Original TARP Redux
Absent a tax rate response focused to bring in bids for toxic assets and an elimination of pernicious mark-to-market accounting standards, we were proponents of the original intent of the TARP – buying up troubled assets, RTC-style, and holding them until the housing market and investors’ willingness to take risk return to somewhat normal behavior.
Engaging in such action removes assets that are causing the mayhem from bank balance sheets and provides a return to the Treasury as the vast majority of these assets have a higher intrinsic value than the depressed market prices currently assigned to these positions. In a way the latest Citigroup and Bank of America rescues, which include the government backstopping troubled assets, are close to the original TARP proposal -- but not enough; it was smart by half.. These assets must be removed in a way similar to what was done during the S&L crisis of the late-1980s/early-1990s.
Now, Treasury Secretary Paulson and FDIC Chairman Bair have come up with what they are calling an “aggregator bank” to buy and house these assets based on the aforementioned purpose.
Well darn, wish they would have begun this process last year instead of ditching it for lack of timeliness in favor of cash injections – a strategy that has not helped as banks hoard the cash in this highly uncertain environment. All we did was waste time
Hopefully, since our most desired way to attack this problem doesn’t have a chance with Congress, they get to it and begin the RTC model; it might actually work.
In the meantime, mark-to-market accounting requires that institutions continue to write-down assets (even those in which institutions had no prior intention of selling), which means the endless circle of cash injections continues. And expect it to get worse. Since Citigroup and Bank of America have government backstops on troubled assets, they’ll unload these positions at horribly low prices, which forces the rest of the industry to mark assets even lower – far below intrinsic values. While this means we’re getting closer to the problem running its course, it also means mark-to-disaster accounting wreaks even more harm.
Economic Data
The Labor Department reported the headline consumer price index (CPI) for December fell 0.7% (-0.9% was expected), marking the third-straight month of decline. The year-over-year (YOY) rate rose 0.1% for December (a decline was expected, which would have marked the first YOY decline in CPI since August 1955).
The decline in the month-over-month reading was largely due to the plunge in energy prices (as we’ve talked about via the other inflation gauges). When you remove just the energy component, CPI was flat last month and up 2.4% year-over-year.
The core rate, which excludes food and energy items, came in flat last month (a decline of 0.2% was expected) and was up 1.8% on a year-over-year basis.
In a separate report, the Commerce Department announced industrial production slid 2.0% last month (double the expectation) -- a huge move, which follows a statistically large 1.3% decline for November.
Consumer goods production fell 1.7%, construction-supply production declined 3.4% (down 32.6% at an annual rate last three months) and computer and office equipment output fell 3.8% (also down more than 30% at an annual rate last quarter). Business equipment did rise (largely machinery and electrical equipment) for the second straight month. Let’s hope a trend has begun.
This decline in overall industrial production marks the fourth monthly drop in the past five and all of those four negative readings were large. That said, the August and September declines (represented by the sharp negative move on the chart above) were a result of Gulf-coast hurricane activity (back-to-back storms) and the Boeing machinist strike. So, the true weakness within this figure began to take hold in November as it occurred without an exogenous event.
For the quarter, manufactured output fell hard, down 13.8% at an annual rate. This is in volume, so it takes out the price-related declines within other data. This is yet another indication the Q4 GDP reading will be the worst since the 1981-82 recession.
On the bright side, the bounce in business equipment may be signaling there’s some life out there. We know the vast majority of businesses have the resources, it is a high level of caution we need to conquer, which is why we’ve spent so much time talking about a tax-rate response to the current woes – nothing can kick start stocks, economic activity and confidence like bold across-the-board tax-rate reductions.
Don’t think we can move rates lower? I think we can reduce capital gains and dividend tax rates to single-digits, move the corporate tax below 30% and do a lot of good by reducing six federal income tax brackets down to two and making sure the top rate does not exceed 25%. Let’s not pretend these changes are static; there is a huge economic boost that results, and as the tax base and entrepreneurial spirits explode, flows to the Treasury will follow.)
Morning Activity
U.S. stock-index futures are lower this morning, showing the affect of overseas financial woes that sent international bourses lower yesterday. But today is Inauguration Day, so maybe some optimism will follow as incoming President Obama will give an uplifting address and get right to work.
We need good policy and we need it fast. An RTC-type response to troubled assets will do a lot of good, but my fear is neglecting (actually abusing) the private sector will only cause Atlas to shrug. That cannot be allowed to occur.
Capital is already on strike; innovators, the providers of seed capital and the engines of production must be incentivized by higher after-tax returns. In terms of infrastructure programs, it must be focused on productive sources such as rebuilding the energy grid, enhancing broadband, improving air-traffic control and restoring vital defense equipment after several years of wear and tear. The current stimulus package appears to be tilted toward entitlement programs; this will not do.
Have a great day!
Brent Vondera, Senior Analyst
We don’t agree with that assessment as the production data, even as it was worse than expected, is hardly a surprise after all other data sets have clearly shown a shutdown occurred last quarter. Rather, the market doesn’t know what to do as investors are attempting to gauge government action instead of focusing on fundamentals. The government is capricious, and thus trading will continue to exhibit quick fluctuations as well.
It was talk that the FDIC and Treasury are going back to the future, as we’ll touch on below, by removing troubled assets from banks’ balance sheets that got things rolling in the back-half of trading.
Market Activity for January 16, 2009
Advancers ended up beating decliners by a two-to-one margin on the NYSE. Roughly 1.5 billion shares were traded, in line with the three-month daily average.
Original TARP Redux
Absent a tax rate response focused to bring in bids for toxic assets and an elimination of pernicious mark-to-market accounting standards, we were proponents of the original intent of the TARP – buying up troubled assets, RTC-style, and holding them until the housing market and investors’ willingness to take risk return to somewhat normal behavior.
Engaging in such action removes assets that are causing the mayhem from bank balance sheets and provides a return to the Treasury as the vast majority of these assets have a higher intrinsic value than the depressed market prices currently assigned to these positions. In a way the latest Citigroup and Bank of America rescues, which include the government backstopping troubled assets, are close to the original TARP proposal -- but not enough; it was smart by half.. These assets must be removed in a way similar to what was done during the S&L crisis of the late-1980s/early-1990s.
Now, Treasury Secretary Paulson and FDIC Chairman Bair have come up with what they are calling an “aggregator bank” to buy and house these assets based on the aforementioned purpose.
Well darn, wish they would have begun this process last year instead of ditching it for lack of timeliness in favor of cash injections – a strategy that has not helped as banks hoard the cash in this highly uncertain environment. All we did was waste time
Hopefully, since our most desired way to attack this problem doesn’t have a chance with Congress, they get to it and begin the RTC model; it might actually work.
In the meantime, mark-to-market accounting requires that institutions continue to write-down assets (even those in which institutions had no prior intention of selling), which means the endless circle of cash injections continues. And expect it to get worse. Since Citigroup and Bank of America have government backstops on troubled assets, they’ll unload these positions at horribly low prices, which forces the rest of the industry to mark assets even lower – far below intrinsic values. While this means we’re getting closer to the problem running its course, it also means mark-to-disaster accounting wreaks even more harm.
Economic Data
The Labor Department reported the headline consumer price index (CPI) for December fell 0.7% (-0.9% was expected), marking the third-straight month of decline. The year-over-year (YOY) rate rose 0.1% for December (a decline was expected, which would have marked the first YOY decline in CPI since August 1955).
The decline in the month-over-month reading was largely due to the plunge in energy prices (as we’ve talked about via the other inflation gauges). When you remove just the energy component, CPI was flat last month and up 2.4% year-over-year.
The core rate, which excludes food and energy items, came in flat last month (a decline of 0.2% was expected) and was up 1.8% on a year-over-year basis.
In a separate report, the Commerce Department announced industrial production slid 2.0% last month (double the expectation) -- a huge move, which follows a statistically large 1.3% decline for November.
Consumer goods production fell 1.7%, construction-supply production declined 3.4% (down 32.6% at an annual rate last three months) and computer and office equipment output fell 3.8% (also down more than 30% at an annual rate last quarter). Business equipment did rise (largely machinery and electrical equipment) for the second straight month. Let’s hope a trend has begun.
This decline in overall industrial production marks the fourth monthly drop in the past five and all of those four negative readings were large. That said, the August and September declines (represented by the sharp negative move on the chart above) were a result of Gulf-coast hurricane activity (back-to-back storms) and the Boeing machinist strike. So, the true weakness within this figure began to take hold in November as it occurred without an exogenous event.
For the quarter, manufactured output fell hard, down 13.8% at an annual rate. This is in volume, so it takes out the price-related declines within other data. This is yet another indication the Q4 GDP reading will be the worst since the 1981-82 recession.
On the bright side, the bounce in business equipment may be signaling there’s some life out there. We know the vast majority of businesses have the resources, it is a high level of caution we need to conquer, which is why we’ve spent so much time talking about a tax-rate response to the current woes – nothing can kick start stocks, economic activity and confidence like bold across-the-board tax-rate reductions.
Don’t think we can move rates lower? I think we can reduce capital gains and dividend tax rates to single-digits, move the corporate tax below 30% and do a lot of good by reducing six federal income tax brackets down to two and making sure the top rate does not exceed 25%. Let’s not pretend these changes are static; there is a huge economic boost that results, and as the tax base and entrepreneurial spirits explode, flows to the Treasury will follow.)
Morning Activity
U.S. stock-index futures are lower this morning, showing the affect of overseas financial woes that sent international bourses lower yesterday. But today is Inauguration Day, so maybe some optimism will follow as incoming President Obama will give an uplifting address and get right to work.
We need good policy and we need it fast. An RTC-type response to troubled assets will do a lot of good, but my fear is neglecting (actually abusing) the private sector will only cause Atlas to shrug. That cannot be allowed to occur.
Capital is already on strike; innovators, the providers of seed capital and the engines of production must be incentivized by higher after-tax returns. In terms of infrastructure programs, it must be focused on productive sources such as rebuilding the energy grid, enhancing broadband, improving air-traffic control and restoring vital defense equipment after several years of wear and tear. The current stimulus package appears to be tilted toward entitlement programs; this will not do.
Have a great day!
