Daily Insight

U.S. stocks looked ready to take a breather (after running hard over the past five weeks) in early trading yesterday, but pared those losses after lunch and had enough momentum going into the final hour for the broad market to end higher.

The trend of the previous 24 sessions has pushed the S&P 500 27% above the nefarious low of 666 hit on March 9 and it may prove tough to keep this going without some abatement. There has been increasing talk that this upswing is getting a bit long in the tooth, which may have had some effect on overall sentiment – while the S&P 500 closed to the upside, six of the 10 major industry groups closed lower and mid and small cap indices end in the red as well. The Dow average was held back by shares of Exxon, Chevron, Boeing and IBM.

More than anything the market didn’t seem to have the alacrity to take on a decisive position ahead of this morning’s retail sales figure. This retail number will be the big news of the day, maybe the week, and the market may have too much riding on it. Our take is that many market participants have put misguided hope in the fact that consumer activity began a sustained rebound in January and that could kick off the pullback that should be expected after a run like the one we’ve seen over the past month - more on the retail sales report below.

In terms of sector performance, financials and material shares alone pushed the S&P 500 higher yesterday. Goldman Sachs knocked the cover off the ball after the bell, posting operating profit that doubled expectations -- maybe this is enough to for financials keep it going, but considering the bounce over the last five weeks (Goldman shares are up 76% and the sector 85%) the good first-quarter results are likely priced in.

Utilities, energy and telecom shares were the biggest drags on the index. (Energy share were hit by an IEA report that predicted 2009 demand for crude could be cut to the lowest level in five years on lower factory production.) Tech and consumer-related shares also closed lower.

Utility stocks have been the biggest laggard during this five-week upswing. While it’s not surprising to see utilities lag during this abrupt rally, considering the sector’s safe-haven status, one shouldn’t ignore the impact the cap and trade bill that is in the works has had on the shares – if this gets through, or is even implemented piece-meal via executive order, it will hit power-plant margins hard. I prepared a commentary on cap and trade a couple of weeks ago, but there have been so many other things to talk about haven’t had a chance to fit it in. I’ll try to do so when Congress comes back from Easter recess and the topic gets more attention.


Market Activity for April 13, 2009


This Week’s Data

We didn’t have an economic release scheduled for yesterday, but get back to it today with retail sales and PPI.

Producer Price Index (Today)

PPI is expected to come in flat for the month. Core prices, which exclude the food and energy components, are expected to rise 0.1% for the month and remain at 4.0% on a year-over-year basis.


The fact that core PPI is running at this rate on a year-over-year basis at this point in the business cycle shows we’re starting from a high base. When the commodity explosion occurs, and I don’t know how we escape it as global monetary and fiscal policies flood the system with trillions of dollars, the inflation that will ensure should come faster than I think most expect.

Retail Sales for March (Today)

Retail sales are expected to rise 0.3% for March, after a 0.1% decline in February. The ex-auto reading is expected to show a 0.1% increase after rising 0.7% in February. I think there’s a good chance this reading will disappoint, and it will be very important to watch how the market deals with this if indeed it doesn’t meet expectations. There has been a lot of optimism that consumer activity is on the rebound after the 1.0% gain in January, followed by a 0.7% gain on the ex-auto reading for February (even as the overall number showed a 0.1% decline). I’m just not sure we’re back on the road to a sustained consumer upswing as the private-sector components of income remain in decline.


Consumer Price Index for March (Wednesday)

Consumer prices as measured by the CPI are expected to rise 0.1% for both the overall number and the core rate. Core CPI on a year-over-year basis is expected to remain at 1.7%.


Industrial Production for March (Wednesday)

Industrial production (IP) has been in the tank for seven months and the degree of decline for five of the past six months has been unusually pronounced. This number must return to positive territory to offer signs that an economic rebound in upon us. We’ll note, this data has a decent lag to it, so we’ll see evidence that IP is bouncing back in the manufacturing surveys first, as they are more real time releases.


Housing Starts for March (Thursday)

Housing starts showed a strong 22% rebound in February. What the market will be watching for is evidence that at least some of this move was part of a fundamental turn in housing rather than just a rebound from the extremely depressed levels of January, which were weather-related (tough weather conditions across the country in Jan. halted construction projects and better-than usual weather in Feb. helped activity snap back. I don’t think we should expect an increase in March, but if the decline is a mild one it will likely prove a positive for stocks.