Brent Vondera, Senior Analyst
Friday, January 16, 2009
Afternoon Review
Bank of America (BAC) -13.70%
In advance of their scheduled earnings release date, Bank of America reported terrible fourth quarter results and received an additional $20 billion from the U.S. government under the TARP. The government will receive preferred stock carrying an eight percent dividend rate and has agreed to a loss sharing program on $118 billion in selected capital. Under the agreement, Bank of America would cover the first $10 billion in losses and the government would cover 90 percent of any subsequent losses.
Revenues rose 22.5 percent year-over-year to $15.68 billion, but were well short of the $20.72 billion consensus. Credit costs were steep for BAC at $8.54 billion, which includes boosting its reserves by $3 billion – nearly double estimates as the consumer credit environment continues to deteriorate. Bank of America ended 2008 with a Tier 1 capital ratio of 9.15 percent.
Bank of America said that fourth quarter results were driven by escalating credit costs, including additions to reserves, and significant write-downs and trading losses in the capital markets businesses.
In light of continuing severe economic and financial market conditions, Bank of America slashed its dividend to $0.01 per share from $0.32 per share.
Intel (INTC) +3.39%
The cyclical slowdown in business conditions in the chip sector clearly weighed on Intel’s results in the quarter. Volume was significantly lower as the health of the computer industry has been deteriorating with cutbacks in spending from consumers and corporations.
Sales of Intel’s Atom chips, which are targeted at the rapidly emerging netbook segment of the PC market, grew 50% sequentially, to $300 million. The growth in sales of Atom chips directly affected Intel’s profitability, as the gross margin came in at 53.1 percent versus 58.9 percent in the third quarter.
There is a lot of concern that the Atom processor may cannibalize demand for Intel’s mainstream processor products, which are more profitable for the company, as consumers opt for low-cost netbooks over notebooks and desktops in the PC market. However, these fears are overblown since netbooks offer limited processing power and less functionality, and thus are not a viable substitute for PCs. This is not to talk down the importance of these chips to a huge new market for Intel, as the lower price points for netbooks and Atom processors allow the firm to sell chips to a significantly larger portion of the worldwide population that presently cannot afford mainstream computers.
Intel did not repurchase any shares during the quarter as the company focused on preserving cash in the current challenging environment. However, dividends remain untouched and management expects to continue using share buybacks as part of the company’s long-term capital structure strategy.
While a supply chain correction, inventories, utilization levels and slowdown in PC demand will dominate near-term concerns, the company remains well positioned structurally to benefit from:
- Accelerating PC growth especially in emerging markets;
- Market share gains in entry level PCs (Atom) and high-end servers (Nehalem);
- Higher margin 32 nm products in 2010; and
- Manufacturing, cost and competitive advantages over competition.
Johnson Controls (JCI) -5.04%
Johnson Controls reported disappointing results for its first fiscal quarter and issued an outlook that expects the trouble to continue. The loss was $1.02 a share for its first quarter ended in December, but the company said its first quarter is typically the weakest and generates the smallest portion of annual earnings.
Johnson Controls, with about 58 percent of revenue from automotive products in the quarter, booked fewer orders as automakers cut output in North America, Europe and Asia to cope with a worldwide recession. Softness in the global construction markets reduced sales for the supplier’s building division, which makes heating and cooling equipment and contributed 42 percent of sales.
Johnson Controls is working to close 21 plants this year to counter global auto production cuts that include a 23 percent reduction in North America in the final three months of 2008.
Johnson Controls said its first quarter is typically the weakest and generates the smallest portion of annual earnings.
Quick Hits
Peter Lazaroff, Junior Analyst
Fixed Income Recap
The curve has flattened 17 basis points this week to 147 basis points from 164 at the close of business last Friday. The 2-year was mostly unchanged on the day to yield .715% and the 10-year rallied slightly to yield 2.19%.
Mortgages
Mortgages continue to be volatile during this period of Fed induced liquidity. The 10 year Treasury has rallied while mortgages have sold off. This inverse movement has resulted in yields on mortgages being 20 basis points wider on the week.
The New York Fed announced today that it bought $23.4 billion in mortgages during the period from January 8 to January 14. Considering that the Fed plans on buying $500 billion before the end of June, this is closer to the expected average than the $10.2 billion reported last period.
Treasuries
The main concern with Treasuries deals with the possibility of the Fed buying them in order to push yields lower. Current Fed-speak is leading the market to think that they will likely exhaust other options before accelerating their buying of Treasuries in the open market, but uncertainty remains. They appear to be content with waiting to see how the current programs, (i.e. commercial paper, Freddie and Fannie debentures and MBS), may help lower rates.
Friday is a half day in the bond market.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Mortgages
Mortgages continue to be volatile during this period of Fed induced liquidity. The 10 year Treasury has rallied while mortgages have sold off. This inverse movement has resulted in yields on mortgages being 20 basis points wider on the week.
The New York Fed announced today that it bought $23.4 billion in mortgages during the period from January 8 to January 14. Considering that the Fed plans on buying $500 billion before the end of June, this is closer to the expected average than the $10.2 billion reported last period.
Treasuries
The main concern with Treasuries deals with the possibility of the Fed buying them in order to push yields lower. Current Fed-speak is leading the market to think that they will likely exhaust other options before accelerating their buying of Treasuries in the open market, but uncertainty remains. They appear to be content with waiting to see how the current programs, (i.e. commercial paper, Freddie and Fannie debentures and MBS), may help lower rates.
Friday is a half day in the bond market.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Daily Insight
U.S. stocks endeavored upon a wild ride yesterdsay, reminiscent of the volatility that took hold back in October and November, as uncertainty over government action can only cause investor sentiment to waver. There is less to go on these days from a fundamental perspective; it is all about the whims of Washington right now – making it virtually impossible to value assets.
Stocks began the session lower and the selling accelerated to round out the morning session, but an afternoon rally allowed the broad market to close slightly to the upside. The tech-laden NASDAQ Composite posted a more meaningful gain.
The main news of the day was that Bank of America is seeking more TARP funds and loan guarantees, specifically related to the Merrill Lynch acquisition since its is those assets that are taking the brunt of the write-downs.
On a larger scale, there was a general concern that certain banks could be nationalized. This, of course, would be highly unlikely as the entire system could not be nationalized, and if the government took control of just a few of the big names, then it would basically wreck the rest of the industry as you’d have runs on banks as individuals and small businesses shifted deposits to the government entities. But when people begin to raise the subject, it just adds one more uncertainty into the mix. So this is part of what was going on yesterday to cause a wide swing between peak and trough.
By the back-half of the session, as the chart illustrates, it became clear the likely action would take place – the government would assist BofA by using a Citigroup-type takeover – and stocks rallied. The fact that this needs to be done is not good, but it’s by far better than some of the alternatives.
Market Activity for January 15, 2009
The government will give BofA $20 billion in TARP funds – in exchange for preferred shares yielding 8% -- and guarantee $118 billion of assets. The bank will cut their common dividend to a penny per share.
So, we continue to count the number of times the government will offer assistance (remember though these are investments, so from a taxpayer perspective there will be a return here) to the same institutions. Say what you want about BofA’s purchase of Merrill – yes, they should have demanded Merrill enter receivership before taking them over, which would have cleansed the investment bank of troubled assets. That notwithstanding, until mark-to-market accounting is eliminated the risk remains that these institutions will need assistance again. This accounting rule, put in place little more than a year ago, makes stability impossible whether assets prices are moving up or down. Banish it!
Crude-Oil
Crude price tumbled another 5% yesterday to close the session at $35.64. This is great news for consumers as real incomes are boosted by the continued move lower. However, everyday crude decline it also illustrates the market’s view that global economic activity is in trouble, and based on what we see in the trade figures that’s a reality.
Jobless Claims
The Labor Department reported initial jobless claims rose 54,000 to 524,000 for the week ended January 10. A 36,000 increase was expected.
This followed two weeks in which claims fell below the 500k mark, which seemed to be due to a number of factors – seasonal adjustments, winter weather that closed unemployment offices and several states that saw their electronic filing systems crash. The Labor Department called last week a “straight forward” week, referring to the inadequate seasonal adjustments to the holiday shortened weeks of the prior two readings, and therefore that those declines in unemployment claims could not be trusted.
Still, we had all but hit the 600k mark in the week prior to Christmas as claims touched 589K, so the fact that we’re in the low 500k handle may be some sort of silver lining.
The hardest hit state was New York, reporting 24,000 initial claims – this illustrates the retail and financial sectors are currently driving job losses.
The four-week average of initial claims, a less volatile measure, fell for the third-straight week to settle in at 518,500.
Continuing Claims, those accepting jobless benefits for more than a week, fell 115,000 from a 26-year high to come in at 4.497 million in the week ended January 2. The insured unemployment rate (the jobless rate for people eligible for benefits) – which tends to track the overall unemployment rate – held at 3.4%. Both of these readings have a one week lag to the initial claims figure.
I’m going to assume the decline in continuing claims was due benefits expiring.
Next week’s claims data will be the most important of the month as it aligns with the employment survey week. The Labor Department will count those that are not employed next week (and were actually looking for a job) as unemployed for the month. Initial indications are that January will post another large job loss; the next jobless claims number will help to confirm or deny that.
Producer Price Index
In a separate report the Labor Department announced producer prices slid 1.9% in December and moved to negative territory on a year-over-year basis, coming in at -0.9% after a reading of +0.4% in November.
The index has been driven lower by declines in the price of energy, which has plunged from the spike we endured last summer – oil, gasoline and natural gas are all down roughly 65% from the July peak.
The PPI core rate (which excludes food and energy) actually accelerated in December, up 4.3% from the year ago period following the November reading of 4.2% -- and remains elevated.
This is why we continue to caution against the conventional wisdom that believes we’re in a deflationary cycle. We are not. It can always turn into one, but based on the data we’ve seen over the past few months and the huge degree to which the Fed has injected money into the system -- using both conventional and quantitative easing techniques – the chances of an inflationary event occurring several months down the road is much greater than prices continuing to spiral lower.
Empire Manufacturing
The NY Federal Reserve Bank’s index of factory activity within the region improved during December to post a reading of -22.2 after a downwardly revised -27.8 for November. A reading below zero represents a contraction in activity, so even though the survey improved, one can see things remain depressed. (The fact that a reading below zero marks contraction is intuitive, but we mention it because there are factory surveys, such as the ISM indexes, in which the line of demarcation is set at 50).
Stock Futures
Stock-index futures are up this morning on the heels of the BofA news and a statement out of Intel that profitability may rebound.