Initial Jobless Claims week ended April 11 (Thursday)

Claims are expected to come in at 660,000 for the latest week. This will be an especially important report as it is for the week that corresponds with the April jobs survey. Overall, we need to see jobless claims trend back to the 500K level, which is still an elevated position but moving out of 600K territory will be a very clear sign the worst for the labor market is over – we’re likely weeks away from this move. In addition, continuing claims need to halt making record highs.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
The two-year finished the day up 9/64, and the ten-year was higher by 19/32. The benchmark curve was unchanged on the day, and remains at +197 basis points. A basis point represents .01%.

The market will get a break from auctions this week. Next week will be a large week for incoming supply with two-, five-, and seven-year auctions being announced.

Today the New York Fed purchased $7.37 billion in Treasury notes ranging in maturities from 3/31/11 to 4/30/12. They will purchase 4.5 to 7 year notes tomorrow and Treasury Inflation-protected bonds on Thursday.

The Fed is $43.9 billion into a $300 billion Treasury purchasing campaign that is scheduled to be completed by August. With the Treasury curve essentially where it is was before the program (10 yr 2.845% as I write, was 3% before the 3/18 announcement) was announced, much of the street is beginning to feel that more will be needed in order for the Fed to achieve its ultimate goal of lowering rates.

MBS
Lower coupon collateral outperformed by 4/32 on the day with very light trading due to the holiday weekend. Prepayments continue to be volatile and unpredictable, but the market remains fixated on how successful the government’s programs turn out to be.

The national average for a 30-year fixed rate mortgage, as defined by the Mortgage Bankers Association, currently stands at 4.73%. That number could easily be 4.6% or 4.55%, but as I have said before, rates being offered to borrowers are slightly higher due to understaffed mortgage brokers and warehouses not being able to keep up with the added demand for refinancing.

Credit
Corporate bonds performed well today despite equities being relatively flat, (Dow -.32% S&P 500 +.25%). CSJ and LQD were up .43% and .96% respectively today.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

ESRX, WLP, CVX, GE, earnings season

S&P 500: +2.17 (+0.25%)

Express Scripts (ESRX) +15.54% and WellPoint (WLP) +8.03%
Express Scripts will purchase WellPoint’s pharmacy benefits management (PBM) business NextRx for $4.68 billion. The deal includes a 10-year contract for Express Scripts to provide PBM services to WellPoint, the biggest health insurer with 35 million members. According to the Wall Street Journal, Express Scripts is buying the business with a mixture of cash and up to $1.4 billion in stock.

NextRx is the fourth largest PBM in the U.S. with 32 million members. NextRx filled about 268 million prescriptions last year, the business represents about 6 percent to 8 percent of WellPoint’s earnings. The acquisition boosts Express Scripts’ prescription volume by about 50 percent, putting the company at comparable volumes as its rivals CVS Caremark and Medco Health Solutions. Express Scripts’ increased size should allow them to bid for contracts to manage major companies’ employee drug benefits.

Acquiring NextRx will give Express Scripts more negotiating power with drug prices, plus more room to its lucrative mail-order pharmacy business. Currently, only about 10 percent of NextRx’s prescriptions are filled by mail order instead of at retail pharmacies, compared with as much as 40 percent of all prescriptions at bigger stand-alone PBMs.

WellPoint benefits from the deal because they monetized a business that could not compete with larger stand-alone PBMs and may use the proceeds to enhance shareholder value by repurchasing shares or paying out a special dividend.


Chevron (CVX) -1.81%
Chevron said it expects first-quarter 2009 earnings to be “sharply lower” than in the fourth-quarter 2008 due to lower prices for crude oil and natural gas as well as narrower margins on the sale of refined products.

Chevron’s upstream business (exploration and production) likely faced higher costs, while the company’s downstream business (refining, marketing, and transportation) is expected to hurt earnings due to weaker international margins and negative timing effects.

A higher effective tax bracket, which ConocoPhillips and Hess Corporation have mentioned, might also weigh on Chevron’s results.