The House also unveiled the details of its stimulus package, and while we’re going to assume there will be a lot of senseless spending in the program higher current-year write-off allowances and bonus depreciation remained in the plan. This should boost business spending once things calm down. That is so long as firms do not hold off on spending plans for fear higher deficits give politicians an easier sell at raising tax rates and thus curtails economic growth. If firms do not feel a sustained rebound is likely, they will remain very cautious.
Have a great weekend!
Brent Vondera, Senior Analyst
Stocks began the session lower and the selling accelerated to round out the morning session, but an afternoon rally allowed the broad market to close slightly to the upside. The tech-laden NASDAQ Composite posted a more meaningful gain.
The main news of the day was that Bank of America is seeking more TARP funds and loan guarantees, specifically related to the Merrill Lynch acquisition since its is those assets that are taking the brunt of the write-downs.
On a larger scale, there was a general concern that certain banks could be nationalized. This, of course, would be highly unlikely as the entire system could not be nationalized, and if the government took control of just a few of the big names, then it would basically wreck the rest of the industry as you’d have runs on banks as individuals and small businesses shifted deposits to the government entities. But when people begin to raise the subject, it just adds one more uncertainty into the mix. So this is part of what was going on yesterday to cause a wide swing between peak and trough.
By the back-half of the session, as the chart illustrates, it became clear the likely action would take place – the government would assist BofA by using a Citigroup-type takeover – and stocks rallied. The fact that this needs to be done is not good, but it’s by far better than some of the alternatives.
Market Activity for January 15, 2009
The government will give BofA $20 billion in TARP funds – in exchange for preferred shares yielding 8% -- and guarantee $118 billion of assets. The bank will cut their common dividend to a penny per share.
So, we continue to count the number of times the government will offer assistance (remember though these are investments, so from a taxpayer perspective there will be a return here) to the same institutions. Say what you want about BofA’s purchase of Merrill – yes, they should have demanded Merrill enter receivership before taking them over, which would have cleansed the investment bank of troubled assets. That notwithstanding, until mark-to-market accounting is eliminated the risk remains that these institutions will need assistance again. This accounting rule, put in place little more than a year ago, makes stability impossible whether assets prices are moving up or down. Banish it!
Crude-Oil
Crude price tumbled another 5% yesterday to close the session at $35.64. This is great news for consumers as real incomes are boosted by the continued move lower. However, everyday crude decline it also illustrates the market’s view that global economic activity is in trouble, and based on what we see in the trade figures that’s a reality.
Jobless Claims
The Labor Department reported initial jobless claims rose 54,000 to 524,000 for the week ended January 10. A 36,000 increase was expected.
This followed two weeks in which claims fell below the 500k mark, which seemed to be due to a number of factors – seasonal adjustments, winter weather that closed unemployment offices and several states that saw their electronic filing systems crash. The Labor Department called last week a “straight forward” week, referring to the inadequate seasonal adjustments to the holiday shortened weeks of the prior two readings, and therefore that those declines in unemployment claims could not be trusted.
Still, we had all but hit the 600k mark in the week prior to Christmas as claims touched 589K, so the fact that we’re in the low 500k handle may be some sort of silver lining.
The hardest hit state was New York, reporting 24,000 initial claims – this illustrates the retail and financial sectors are currently driving job losses.
The four-week average of initial claims, a less volatile measure, fell for the third-straight week to settle in at 518,500.
Continuing Claims, those accepting jobless benefits for more than a week, fell 115,000 from a 26-year high to come in at 4.497 million in the week ended January 2. The insured unemployment rate (the jobless rate for people eligible for benefits) – which tends to track the overall unemployment rate – held at 3.4%. Both of these readings have a one week lag to the initial claims figure.
I’m going to assume the decline in continuing claims was due benefits expiring.
Next week’s claims data will be the most important of the month as it aligns with the employment survey week. The Labor Department will count those that are not employed next week (and were actually looking for a job) as unemployed for the month. Initial indications are that January will post another large job loss; the next jobless claims number will help to confirm or deny that.
Producer Price Index
In a separate report the Labor Department announced producer prices slid 1.9% in December and moved to negative territory on a year-over-year basis, coming in at -0.9% after a reading of +0.4% in November.
The index has been driven lower by declines in the price of energy, which has plunged from the spike we endured last summer – oil, gasoline and natural gas are all down roughly 65% from the July peak.
The PPI core rate (which excludes food and energy) actually accelerated in December, up 4.3% from the year ago period following the November reading of 4.2% -- and remains elevated.
This is why we continue to caution against the conventional wisdom that believes we’re in a deflationary cycle. We are not. It can always turn into one, but based on the data we’ve seen over the past few months and the huge degree to which the Fed has injected money into the system -- using both conventional and quantitative easing techniques – the chances of an inflationary event occurring several months down the road is much greater than prices continuing to spiral lower.
Empire Manufacturing
The NY Federal Reserve Bank’s index of factory activity within the region improved during December to post a reading of -22.2 after a downwardly revised -27.8 for November. A reading below zero represents a contraction in activity, so even though the survey improved, one can see things remain depressed. (The fact that a reading below zero marks contraction is intuitive, but we mention it because there are factory surveys, such as the ISM indexes, in which the line of demarcation is set at 50).
Stock Futures
Stock-index futures are up this morning on the heels of the BofA news and a statement out of Intel that profitability may rebound.
The House also unveiled the details of its stimulus package, and while we’re going to assume there will be a lot of senseless spending in the program higher current-year write-off allowances and bonus depreciation remained in the plan. This should boost business spending once things calm down. That is so long as firms do not hold off on spending plans for fear higher deficits give politicians an easier sell at raising tax rates and thus curtails economic growth. If firms do not feel a sustained rebound is likely, they will remain very cautious.
Have a great weekend!
Brent Vondera, Senior Analyst
Thursday, January 15, 2009
Afternoon Review
J.P. Morgan Chase (JPM) -6.06%
JPM managed to squeak out positive fourth quarter earnings of seven cents a share after several one-time charges and gains, but CEO Jamie Dimon said the results were “very disappointing.” Without the gains, JPM lost 28 cents a share.
The addition of Washington Mutual was a definite positive for JPM’s fourth quarter, boosting income and resulting in one-time gains. JPM also indicated that deposits at WaMu were basically flat, which a huge positive since there was some concern that WaMu customers would move their assets in response to the bank’s failures. But the acquisition wasn’t all warm and fuzzy. In fact, the WaMu deal may end up costing JPMorgan billions down the line.
For the second consecutive quarter, JPM did not earn enough to cover its dividend payment, but the company does not appear to be concerned and remains committed to paying it. The company was able to strengthen their capital position, and their Tier 1 capital ratio now stands at 10.8 percent. Tier 1 capital is a metric of a bank’s ability to sustain future losses. Regulators consider a bank to be well-capitalized with a Tier 1 ratio of at least 6 percent.
Looking into 2009, Dimon said, “If the economic environment deteriorates further, which is a distinct possibility, it is reasonable to expect additional negative impact on our market-related business, continued higher loan losses and increases to our credit reserves.”
Bank of America (BAC) -18.43%
Bank of America was slaughtered on news that they are close to receiving billions more from the government to help it absorb Merrill Lynch. Reports indicated the arrangement might protect BAC from losses on Merrill’s bad assets. According to The Wall Street Journal, BAC told the government in mid-December that it was unlikely to complete its purchase because of Merrill’s larger-than-expected losses in the fourth quarter.
It looks like Bank of America may have bit off more than it can chew. In Bank of America’s defense, they had very little time to look over Merrill’s books before their shotgun wedding, and other banks received government aid for rescuing failing banks – JPMorgan had assistance from the government in its purchase of Bear Sterns as did Citigroup in their attempt to buy Wachovia. So why shouldn’t Bank of America get some help as well? It is unlikely that the government would allow such a big bank to fail, but the future for these banks is anyone’s guess when the government is controlling the financial markets.
Full-disclosure of the arrangement will be given with company’s earnings report next Tuesday. Regardless of the government’s potential involvement, Bank of America is expected to cut their dividend to at least two-thirds of the current payout.
Intel (INTC) +1.61%
Intel reported a fourth quarter profit decline of 90 percent after the markets closed. The recession curbed demand and forced the company to write down the value of its investments. Intel’s earnings call should provide some good insight into the technology sector and I will address the comments tomorrow.
Quick Hits
- FDIC’s Bair Says She’d Be ‘Very Surprised by U.S. Bank Nationalization
- I highly recommend this financial bailout game (make sure sound is on)
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks slid to a six-week low after a dismal retail sales report extended the record of monthly declines in consumer activity to a sixth month.
Nearly half of the decline in overall retail sales during December was due to a 16% decline in gas station receipts (largely price-related) but that didn’t do much to assuage investors’ concerns. Every component within the report showed a decline, even the eating, drinking component – an area heretofore that had been upbeat during this period of substantial consumer weakness.
The broad market has now given back half of the rally that drove the S&P 500 24% above the multi-year low hit on November 20. So much for the so-called January Effect and the supposed euphoria over the much talked about stimulus proposal.
Decliners whipped advancers by nine-to-one margin on the NYSE Composite; volume was somewhat light with 1.3 billion shares traded.
Market Activity for January 14, 2009
We did talk about an expected pullback in the January 5 letter as predictions that the S&P 500 was going hit pre-Lehman collapse levels (1250 on that index) hit a crescendo. There was just too much data we had to get through. Besides, the market was destined to take a breather after the December run.
We’ll be stuck in a trading range for some while (wish I could define that in actual time), based on what is currently known. However, we do have a decent potential of hitting 1050 on the S&P 500 – that would get us to a market multiple of 22 times what we see as trough earnings on the index.
Such a multiple is at the low-end for a trough earnings P/E, but one should not expect a mid or high range level based on the challenges we face now that the government is so involved and both economic and geopolitical risks abound.
I suppose it will take a hugely positive financial sector event to free us of this range-bound scenario, or a bold tax-rate strategy – yes, I’ll keep dreaming.
In the meantime, we’ll count the number of times the same financial institutions must be rescued before regulators decide to eliminate mark-to-market accounting standards. It was an enormous mistake to implement this accounting rule in November 2007; it has greatly exacerbated the current situation.
Mortgage Applications
The Mortgage Bankers Association reported mortgage applications jumped 15.8% in the week ended January 9 as the 15-year fixed mortgage rates fell to 4.63% and the 30-year fell to a record low of 4.89%.
Refinancing activity drove the index higher as this segment jumped 25.6% last week. Unfortunately, home purchasing activity didn’t follow the trend, falling 14.1% -- ending three weeks of increase.
A wave of refinancing will help to put more money in consumers’ pockets, which appears to be very much needed as we’ll discuss another ugly retail sales report below. However, we need purchases to make a comeback in order to boost investor sentiment. Lower mortgages rates will undoubtedly help, but the tough labor market conditions will delay a sustained rebound in home sales.
Retail Sales (December)
U.S. retail sales fell twice has hard as expected in December as job losses combined with a desire among consumers to boost cash savings (as their two primary savings vehicles, homes and stocks, decline) to crush activity.
Overall sales fell 2.7% in December, which follows a downwardly revised 2.1% decline in November – originally reported as a 1.8% decline. This marks the sixth month of decline for overall retail sales, which has not been seen since these records began in 1992. Prior to this stretch of weakness, the previous record was two months of decline.
Excluding auto, retail sales fell 3.1%, which follows a 2.5% drop in November and a 2.9% in October.
Falling prices are certainly playing a role here, especially with regard to pump prices (gasoline station sales were down 15.9% in December, some of which was price-related). However, the weakness was broad-based with every major category posting a decline.
Over the past three months, retail sales have collapsed, plummeting 28.35% at an annual pace. While gasoline sales account for much of this decline (gas station receipts plunged 87.3% three-months annualized) retail sales ex gasoline is still down 13.9% at an annual rate for the quarter.
Sales less autos, gasoline and building materials – the figure that flows directly into the personal consumption component of GDP – fell 1.4% in November and is down a massive 8.8% for the fourth quarter. A GDP reading of as least -5.5% (that’s at a real annual rate) seems assured based on this rate of decline.
Import Prices
The Labor Department announced import prices posted another big decline, down 4.2% for the month and 9.3% over the past 12 months.
The sharp decline in this data has been driven by petroleum-price activity; this component of the report fell 21.4% in December and 47% for the past year. This is a massive shift as the component was up 47% on a year-over-year basis as recently as September.
Excluding petro, import prices fell 1.1% in December and are up 0.9% year-over-year.
While the Fed seems confident, based on the latest meeting’s notes, that inflation will remain tame, we do not agree. Some even fear a sustained deflationary event. If this were the case all components of the data would be showing large negative readings, which is not the case – instead it is petroleum prices coming off of the spike that occurred last summer that is causing the large negative reading for the overall inflation gauges.
Once banks begin to push Fed cash injection into the economy via increased lending activity (whenever that may be) this will combine with a fiscal stimulus that will reach $1 trillion ($500 billion in the first year of implementation) to drive commodity prices higher and thus overall rates of inflation. While the Fed is focused on other things, if they do not confront this threat in its early stages, our expectation is we’ll then have a longer-term inflation problem to deal with. But that is down the road.
Have a great day!
Brent Vondera, Senior Analyst
Nearly half of the decline in overall retail sales during December was due to a 16% decline in gas station receipts (largely price-related) but that didn’t do much to assuage investors’ concerns. Every component within the report showed a decline, even the eating, drinking component – an area heretofore that had been upbeat during this period of substantial consumer weakness.
The broad market has now given back half of the rally that drove the S&P 500 24% above the multi-year low hit on November 20. So much for the so-called January Effect and the supposed euphoria over the much talked about stimulus proposal.
Decliners whipped advancers by nine-to-one margin on the NYSE Composite; volume was somewhat light with 1.3 billion shares traded.
Market Activity for January 14, 2009
We did talk about an expected pullback in the January 5 letter as predictions that the S&P 500 was going hit pre-Lehman collapse levels (1250 on that index) hit a crescendo. There was just too much data we had to get through. Besides, the market was destined to take a breather after the December run.
We’ll be stuck in a trading range for some while (wish I could define that in actual time), based on what is currently known. However, we do have a decent potential of hitting 1050 on the S&P 500 – that would get us to a market multiple of 22 times what we see as trough earnings on the index.
Such a multiple is at the low-end for a trough earnings P/E, but one should not expect a mid or high range level based on the challenges we face now that the government is so involved and both economic and geopolitical risks abound.
I suppose it will take a hugely positive financial sector event to free us of this range-bound scenario, or a bold tax-rate strategy – yes, I’ll keep dreaming.
In the meantime, we’ll count the number of times the same financial institutions must be rescued before regulators decide to eliminate mark-to-market accounting standards. It was an enormous mistake to implement this accounting rule in November 2007; it has greatly exacerbated the current situation.
Mortgage Applications
The Mortgage Bankers Association reported mortgage applications jumped 15.8% in the week ended January 9 as the 15-year fixed mortgage rates fell to 4.63% and the 30-year fell to a record low of 4.89%.
Refinancing activity drove the index higher as this segment jumped 25.6% last week. Unfortunately, home purchasing activity didn’t follow the trend, falling 14.1% -- ending three weeks of increase.
A wave of refinancing will help to put more money in consumers’ pockets, which appears to be very much needed as we’ll discuss another ugly retail sales report below. However, we need purchases to make a comeback in order to boost investor sentiment. Lower mortgages rates will undoubtedly help, but the tough labor market conditions will delay a sustained rebound in home sales.
Retail Sales (December)
U.S. retail sales fell twice has hard as expected in December as job losses combined with a desire among consumers to boost cash savings (as their two primary savings vehicles, homes and stocks, decline) to crush activity.
Overall sales fell 2.7% in December, which follows a downwardly revised 2.1% decline in November – originally reported as a 1.8% decline. This marks the sixth month of decline for overall retail sales, which has not been seen since these records began in 1992. Prior to this stretch of weakness, the previous record was two months of decline.
Excluding auto, retail sales fell 3.1%, which follows a 2.5% drop in November and a 2.9% in October.
Falling prices are certainly playing a role here, especially with regard to pump prices (gasoline station sales were down 15.9% in December, some of which was price-related). However, the weakness was broad-based with every major category posting a decline.
Over the past three months, retail sales have collapsed, plummeting 28.35% at an annual pace. While gasoline sales account for much of this decline (gas station receipts plunged 87.3% three-months annualized) retail sales ex gasoline is still down 13.9% at an annual rate for the quarter.
Sales less autos, gasoline and building materials – the figure that flows directly into the personal consumption component of GDP – fell 1.4% in November and is down a massive 8.8% for the fourth quarter. A GDP reading of as least -5.5% (that’s at a real annual rate) seems assured based on this rate of decline.
Import Prices
The Labor Department announced import prices posted another big decline, down 4.2% for the month and 9.3% over the past 12 months.
The sharp decline in this data has been driven by petroleum-price activity; this component of the report fell 21.4% in December and 47% for the past year. This is a massive shift as the component was up 47% on a year-over-year basis as recently as September.
Excluding petro, import prices fell 1.1% in December and are up 0.9% year-over-year.
While the Fed seems confident, based on the latest meeting’s notes, that inflation will remain tame, we do not agree. Some even fear a sustained deflationary event. If this were the case all components of the data would be showing large negative readings, which is not the case – instead it is petroleum prices coming off of the spike that occurred last summer that is causing the large negative reading for the overall inflation gauges.
Once banks begin to push Fed cash injection into the economy via increased lending activity (whenever that may be) this will combine with a fiscal stimulus that will reach $1 trillion ($500 billion in the first year of implementation) to drive commodity prices higher and thus overall rates of inflation. While the Fed is focused on other things, if they do not confront this threat in its early stages, our expectation is we’ll then have a longer-term inflation problem to deal with. But that is down the road.
Have a great day!
Brent Vondera, Senior Analyst
Wednesday, January 14, 2009
Afternoon Review
Principal Financial Group (PFG) -11.31%
Principal moved lower amid concerns that losses on fixed-income investments will deplete capital. Life insurers are facing an increase in defaults on corporate bonds and commercial mortgages as the U.S. recession depends. The carriers cut jobs, asked regulators to ease reserve standards and applied for government aid in the fourth quarter to replenish their dwindling capital cushion.
The biggest risk, at this point, is a new wave of credit defaults that would undermine these companies’ capital adequacy.
Caterpillar (CAT) –4.95%
Caterpillar fell on speculation that the government stimulus spending plans may not give the company a boost. In addition, a Morgan Stanley report said the company faces a “steep fall” in sales from emerging markets. Bets against shares of Caterpillar reached their highest level since April.
REITs
Our REIT holdings (VNQ, ICF, IYR) all fell more than five percent today and are down over 15 percent YTD. After three quarters on flat returns in 2008, our REIT holdings fell between 38 and 40 percent in the final quarter.
The biggest concern surrounding REITs is liquidity. REITs carry high debt levels and most will need to repay or refinance obligations in the year ahead. Securing capital at attractive terms should remain challenging, which will squeeze companies with large development pipelines that rely on banks to provide funds for construction.
It is likely that several REITs will need to issue new equity or reduce dividend payments to improve liquidity. While this may provide some relief, it hurts investors’ confidence and further reduces share prices.
The main reason Acropolis invests in REITs is because of their relatively low correlation with the stock market, and thus it diversifies away from some of the risk inherent in the stock market. Rather than investing in individual REIT companies, we use the following ETFs to get diversified real estate exposure:
VNQ (Vanguard REIT ETF) boasts a relatively broad-based domestic portfolio, making it a suitable choice for one-stop, no fuss real estate exposure. The biggest risk the fund carries is that more than 40% of assets are in its top ten positions. If one or more of these names falter, the fund’s performance will suffer. VNQ carries a 0.12 expense ratio, which ranks as the cheapest real estate ETF on the market.
ICF (iShares Cohen & Steers Realty Majors Index Fund) has solid exposure to the biggest, best-managed public landlords of the major property types – office, retail, industrial and multifamily. ICF carries a 0.35% expense ratio, which is cheaper than most, but not all REIT mutual funds and ETFs.
IYR (iShares Dow Jones U.S. Real Estate Index Fund) has exposure to the largest biggest, best-managed public landlords of the major property types – office, retail, industrial and multifamily – as well as some more exotic corners of the REIT world like timber and brokers. IYR carries a 0.48% expense ratio, which is cheaper than most, but not all REIT mutual funds and ETFs.