General Electric (GE) +7.06%
The Wall Street Journal reports that GE increased its stake in car-battery maker A123 to 10 percent, but the big move upwards may be more related to the fact that GE shares are trading more like a bank than an industrial company.


Earnings season on its way
Earnings have already begun to trickle in, but things are really getting started this week. Tomorrow we get our first look into the technology and healthcare sectors as bellwethers Intel (INTC) and Johnson & Johnson (JNJ) report. I should note that Goldman Sachs (not on our Approved List) will be reporting, which should have implications for the financial sector.

Intel’s results will be closely watched for clues on corporate and consumer technology spending since Intel controls more than three-fourths of the microprocessor market – microprocessing chips serve as the nervous system for computers. Revenue is expected to be lower, reflecting a supply chain correction as companies pared back inventory; however, it will be more important to hear where Intel thinks demand is trending.

Profitability margins – often considered the most important metric of semiconductor earnings – were likely pressured by rapid growth in sales of lower-cost Atom chips and lower utilization rates. Future declines could be offset by higher-margin products introduced this quarter, like Nehalem, and ULV chips for ultra-light laptops. In addition, Intel is making some of its largest investments ever for a new manufacturing process, which will allow them to build faster, smaller chips that consumer less energy and cost less to produce.

What to look for from INTC: (1) outlook for corporate and consumer IT spending, (2) profitability margins, and (3) product mix

Johnson & Johnson provides a diverse look across the healthcare sector, with leading positions in medical devices, over-the-counter medicines and several pharmaceutical markets. Despite its diverse product portfolio, the economy likely weighed on operating results. Last quarter, the company noted that consumers and patients were becoming more frugal, with hospitals chopping purchases and slowing sales on products ranging from contact lenses to diabetes test strips. Pharmaceutical sales were particularly weak due to generic drug competition as well as increasing layoffs that left more people without drug-benefit plans. I suspect these trends continued into the first quarter of 2009.

I am expecting J&J to announce an increase to their dividend, which they have increased annually at a double-digit rate over the last five years. I won’t be disappointed if the increase is less than 10 percent, but I will be disappointed if there is no increase at all. Most importantly, I will be listening for any updates on the company’s 10 potential blockbusters in late-stage development. The company faces roughly $6.3 billion (10 percent of sales) in patent exposure through 2009, but patent exposure significantly lessens going forward. Growth in J&J’s other businesses are expected offset the loss of patent protection.

What to look for from JNJ: (1) pipeline updates, (2) dividend increase



Quick Hits

• Bernanke Bet on Keynes Has Meltzer Siding With Friedman on Inflation Risks
• Wall Street in Wells Fargo Moment as Obama Stress Tests Earnings Euphoria
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. markets were closed for Good Friday. Today will likely be a relatively light session as European bourses are closed, which may keep some overseas investors on the sidelines even regarding their U.S. trading activity.

Market Activity for April 10, 2009

Ahoy, Miscreants!

The pirate encounter ended successfully as everyone knows by now; one couldn’t have hoped for a better conclusion, at least regarding this specific incident – certainly we have much work to do still in deterring this activity from taking innocent people hostage and keeping the shipping lanes free-flowing.

The whole incident was becoming worrisome as it looked as if we’d refrain from using our overwhelming power in this confrontation and the messages the wrong decisions would send to our enemies, who were surely watching.

No one knows the extent to which a bad outcome would have had on the economy, it may very well have given certain regimes the confidence to challenge us, which lead to events that diminish confidence in the future and hence results in both businesses and consumers reigning in spending plans to an even greater degree than has already occurred. Of course, the higher insurance costs and likelihood that ships would choose more circuitous routes are the direct economic burdens to bear. A serious effort to make pirates pay for their decisions via direct and harsh confrontations instead of simply surrendering and paying ransoms will diminish the increased costs that piracy puts on the global economy – a number of historical events shows us to path to defeating this problem.

But whether it be how the crew of the Maersk Alabama largely thwarted the pirate attack, to the bravery and wherewithal of the captain, to the U.S. Navy’s operations, the message to the world regarding every aspect of this encounter was very American – exceptional in every degree.