Quick Hits
- Economic Stimulus Package May Reach $850 Billion
- Greenhouse-Gas Limits Proposed by Industry Would Raise Coal Plant Costs
Peter Lazaroff, Junior Analyst
Daily Insight
Most U.S. stocks gained ground yesterday, helping the S&P 500 and NASDAQ Composite end a two-day slide. However, the Dow Industrial Average failed to close in positive territory, held back by shares of Untied Technologies, Boeing and Hewlett-Packard.
Energy share helped the broad market manage a slight gain, as the price of crude rose for the first day in six. Shares of Microsoft and the biotech sector pushed the NASDAQ higher.
News floating around for a couple of months now that Citigroup will end its financial supermarket model began to take shape this past weekend and we received further indication yesterday the diversified banking institution will return to a model that looks more like the old Citicorp. The company will officially announce its plans next week; it’s been reported Citi will sell a majority stake in Smith Barney to Morgan Stanley and will likely spin-off its CitiFinancial consumer-lending unit. The new firm will focus on providing services to large corporations and affluent individuals.
Market Activity for January 13, 2009
It is also being reported Citi will set up a “bad bank” to house troubled assets and attempt to sell that unit off at some time.
That’s interesting since this is essentially the original purpose of the TARP, but for the banking industry in general. Too bad they chose to ditch this idea in favor of injecting capital into banks, which has really done nothing but allow banks to remain afloat. They won’t increase lending in this environment so long as mark-to-market accounting standards remain in place; they will simply continue to hoard the cash.
It would be highly preferable to see tax rates slashed across the board, a five-year moratorium on federal and state capital gains taxes on investments in troubled assets (which should bring the bids the market needs) and of course elimination of mark-to-market accounting in terms of basing capital adequacy ratios. But with Washington remaining obstinate, the original TARP proposal was the next best thing.
Crude-Oil
Oil futures slid 11.89% last week and fell another 8% on Monday, before rebounding 3.5% yesterday and into this morning’s trading. In the previous week crude was bid higher due to the heating up of Middle East conflicts and the game Russia continues to play with European energy supplies, but that gave way to global economic concerns and reduced demand forecasts.
Crude touched $50 on January 6, but has returned to the $30 handle, trading at $38.97 per barrel as I type.
It seems quite likely that oil prices will remain depressed so long as traders’ primary concern remains global economic contraction. In the meantime, the silver-lining is that money remains in consumers’ pockets via this low cost of energy, boosting real incomes.
Although for stocks, low oil prices currently work as a two-edged sword as we really need global economic worries to ease for stocks to resume the rally that’s brought us nicely off of the November 20 low. Oil and stocks may move in tandem for some time still.
But don’t expect energy prices to remain low as we look out over the next few months. For one, the massive amounts of liquidity the Fed has pumped into the system will explode throughout the economy whenever lending activity becomes normalized and risk aversion wanes even the least bit. This is going to push commodity prices higher and oil will certainly participate.
Another thing is the fact that energy policy over the next couple of years may not quite work the way some in Washington hope. We’ll see a focus on alternative sources, which is a good thing – especially if nuclear power is allowed to escape an onerous and inefficient permit process that delays production and drives costs far higher than they would otherwise be.
But we cannot abuse traditional energy sources, pretending as if they do not offer serious benefits both in cost to individual consumers (particularly those at the lower rungs of the economic ladder) and the economy in the aggregate.
To this point, I noticed the Senate advanced a $10 billion conservation plan last week that would set aside over two million acres among eight states. The Bureau of Land Management estimates the legislation would take nearly nine trillion cubic feet of natural gas and 300 million barrels of oil out of production in Wyoming alone.
The U.S. uses 21 million barrels of oil per day, so the 300 million figure is not huge (although we are talking about just one state), but anything other than a boost to supplies is not helpful over the long term. In terms of natural gas, the amount taken off line is equivalent to removing annual production levels of the two-largest NG production states – Alaska and Texas, according to the Energy Information Administration.
The irony here is that those most vocal on the topic of energy independence are also the primary proponents of this legislation. We have a 30 year history of voluntarily curtailing domestic energy production, which has made us increasingly more dependent on foreign energy sources.
Economic Data
The Commerce Department reported the trade gap narrowed by an enormous margin in November coming in at $40.4 billion from $56.7 billion in October. Imports plunged 12% for the month and exports were down 5.8%. The enormous decline in energy prices was a primary factor for the decline in import activity; significant weakness in consumer activity obviously played a role too.
The real trade gap, adjusting for prices, narrowed to $39.5 billion in November from $45.6 billion in October. Real exports declined 3.3%, real imports dropped 6.8%.
The export data within major regions indicates the degree of the global slowdown as year-over-year U.S. exports to China fell 10.7%, 18.9% to Asian NICs (newly industrialized countries), 15.2% to Canada and 1.1% to the European Union. This shows a synchronized global recession has occurred; so much for that “decoupling theory.”
Amazingly, U.S. exports to OPEC countries remains very strong, up 22.7% in November, although we’d expect this to grind to a halt due to the collapse in the price of oil.
(In terms of fourth-quarter GDP, this significant narrowing means trade will be less of a drag on the figure than expected. Still, we’re likely to see at least a 5.5% real rate of decline in economic growth when the reading is released on January 30, and may be solidly in the -6% handle.)
Real goods exports fell a huge 39.7% at an annualized rate over the past three months; this number was up 11.3% in the 12 months ended August 2008. This shows as clearly as anything does just how quickly things changed globally.
Real goods imports dropped 29.3% at an annual rate over the three months ending November; this figure down just 2.11% in the 12 months ended August 2008. And this shows how dramatically things have change domestically since September.
We often warn those who desire a very narrow trade balance to be careful what you wish for, you may not like it. No doubt, the degree to which import activity outpaced exports by 2005 had gotten out of control. This was due to the Fed’s mistaken monetary policy that sent real short-term interest rates negative, and thus subsidized debt. The credit expansion that ensued did have a lot to do with how wide the trade gap had become.
Yet, the gap was narrowing in 2006 and 2007 as the Fed removed that easing policy that kept rates too low for too long. In an event, a U.S. economy that had been in growth mode for the vast majority of the past 25 years resulted in a powerful and prosperous consumer base – which is still the case in the aggregate even with our current troubles. Thus trade deficits will result.
Overall, we shouldn’t fear trade deficits. This is not 18th century mercantilism. So long as we engage in pro-growth polices many of those dollars used to purchase imports come back home in the form of investment, which is what the trade-deficit curmudgeons never factor.
What we should fear are Federal Reserve monetary policy mistakes; the harm rendered by these mistakes is widespread and extremely damaging.
Let’s learn from this situation. Instead of castigating capitalism – for all of its faults it is undoubtedly the most efficient allocator of resources – we need to focus the blame on the FOMC and their Keynesian models.
For sure, an out of control Fannie and Freddie, supposedly sophisticated accounting standards that were never modeled against a full-blown decline in asset prices and congressional demands to extend credit to those with very low credit scores or be accused of “redlining” are also serious contributors to the current problem. However, none of those are large issues if the Fed doesn’t push real fed funds negative for two full years as was the case October 2002-March 2005.
Have a great day!
Brent Vondera, Senior Analyst
Energy share helped the broad market manage a slight gain, as the price of crude rose for the first day in six. Shares of Microsoft and the biotech sector pushed the NASDAQ higher.
News floating around for a couple of months now that Citigroup will end its financial supermarket model began to take shape this past weekend and we received further indication yesterday the diversified banking institution will return to a model that looks more like the old Citicorp. The company will officially announce its plans next week; it’s been reported Citi will sell a majority stake in Smith Barney to Morgan Stanley and will likely spin-off its CitiFinancial consumer-lending unit. The new firm will focus on providing services to large corporations and affluent individuals.
Market Activity for January 13, 2009
It is also being reported Citi will set up a “bad bank” to house troubled assets and attempt to sell that unit off at some time.
That’s interesting since this is essentially the original purpose of the TARP, but for the banking industry in general. Too bad they chose to ditch this idea in favor of injecting capital into banks, which has really done nothing but allow banks to remain afloat. They won’t increase lending in this environment so long as mark-to-market accounting standards remain in place; they will simply continue to hoard the cash.
It would be highly preferable to see tax rates slashed across the board, a five-year moratorium on federal and state capital gains taxes on investments in troubled assets (which should bring the bids the market needs) and of course elimination of mark-to-market accounting in terms of basing capital adequacy ratios. But with Washington remaining obstinate, the original TARP proposal was the next best thing.
Crude-Oil
Oil futures slid 11.89% last week and fell another 8% on Monday, before rebounding 3.5% yesterday and into this morning’s trading. In the previous week crude was bid higher due to the heating up of Middle East conflicts and the game Russia continues to play with European energy supplies, but that gave way to global economic concerns and reduced demand forecasts.
Crude touched $50 on January 6, but has returned to the $30 handle, trading at $38.97 per barrel as I type.
It seems quite likely that oil prices will remain depressed so long as traders’ primary concern remains global economic contraction. In the meantime, the silver-lining is that money remains in consumers’ pockets via this low cost of energy, boosting real incomes.
Although for stocks, low oil prices currently work as a two-edged sword as we really need global economic worries to ease for stocks to resume the rally that’s brought us nicely off of the November 20 low. Oil and stocks may move in tandem for some time still.
But don’t expect energy prices to remain low as we look out over the next few months. For one, the massive amounts of liquidity the Fed has pumped into the system will explode throughout the economy whenever lending activity becomes normalized and risk aversion wanes even the least bit. This is going to push commodity prices higher and oil will certainly participate.
Another thing is the fact that energy policy over the next couple of years may not quite work the way some in Washington hope. We’ll see a focus on alternative sources, which is a good thing – especially if nuclear power is allowed to escape an onerous and inefficient permit process that delays production and drives costs far higher than they would otherwise be.
But we cannot abuse traditional energy sources, pretending as if they do not offer serious benefits both in cost to individual consumers (particularly those at the lower rungs of the economic ladder) and the economy in the aggregate.
To this point, I noticed the Senate advanced a $10 billion conservation plan last week that would set aside over two million acres among eight states. The Bureau of Land Management estimates the legislation would take nearly nine trillion cubic feet of natural gas and 300 million barrels of oil out of production in Wyoming alone.