Chinese Stimulation

China is in the process of massively stimulating their economy. There is the much talked about $600 billion stimulus over the next two years (which will end up being far more than that as they use their state-run banks to offer easy credit – probably spells trouble for them down the road but for now will provide a huge boost). This level of stimulus amounts to 18% of their GDP, which would be the equivalent of us engaging in a $2.5 trillion stimulus program – and all infrastructure-based. Chinese demand for raw materials (base metals, oil etc.) are showing signs of life again.

We have previously talked about how Geithner should offer a quid pro quo to the Chinese – we will stop calling them a currency manipulator, which is a waste of time anyway since we’re all currency manipulators in a world of fiat money – and in turn they are to triple their stimulus plans. This way we get the economic benefit, but without driving debt levels even higher than they are already going.

But it appears the Chinese are engaging in this anyway, not to the extent that it triples the program but they are using their banks to really foment a boom – loan activity was up six-fold from the year-ago period, according to Bloomberg News.

This means we should see an export boost (exports to China were strong in the latest trade figures and there should be more of this to come) and thus the economy should show life more quickly. This event may just ease the degree of GDP contraction in the first-quarter – it looked like we were headed for another decline of 6%-6.5% at a real annual, the latest trade figures may help that contraction a bit, something closer to 5% may be the reading. And for the current quarter we may even see a slight increase, another decline has been the consensus view. (The caveat is the consumer, which I think will continue to put a drag on GDP as the private sector components of personal income are showing significant declines, but we shall see.)

Economic Data

We don’t have a release today, but get to it tomorrow with producer prices and retail sales (both March data).

PPI is expected to come in flat for the month. Core prices, which exclude the food and energy components, are expected to rise 0.1% for the month and remain at 4.0% on a year-over-year basis.


Retail sales are expected to rise 0.3% for March, after a 0.1% decline in February. The ex-auto reading is expected to show a 0.1% increase after rising 0.7% in February.

I think there’s a good chance this reading will disappoint, and it will be very interesting to see how the market deals with this if indeed it fails to meet expectations. There has been a lot of optimism of late that consumer activity is on the rebound after a 1.0% gain in January, followed by a 0.7% gain on the ex-auto reading for February – after a significant retrenchment during the previous six months, notice the gap in negative territory as identified by the green circle (chart below). It is unusual to see such a gap in negative territory, normally a decline in retail sales is quickly followed by an increase. Unfortunately, this data only goes back to 1992, we would have to go back to the 1980 recession to get a comparable contraction in consumer activity.

I’m just not sure we’re back on the road to a sustained consumer upswing as the private-sector components of income remain in decline. We’ll see months of nice gains simply as we come off of these weak levels, but it won’t be consistent for quite a while still in my view. .


Have a great day!


Brent Vondera, Senior Analyst

April 2009 Portfolio Insights

Click here to read this quarter's Portfolio Insights. This issue includes:

• Getting It Right Twice
• Does It Pay to Diversify?
• New at Acropolis
• Inside the Economy
• Bailout Scorecard
• Equity Markets Activity
• Fixed Income Strategy
• Ask Acropolis
• Big Picture

Click here or on the cartoon to access the issue.

Fixed Income Recap

Treasuries
The two-year finished the day down 3/64, and the ten-year was lower by 35/64. The benchmark curve was six basis points steeper on the day, and currently sits at +161 bps, a basis point flatter for the week. A basis point represents .01%.

$17.8 billion of the on-the-run ten-year Treasury note was auctioned today with a bid to cover ratio of 2.49 and a yield of 2.95%. The ten-year finished the day up 1/4 from the close of the auction to yield 2.92%.

MBS
The Federal Reserve Bank of New York announced $30.4 billion in agency MBS purchases for the seven day period ending yesterday. The Fed has purchased a total of $333 billion in agency MBS to date with a daily average of $4.75 billion. Wow!

Credit
Credit spreads moved tighter today on positive earnings guidance released by Wells Fargo (ticker WFC). The better than expected news from the financial sector helped the overall market for credit today. Wells officially announces earnings on the 22nd, but today’s earnings guidance (55 cents per share) was more than double the streets estimate. The company sighted better than expected loan performance and increased activity in their mortgage refinancing business; signs that credit conditions may be turning and people are taking advantage of the lower mortgage rates. With prices down all across bondland CSJ (1-3 year IG credit) and LQD (Intermediate IG Credit) were up .47% and .67% respectively.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

Daily Insight

U.S. stocks rallied, ending a two-session respite to an upswing that has now pushed the S&P 500 higher by 26.6% from the March 9 wicked low of 666. Yesterday’s move was broad-based with really nice volume, especially for the session prior to Good Friday (normally light) – 1.7 billion shares traded on the NYSE, 20% above the three-month average.

The market didn’t get any help from the day’s economic data as jobless claims remain very elevated, same-store retail sales fell 2.1% for March and the trade figures showed consumer activity remained subdued as U.S. imports fell for a seventh-straight month in February.

However, Wells Fargo pre-announced that profit would easily surpass expectations, fueling a 15.5% rise in financial shares and a 24% jump in bank stocks, in particular. We should see more of this to come. As we mentioned earlier in the week, rising interest margins will help bank results this quarter – borrow near zero and lend at 5-6%. Mortgage originations also helped Wells during the quarter; they dominate California, which has seen bargain hunting increase over the past couple of months due to a 40% average decline in home prices in the state – refinancing activity nearly doubled last quarter thanks to ultra-low mortgage rates.

Investor optimism returned after a couple of days in which doubt had set in (positive comments on the economy yesterday from WH chief economic adviser Larry Summers and Fed official Gary Stern helped that sentiment turn), helped propel industrial and basic material stocks. Energy names in general under-performed, but the sub-sector energy equipment & services shares rose in line with the overall market.

Consumer staples and utilities, the typical safe-havens, were the only sectors that failed to close on the plus side.


Market Activity for April 9, 2009

Latest Retail Sales Data

The same-store retail sales figures (when you read same-store sales it refers to the year-over-year change) were not very good for March, which follows with my assumption that the March retail sales report will decline. We’ll note, however, that Easter fell in March last year, so this does have on effect on comparisons – we’ll likely see some make-up in the April data.

The International Council of Shopping Centers’ (ICSC) index fell 2.1% for March based on the year-ago period – a 0.8% decline was expected. Four of the six segments of the index showed a decline, the drug and wholesale clubs ex-fuel components were the two in the black.

The luxury segment led the declined for the seventh-straight month, down 20.3%; department-store sales fell 10.9%; apparel sales declined 8.4%; discount-store sales slipped 0.6% wholesale club sales fell 2.3% (again, when you exclude fuel sales from this segment’s sales rose, up 4.6%); drug-store sales rose 0.9%.

Jobless Claims

Initial jobless claims fell 20,000 to 654,000 for the week ended April 4 – the previous week’s reading was revised higher by 5,000 for what it’s worth. Initial claims have exceeded the 600K level for 10-straight weeks. The four-week average was effectively unchanged, falling less than 1,000 to 657,250.


Continuing claims rose another 95,000 to a new record of 5.84 million in the week ended March 27 (continuing claims lag initial by one week, that’s not a typo). The insured unemployment rate, which is tied to the continuing claims data and closely tracks the direction of the overall unemployment rate increased to 4.4% from 4.3%, and remains at a 26-year high. This insured jobless figure give us an indication the overall unemployment rate will move higher from the 8.5% posted as of the March employment report). We’ll get a better look next week as that’s the week that corresponds to the April jobs survey.


Bottom line is we’ll need to see the initial claims figure trend back to the 500K level. The overall unemployment rate is a lagging indicator, meaning it will continue to rise even as the economy rebounds, but initial claims is one of the most reliable real-time indicators we have. Until this trend to 500K begins, we should not expect much regarding the degree of an economic bounce. As most readers know, the ISM numbers are key to watch also as these are the other real-time indicators -- ISM manufacturing will need to hit the 40 handle (last reading was 36.3) and ISM service-sector will need to improve (it has dropped the past two months).

Import Prices

The Labor Department reported import prices rose for the first time in seven months as the petroleum products component jumped 10.5% in March, coming off of previously depressed levels.


Most other components continued to decline as a stronger dollar and weak demand kept prices down. The fuels component (which excludes petro and involves just coal and natural gas prices) continues to fall at massive rates – the price of imported coal fell 14% and natural gas was down 15.8% last month, according to the report. But those segments aren’t that meaningful as we don’t import much of these products. Paper and metals prices were the main reasons for the year-over-year decline. These two segments fell 2.4% and 1.8%, respectively for the month and their 12-month declines accelerated based on the prior months figures.