The U.S. uses 21 million barrels of oil per day, so the 300 million figure is not huge (although we are talking about just one state), but anything other than a boost to supplies is not helpful over the long term. In terms of natural gas, the amount taken off line is equivalent to removing annual production levels of the two-largest NG production states – Alaska and Texas, according to the Energy Information Administration.
The irony here is that those most vocal on the topic of energy independence are also the primary proponents of this legislation. We have a 30 year history of voluntarily curtailing domestic energy production, which has made us increasingly more dependent on foreign energy sources.
Economic Data
The Commerce Department reported the trade gap narrowed by an enormous margin in November coming in at $40.4 billion from $56.7 billion in October. Imports plunged 12% for the month and exports were down 5.8%. The enormous decline in energy prices was a primary factor for the decline in import activity; significant weakness in consumer activity obviously played a role too.
The real trade gap, adjusting for prices, narrowed to $39.5 billion in November from $45.6 billion in October. Real exports declined 3.3%, real imports dropped 6.8%.
The export data within major regions indicates the degree of the global slowdown as year-over-year U.S. exports to China fell 10.7%, 18.9% to Asian NICs (newly industrialized countries), 15.2% to Canada and 1.1% to the European Union. This shows a synchronized global recession has occurred; so much for that “decoupling theory.”
Amazingly, U.S. exports to OPEC countries remains very strong, up 22.7% in November, although we’d expect this to grind to a halt due to the collapse in the price of oil.
(In terms of fourth-quarter GDP, this significant narrowing means trade will be less of a drag on the figure than expected. Still, we’re likely to see at least a 5.5% real rate of decline in economic growth when the reading is released on January 30, and may be solidly in the -6% handle.)
Real goods exports fell a huge 39.7% at an annualized rate over the past three months; this number was up 11.3% in the 12 months ended August 2008. This shows as clearly as anything does just how quickly things changed globally.
Real goods imports dropped 29.3% at an annual rate over the three months ending November; this figure down just 2.11% in the 12 months ended August 2008. And this shows how dramatically things have change domestically since September.
We often warn those who desire a very narrow trade balance to be careful what you wish for, you may not like it. No doubt, the degree to which import activity outpaced exports by 2005 had gotten out of control. This was due to the Fed’s mistaken monetary policy that sent real short-term interest rates negative, and thus subsidized debt. The credit expansion that ensued did have a lot to do with how wide the trade gap had become.
Yet, the gap was narrowing in 2006 and 2007 as the Fed removed that easing policy that kept rates too low for too long. In an event, a U.S. economy that had been in growth mode for the vast majority of the past 25 years resulted in a powerful and prosperous consumer base – which is still the case in the aggregate even with our current troubles. Thus trade deficits will result.
Overall, we shouldn’t fear trade deficits. This is not 18th century mercantilism. So long as we engage in pro-growth polices many of those dollars used to purchase imports come back home in the form of investment, which is what the trade-deficit curmudgeons never factor.
What we should fear are Federal Reserve monetary policy mistakes; the harm rendered by these mistakes is widespread and extremely damaging.
Let’s learn from this situation. Instead of castigating capitalism – for all of its faults it is undoubtedly the most efficient allocator of resources – we need to focus the blame on the FOMC and their Keynesian models.
For sure, an out of control Fannie and Freddie, supposedly sophisticated accounting standards that were never modeled against a full-blown decline in asset prices and congressional demands to extend credit to those with very low credit scores or be accused of “redlining” are also serious contributors to the current problem. However, none of those are large issues if the Fed doesn’t push real fed funds negative for two full years as was the case October 2002-March 2005.
Have a great day!
Brent Vondera, Senior Analyst
Tuesday, January 13, 2009
Afternoon Review
General Electric (GE) -5.62%
Barclays said in a research note that General Electric’s fourth-quarter profit may be at the low end of its forecast. The note also predicted that tax benefits at GE Capital will contribute a “substantial” portion to per-share results, and thus earnings quality will be weak.
Also hurting sentiment for the company was news that Vivendi SA, NBC Universal’s 20 percent venture partner, said it may write down its stake in the company because of declining media values. GE does not expect to take a writedown on its majority stake of NBC Universal.
S&P cut GE’s outlook on Dec. 18, giving the company a one-in-three chance of losing its top rating over the next two years. S&P said an example that would lead to the re-examination of their opinion would be if GE failed to generate free cash flow after dividends and assets sales in 2009 or 2010. Moody’s may follow suit and cut their outlook on GE’s AAA credit rating if earnings results disappoint. Both ratings companies are unlikely to base any change on the fourth quarter itself, unless, of course, there is a material change in GE’s outlook.
Pfizer (PFE) +1.32%
Bloomberg reports that Pfizer wants to sell 100 experimental medicines to rivals as it shifts its research efforts to medicines to treat cancer, brain disorders and pain. The report also notes that Pfizer will fire 800 researchers, eight percent of its scientists, as part of a research reshuffling.
There is wide speculation that Pfizer is hunting for acquisitions that will help replace revenues from products losing patent protection in the next several years.
J.P. Morgan Chase (JPM) +5.78%
JPM’s announcement that it would move up its earnings release to Thursday from a scheduled report next week has created a minor stir in amongst the media. This normally would not be a big deal, but any unforeseen event – no matter how big or small – in the financial industry is going to cause a bit of commotion.
Some are taking it as a sign that they have bad results and need to raise more capital, while others see it as a sign that JPM has great earnings that they can’t wait any longer to tell the world about. There is also growing speculation that JPM has gotten involved in the bidding for Smith Barney, Citigroup’s brokerage unit, either with the intent to buy the unit or just get involved in the joint venture.
Energy
Oil gained on Saudi Arabia’s plan to make deeper production cuts, lifting energy shares including:
- Chevron (CVX) +1.41%
- ExxonMobil (XOM) +1.80%
- Transocean (RIG) +2.93%
- Noble (NE) +2.61%
- Arch Coal (ACI) +5.00%
- Peabody Energy (BTU) +4.90%
Quick Hits
- Bernanke Says Stimulus May Be Inadequate, Signals Asset Buying, Guarantees
- Bank of America to Use Merrill Lynch Name, Bull Logo
- From Advisors’ Perspectives: Our examination of the 69 naming deals by publicly traded companies shows that the performance of companies that purchase naming rights trails the S&P 500 index by 4.7% over the course of the deal. If you invested in a company the day it announced a naming agreement and sold when the agreement was done (or still held onto it for current name holders), your portfolio would be down 9.1%, as compared to -4.5% for the S&P 500.
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks began the session lower on earnings concerns – Q4 earnings season begins to roll this week – and downward pressure increased as the day progressed as more people begin to realize that infrastructure-based stimulus has a large lag to it.
In terms of profit worries, one has to believe equity values have lower earnings priced in; it’s not like a profit decline of 20-25% comes as much of a surprise after the economic data we’ve been battered with over the past three months. So we’re not sure this was the primary concern yesterday.
It’s more likely stocks had a rough session due to growing concerns over the efficacy of the stimulus proposals, a topic we touched on last week. Those crafting the plan can say the proverbial shovels are already in the ground, waiting for the nod to begin projects, all they want. The reality is there are federal and state appropriations that must be dealt with first and the typical infighting over prioritization.
Then there is the issue of the private sector delaying spending plans as they may be expecting higher government spending will be followed by tax hikes, which will only curtail growth just when it seems things have turned. Maybe intertemporal economic decisions are not quite this lucid within the business community, but it’s a concern nonetheless.
Market Activity for January 12, 2009
Also delivering a blow to investor sentiment was news Larry Summers (Obama’s top economic advisor) sent a letter to Congress outlining onerous conditions on financial institutions.
Bank stocks got hammered, leading the losses as the sector shed 5.7%, The only good news here is maybe banks will pay the TARP money back as quickly as possible so to get out from under these damaging conditions, such as limits on executive compensation, banning dividend payouts beyond de minimis amounts, and limits on stock buybacks and acquisitions.
(Certainly, these institutions are not raising dividends and buying back stock anytime in the near future, but these restrictions may prove quite damaging for their stock prices two-three years from now. On executive compensation limits, at a time when a firm needs to acquire top talent those that can deliver most effectively will simply look in another direction if their pay is going to be held back – these demands are very near-sighted and quite hostile to relatively free market principles. But that has been one of the concerns all along.)
So the market is still assessing all of these things. We may very well extend upon the rally that has given us a 16% boost from the multi-year nadir hit on November 20, but not without a pull-back period of assessment as we’re finding.
The broad market’s 8% decline over the past four sessions comes as some credit spreads have narrowed significantly. The TED Spread (as most readers know is a measure of the market’s willingness to take risk – a wider spread means risk aversion) has narrowed the most since this whole fiasco truly began in September.
Further, the spread on top-rated credit card-backed debt and similar bonds backed by auto loans have also narrowed thanks to the Fed’s Term Asset Backed Lending Facility (TALF). These spreads moved to historic wides as investors fled to the safety of U.S. government bonds. Now with the Fed beginning to step in, these loans will come off of more prohibitive levels for consumers.
That said, no one can make consumers borrow, the large issue of a deteriorating labor market will keep activity subdued. Personally, while the Fed is the lender of last resort, I don’t believe them stepping into the consumer-loan market is part of their job, but mention it just to explain what’s occurring.
Commercial Paper issuance has also rebounded. This source of short-term funding that businesses use to meet payroll and purchase inventory was in the process of collapsing in September and October. The Fed attacked this problem via its Commercial Paper Funding Facility (CPFF), one of its most successful moves yet.
Now, the levels CP issuance hit in 2007 and into 2008 where not sustainable, so the goal wasn’t to get this activity back to those levels. Instead, the objective was to halt a very troubling slide that resulted in credit access being shut off to even fairly well-positioned small businesses as investors fled for safety when the Lehman collapse occurred on September 15.
Part of what’s occurred in the labor market has resulted from firms having to close their doors as funding shutdown. And we’re not talking about businesses that were poorly managed – that is what recessions are about, killing off these unfit firms – but rather those that were pretty well managed but merely not ready for a credit freeze-up that has not been seen for a very long time.
So while financial stability has improved, investors are still leery of additional fallout.
This morning will be another quiet one on the economic front. We do get the November trade balance and the monthly budget statement for December; however, we already know what these two are going to look like.
The trade gap will very likely narrow as the plunge in energy prices and very weak consumer activity caused imports to trail export activity for November. Both will be weak, but imports likely more so.
The monthly budget statement will show the government ran another huge deficit in December, but this is no surprise. Government spending has exploded, while the weak economy has caused revenues to decline.
The first-half of the TARP money makes up much of this spending explosion, but remember that these funds were issued via preferred shares yielding 5%. One can argue about the terms, and of course the plan in general, but the vast majority of these funds will be paid back with interest.
More concerning to me is the spending that will occur this year and next (and the overall permanence of government programs) as the funds go to who knows what with little chance of much of these projects delivering productivity enhancements down the road. This spending will massively increase the deficit, which is expected to come in at $1 trillion for fiscal year 2009. It will also crowd out private-sector activity if history is any guide.
I laugh at all of those in the press that have made a big deal about budget deficits over the past three decades – deficits that were quite manageable, averaging 2.4% of GDP. A deficit of $1 trillion amounts to 7% as a percentage of GDP, and won’t be any smaller for 2010 in my view.
Have a great day!
Brent Vondera, Senior Analyst
In terms of profit worries, one has to believe equity values have lower earnings priced in; it’s not like a profit decline of 20-25% comes as much of a surprise after the economic data we’ve been battered with over the past three months. So we’re not sure this was the primary concern yesterday.
It’s more likely stocks had a rough session due to growing concerns over the efficacy of the stimulus proposals, a topic we touched on last week. Those crafting the plan can say the proverbial shovels are already in the ground, waiting for the nod to begin projects, all they want. The reality is there are federal and state appropriations that must be dealt with first and the typical infighting over prioritization.
Then there is the issue of the private sector delaying spending plans as they may be expecting higher government spending will be followed by tax hikes, which will only curtail growth just when it seems things have turned. Maybe intertemporal economic decisions are not quite this lucid within the business community, but it’s a concern nonetheless.
Market Activity for January 12, 2009
Also delivering a blow to investor sentiment was news Larry Summers (Obama’s top economic advisor) sent a letter to Congress outlining onerous conditions on financial institutions.
Bank stocks got hammered, leading the losses as the sector shed 5.7%, The only good news here is maybe banks will pay the TARP money back as quickly as possible so to get out from under these damaging conditions, such as limits on executive compensation, banning dividend payouts beyond de minimis amounts, and limits on stock buybacks and acquisitions.
(Certainly, these institutions are not raising dividends and buying back stock anytime in the near future, but these restrictions may prove quite damaging for their stock prices two-three years from now. On executive compensation limits, at a time when a firm needs to acquire top talent those that can deliver most effectively will simply look in another direction if their pay is going to be held back – these demands are very near-sighted and quite hostile to relatively free market principles. But that has been one of the concerns all along.)
So the market is still assessing all of these things. We may very well extend upon the rally that has given us a 16% boost from the multi-year nadir hit on November 20, but not without a pull-back period of assessment as we’re finding.
The broad market’s 8% decline over the past four sessions comes as some credit spreads have narrowed significantly. The TED Spread (as most readers know is a measure of the market’s willingness to take risk – a wider spread means risk aversion) has narrowed the most since this whole fiasco truly began in September.
Further, the spread on top-rated credit card-backed debt and similar bonds backed by auto loans have also narrowed thanks to the Fed’s Term Asset Backed Lending Facility (TALF). These spreads moved to historic wides as investors fled to the safety of U.S. government bonds. Now with the Fed beginning to step in, these loans will come off of more prohibitive levels for consumers.
That said, no one can make consumers borrow, the large issue of a deteriorating labor market will keep activity subdued. Personally, while the Fed is the lender of last resort, I don’t believe them stepping into the consumer-loan market is part of their job, but mention it just to explain what’s occurring.
Commercial Paper issuance has also rebounded. This source of short-term funding that businesses use to meet payroll and purchase inventory was in the process of collapsing in September and October. The Fed attacked this problem via its Commercial Paper Funding Facility (CPFF), one of its most successful moves yet.
Now, the levels CP issuance hit in 2007 and into 2008 where not sustainable, so the goal wasn’t to get this activity back to those levels. Instead, the objective was to halt a very troubling slide that resulted in credit access being shut off to even fairly well-positioned small businesses as investors fled for safety when the Lehman collapse occurred on September 15.
Part of what’s occurred in the labor market has resulted from firms having to close their doors as funding shutdown. And we’re not talking about businesses that were poorly managed – that is what recessions are about, killing off these unfit firms – but rather those that were pretty well managed but merely not ready for a credit freeze-up that has not been seen for a very long time.
So while financial stability has improved, investors are still leery of additional fallout.
This morning will be another quiet one on the economic front. We do get the November trade balance and the monthly budget statement for December; however, we already know what these two are going to look like.
The trade gap will very likely narrow as the plunge in energy prices and very weak consumer activity caused imports to trail export activity for November. Both will be weak, but imports likely more so.
The monthly budget statement will show the government ran another huge deficit in December, but this is no surprise. Government spending has exploded, while the weak economy has caused revenues to decline.
The first-half of the TARP money makes up much of this spending explosion, but remember that these funds were issued via preferred shares yielding 5%. One can argue about the terms, and of course the plan in general, but the vast majority of these funds will be paid back with interest.
More concerning to me is the spending that will occur this year and next (and the overall permanence of government programs) as the funds go to who knows what with little chance of much of these projects delivering productivity enhancements down the road. This spending will massively increase the deficit, which is expected to come in at $1 trillion for fiscal year 2009. It will also crowd out private-sector activity if history is any guide.
I laugh at all of those in the press that have made a big deal about budget deficits over the past three decades – deficits that were quite manageable, averaging 2.4% of GDP. A deficit of $1 trillion amounts to 7% as a percentage of GDP, and won’t be any smaller for 2010 in my view.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
The curve flattened 7 basis points today to 156 basis points as the 2-year was mostly unchanged on the day to yield .74% and the 10-year rallied about three-quarters of a point in price to yield 2.3%.
Mortgages Widen
New-issue 30-year Agency MBS widened out to begin the week at 107 basis points over comparable Treasuries from just 78 basis points late last week. This is likely a correction to the market overreacting with regards to the impact of the Fed buying MBS. The impact is likely to be great, but it will take a few weeks in order for the market to gain more insight into what the exactly the Fed is looking to buy.
The New York Fed reported $10.2 billion of Agency MBS purchases from January 5th through the 7th, while concentrating on 4.5% and 5% coupon 30 year pass-throughs, as we expected. This is perhaps a slower start compared to what the market expected, causing the considerable widening today. We will continue to get a report on their purchases every Thursday for as long as the program is in effect.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Mortgages Widen
New-issue 30-year Agency MBS widened out to begin the week at 107 basis points over comparable Treasuries from just 78 basis points late last week. This is likely a correction to the market overreacting with regards to the impact of the Fed buying MBS. The impact is likely to be great, but it will take a few weeks in order for the market to gain more insight into what the exactly the Fed is looking to buy.
The New York Fed reported $10.2 billion of Agency MBS purchases from January 5th through the 7th, while concentrating on 4.5% and 5% coupon 30 year pass-throughs, as we expected. This is perhaps a slower start compared to what the market expected, causing the considerable widening today. We will continue to get a report on their purchases every Thursday for as long as the program is in effect.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Monday, January 12, 2009
Afternoon Review
Hologic (HOLX) +13.12%
Hologic – a leading developer, manufacturer and supplier of premium diagnostics, medical imaging systems and surgical products dedicated to serving the healthcare needs of women – announced preliminary first quarter fiscal 2009 earnings that exceeded the company’s initial guidance. The company’s revenues, however, are now expected to be three percent below their previously issued guidance.
Hologic lost nearly 62 percent in 2008, 32 percent of that decline coming in the fourth quarter. Companies within the medical equipment industry saw an unprecedented decline in hospital spending due to the severe and rapid economic downturn. Hospital systems across the country have responded to tightening access to capital by restricting capital expenditures, implementing tight spending controls and reducing personnel.
Bank of America -12.01%
A Citigroup analyst issued a report today suggesting that Bank of America may post a loss of $0.75/share, compared with his earlier estimate of a $0.02/share profit, and they may reduce its dividend to $0.05/share from $0.32/share.
Bank of America raised $10 billion in October in a share sale, received $25 billion from TARP and halved its dividend to prepare for a slower economy. However, the analyst report estimates that Bank of America may have cumulative losses of $165 billion between 2008 and 2011. “So far about 33 percent have been taken either through loan loss provision or purchase accounting marks.” About a third of the expected losses, or $57 billion, are likely from credit-card lending, with about $29 billion from home loans made by Countrywide Financial Corp.
Also hurting financial shares was a statement from President-elect Obama that companies who receive TARP money should face restrictions with their dividend payments and share repurchases.
Principal Financial Group (PFG) -11.41%
Principal, as well as other life insurers tumbled on news that the National Association of Insurance Commissioners rejected an industry plea to loosen reserve standards after investment losses depleted capital across the industry.
Financial stocks were battered after news reports that Obama would limit dividend payments and share repurchases for institutions that receive TARP funds.
Seagate Technology (STX) -15.60%
Seagate, the world’s biggest maker of hard-disk drives, replaced CEO William Watkins and said it will cut 10 percent of its U.S. workforce as sales and profit drop amid the recession. The new CEO will be Chairman Stephen Luczo, who ran the company for six years before Watkins was in the position.
Earnings Season
The big market declines today is evidence that investors are bracing for a grim earnings season, which began this afternoon after the close with Alcoa posting disappointing results.
Analysts are expecting to see a decline of more than 15 percent in aggregate fourth-quarter earnings at S&P 500 companies, once all the reports are in hand. Such a decline would represent the sixth straight quarter of falling S&P profits. However, there is increasing sentiment that earnings expectations are still too high.
Two of the more interesting companies set to report earnings this week are JPMorgan (JPM) and Intel (INTC). The market will be paying close attention to their comments on the outlook for future quarters, looking for hints about when the long-running U.S. recession will wind down as well as the general health of the financial and technology sectors.
--
Peter Lazaroff, Junior Analyst
Hologic – a leading developer, manufacturer and supplier of premium diagnostics, medical imaging systems and surgical products dedicated to serving the healthcare needs of women – announced preliminary first quarter fiscal 2009 earnings that exceeded the company’s initial guidance. The company’s revenues, however, are now expected to be three percent below their previously issued guidance.
Hologic lost nearly 62 percent in 2008, 32 percent of that decline coming in the fourth quarter. Companies within the medical equipment industry saw an unprecedented decline in hospital spending due to the severe and rapid economic downturn. Hospital systems across the country have responded to tightening access to capital by restricting capital expenditures, implementing tight spending controls and reducing personnel.
Bank of America -12.01%
A Citigroup analyst issued a report today suggesting that Bank of America may post a loss of $0.75/share, compared with his earlier estimate of a $0.02/share profit, and they may reduce its dividend to $0.05/share from $0.32/share.
Bank of America raised $10 billion in October in a share sale, received $25 billion from TARP and halved its dividend to prepare for a slower economy. However, the analyst report estimates that Bank of America may have cumulative losses of $165 billion between 2008 and 2011. “So far about 33 percent have been taken either through loan loss provision or purchase accounting marks.” About a third of the expected losses, or $57 billion, are likely from credit-card lending, with about $29 billion from home loans made by Countrywide Financial Corp.
Also hurting financial shares was a statement from President-elect Obama that companies who receive TARP money should face restrictions with their dividend payments and share repurchases.
Principal Financial Group (PFG) -11.41%
Principal, as well as other life insurers tumbled on news that the National Association of Insurance Commissioners rejected an industry plea to loosen reserve standards after investment losses depleted capital across the industry.
Financial stocks were battered after news reports that Obama would limit dividend payments and share repurchases for institutions that receive TARP funds.
Seagate Technology (STX) -15.60%
Seagate, the world’s biggest maker of hard-disk drives, replaced CEO William Watkins and said it will cut 10 percent of its U.S. workforce as sales and profit drop amid the recession. The new CEO will be Chairman Stephen Luczo, who ran the company for six years before Watkins was in the position.
Earnings Season
The big market declines today is evidence that investors are bracing for a grim earnings season, which began this afternoon after the close with Alcoa posting disappointing results.
Analysts are expecting to see a decline of more than 15 percent in aggregate fourth-quarter earnings at S&P 500 companies, once all the reports are in hand. Such a decline would represent the sixth straight quarter of falling S&P profits. However, there is increasing sentiment that earnings expectations are still too high.
Two of the more interesting companies set to report earnings this week are JPMorgan (JPM) and Intel (INTC). The market will be paying close attention to their comments on the outlook for future quarters, looking for hints about when the long-running U.S. recession will wind down as well as the general health of the financial and technology sectors.
--
Peter Lazaroff, Junior Analyst
Daily Insight
U.S. stocks moved lower on Friday, marking the worst weekly performance in seven weeks, after the December jobs report showed the economy shed 1.5 million payroll positions last quarter. While the December employment reading was not as bad as the whisper number, back-to-back monthly losses of more than 500k makes it about impossible for stocks to shake off the pessimism that results.
I think there is a positive view we can take from these job-loss numbers, however. The speed at which firms have cuts jobs is commensurate with the speed at which economic activity ground to a halt and as a result we may see the worst will have occurred when look back two months from now. Its possible firms may be close to meeting their headcount objectives and the degree of monthly losses may ease faster than most currently anticipate.
For now, the high number of job cuts only increases global-recession concerns and with earnings season kicking off this week – surely posting the worst decline since the second-quarter of 2001 and possibly the worst since 1991 – all of those expecting the so-called “January Effect” to boost stock prices, without an additional pullback, may be disappointed.
Market Activity for January 9, 2009
The broad market, as measured by the S&P 500, remains 18% above the November 20 low even after last week’s 4.45% decline. The even broader NYSE Composite remains 22.5% higher than that November low.
The Economy
The Labor Department reported the number of job losses last month was pretty much in-line with the overt expectation, shedding 524,000 payroll positions. This marks the fourth-straight month in which nonfarm payrolls fell by more than 400,000.
Seventy-five percent of the job losses for all of 2008 occurred in the final four months, so maybe this helps to explain our sentiment that the economy truly didn’t move into recession until September. Payrolls dropped 1.5 million in the fourth quarter, the largest quarterly decline since 1945.
In any event, the unofficial number circulating among traders – the whisper number -- was for something much larger, closer to 650,000. So in this regard the actual reading was viewed with some optimism when released. Unfortunately, a reading of -524,000 (on top of downward revisions for the past couple of months) weighed on investor sentiment and this showed up in the final hour of trading.
All but two sectors/industries shed positions last month. Education and health services remain the bright spots, adding 7,000 and 38,000, respectively. Neither of these areas has recorded a decline in this downturn.
Goods producing industries lost another 251,000 in December (accelerating from the 182,000 lost in November), 101k coming from construction and 149k from manufacturing. The service sector lost 273,000 (an improvement from the 402,000 plunge in November, but I guess anything would be from that level). Trade and transport shed 121k, while retail trade eliminated 67k positions.
The unemployment rate jumped to 7.2% -- the highest level since 1993 -- from 6.8% in November. Household employment, the unemployment rate runs off of the household survey, plunged 806,000 in December. The difference from the payroll survey (which is the job change number represented in the chart above) and the household survey is the latter includes the self-employed.
Hours worked fell a massive 7.7% at an annual rate in the fourth quarter, offering a clear indication we’ll get a 5%-plus decline in real GDP for the fourth quarter. The figure is released on January 30.
The bright side of the report was the earnings figure, which remains remarkably strong.
Average hourly earnings came in at 3.7% on a year-over-year basis. While this is down slightly from 3.8% in November, hourly earnings have bounced over the past three months and with the inflation gauges posting very low readings due to the plunge in energy prices real (inflation-adjusted) incomes are very positive – up 2.6% on a year-over-year basis. This is a significant benefit to the consumer.
Now, I must make it clear, a very weak job market and the drop in hours worked (which has caused an index of hours worked multiplied by average hourly earnings to deteriorate in a meaningful way -- down 5.6% at an annual rate over the last three months) will weigh on consumer activity.
Further, consumers are building cash savings due to the substantial decline in equity and home prices, so this should keep activity depressed for a little while still.
But because of the fact that real wage growth is substantially higher than the historic average of 0.6% it isn’t crazy to assume consumer activity may bounce more quickly than many currently believe. (I’ll note the long-term average for real disposable income growth – after-tax, inflation-adjusted income – a much broader measure than the rather narrow hourly wage data, is 3.15% per year -- that’s important perspective especially since the press only reports on the lower figure.)
This quicker-than-expected bounce assumes that we will have seen the worst the labor market has to offer over the next two months. We’ll have to wait for a couple of jobless claims readings and another ISM report for a better indication, but one has to assume much work in reducing headcount has been accomplished.
Have a great day!
Brent Vondera, Senior Analyst
I think there is a positive view we can take from these job-loss numbers, however. The speed at which firms have cuts jobs is commensurate with the speed at which economic activity ground to a halt and as a result we may see the worst will have occurred when look back two months from now. Its possible firms may be close to meeting their headcount objectives and the degree of monthly losses may ease faster than most currently anticipate.
For now, the high number of job cuts only increases global-recession concerns and with earnings season kicking off this week – surely posting the worst decline since the second-quarter of 2001 and possibly the worst since 1991 – all of those expecting the so-called “January Effect” to boost stock prices, without an additional pullback, may be disappointed.
Market Activity for January 9, 2009
The broad market, as measured by the S&P 500, remains 18% above the November 20 low even after last week’s 4.45% decline. The even broader NYSE Composite remains 22.5% higher than that November low.
The Economy
The Labor Department reported the number of job losses last month was pretty much in-line with the overt expectation, shedding 524,000 payroll positions. This marks the fourth-straight month in which nonfarm payrolls fell by more than 400,000.
Seventy-five percent of the job losses for all of 2008 occurred in the final four months, so maybe this helps to explain our sentiment that the economy truly didn’t move into recession until September. Payrolls dropped 1.5 million in the fourth quarter, the largest quarterly decline since 1945.
In any event, the unofficial number circulating among traders – the whisper number -- was for something much larger, closer to 650,000. So in this regard the actual reading was viewed with some optimism when released. Unfortunately, a reading of -524,000 (on top of downward revisions for the past couple of months) weighed on investor sentiment and this showed up in the final hour of trading.
All but two sectors/industries shed positions last month. Education and health services remain the bright spots, adding 7,000 and 38,000, respectively. Neither of these areas has recorded a decline in this downturn.
Goods producing industries lost another 251,000 in December (accelerating from the 182,000 lost in November), 101k coming from construction and 149k from manufacturing. The service sector lost 273,000 (an improvement from the 402,000 plunge in November, but I guess anything would be from that level). Trade and transport shed 121k, while retail trade eliminated 67k positions.
The unemployment rate jumped to 7.2% -- the highest level since 1993 -- from 6.8% in November. Household employment, the unemployment rate runs off of the household survey, plunged 806,000 in December. The difference from the payroll survey (which is the job change number represented in the chart above) and the household survey is the latter includes the self-employed.
Hours worked fell a massive 7.7% at an annual rate in the fourth quarter, offering a clear indication we’ll get a 5%-plus decline in real GDP for the fourth quarter. The figure is released on January 30.
The bright side of the report was the earnings figure, which remains remarkably strong.
Average hourly earnings came in at 3.7% on a year-over-year basis. While this is down slightly from 3.8% in November, hourly earnings have bounced over the past three months and with the inflation gauges posting very low readings due to the plunge in energy prices real (inflation-adjusted) incomes are very positive – up 2.6% on a year-over-year basis. This is a significant benefit to the consumer.
Now, I must make it clear, a very weak job market and the drop in hours worked (which has caused an index of hours worked multiplied by average hourly earnings to deteriorate in a meaningful way -- down 5.6% at an annual rate over the last three months) will weigh on consumer activity.
Further, consumers are building cash savings due to the substantial decline in equity and home prices, so this should keep activity depressed for a little while still.
But because of the fact that real wage growth is substantially higher than the historic average of 0.6% it isn’t crazy to assume consumer activity may bounce more quickly than many currently believe. (I’ll note the long-term average for real disposable income growth – after-tax, inflation-adjusted income – a much broader measure than the rather narrow hourly wage data, is 3.15% per year -- that’s important perspective especially since the press only reports on the lower figure.)
This quicker-than-expected bounce assumes that we will have seen the worst the labor market has to offer over the next two months. We’ll have to wait for a couple of jobless claims readings and another ISM report for a better indication, but one has to assume much work in reducing headcount has been accomplished.
Have a great day!
Brent Vondera, Senior Analyst
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