Trade Balance

The Commerce Department reported the U.S. trade deficit narrowed for the seventh–straight month to the lowest level in nine years. The gap shrank 28%, the largest decline since October 1996, to $26 billion in February from $36.2 billion in January.


Imports fell 5.1% in February, down 28.8% over the past 12 months, as both consumers and businesses pull-back. On the business side, capital goods (down 6%) and industrial supplies (down 9.3%) led the decline in import activity. On the consumer front, apparel imports slipped 6.5%, automotive was down 8.2% and food and beverage down 2.0%.

Exports did rise, up 1.6% for the month -- the first increase in six months. Consumer goods, semiconductors and telecom equipment drove exports higher.

By country, U.S. exports to Australia jumped 16.4%; export to China were up 12%; exports to Europe rose 6%; Canada up 5.9%; and to OPEC countries up 10%.

While it is nice to see the export data show an increase, the import side of the report illustrates that consumer and business spending remains in the tank. We’ll want to see imports trend higher (that is, we’ll want to see a multi-month increase), which will be another indication that the economy is on the rebound.

Have a great weekend and a Happy Easter and Passover!


Brent Vondera, Senior Analyst

WMT, WFC, the Fed

S&P 500: +31.40 (+3.81%)

The biggest news story of the day was Wells Fargo reporting a first-quarter profit that beat even the most optimistic estimates, sparking a rally in financial shares. Adding to the positive sentiment were reports that banks are holding up in the government's stress tests, but some still may need aid.


Wal-Mart Stores (WMT) -3.71%
Wal-Mart again posted revenue gains in the month of March, but they fell short of lofty expectations. Same-store sales (stores open at least 12 months) rose 1.4 percent, again driven by the health and wellness, and home and grocery segments. The world’s largest retailer projects its sales growth will be at the high end of its 1 to 3 percent guidance for the quarter ending May 1.

Wal-Mart continues to focus advertising on dinnerware and drapes while slashing prices on staple food items to appeal to consumers entertaining more at home. The company expects Easter to drive April sales performance.

Other retailers reported mixed results as many are still struggling with waning consumer confidence. While some retailers cited the shift in Easter this year out of March and into the April reporting period as a reason for weakness, others noted a gain from having an extra day in the reporting period, since stores didn’t have to close for Easter Sunday in March.


Quick Hits

• How Bernanke Staged a Revolution
• The Federal Reserve: Sacred Territory
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks gained ground yesterday on M&A activity within the home-building sector, another nice mortgage application report and the first decline in the wholesale inventory/sales ratio in eight months. Oh, and insurance shares also helped out on news that the Treasury will give them Troubled Asset Relief Program (TARP) funds.

Egad! TARP the insurance companies? Following other actions, such as forcing TARP funds on some banks, a proposal to make Treasury Secretary Geithner the official arbiter of “appropriate” compensation, and now appearing to use the government’s bank stress tests to force the selling of “troubled” assets this gives the impression that one big power grab is the agenda. If you’re an insurance company that is in trouble – its receivership for you. This process works just fine; besides, we need to get a grip, polices aren’t paid out all at the same time and most never need payout at all. Let’s not go overboard here, especially since many insurance profits are only back to 2005 levels – we don’t need to bailout insurance companies’ investment portfolios.

Back to yesterday’s trading, the economic data drove the market higher, reversing what looked to be a down session as futures were meaningfully lower in pre-market. The fact that the purchases segment of the mortgage apps data showed a nice increase and wholesaler sales rose for the first time since the economy hit the dirt late last summer, which is why the inventory/sales ratio improved, was big news.

The gains were broad-based, as nine of the 10 major industry groups gained ground – led by consumer discretionary and tech shares. Telecom was the only group to remain below the flat line.


Market Activity for April 8, 2009


Crude

The price of oil for May delivery rose for the first session in four after the Energy Department’s weekly inventory report showed stockpiles rose less than expected. Crude supplies rose 1.65 million barrels to 361.1 million last week. Even though this is the highest level since July 1993 stockpiles were forecast to jump 6.94 million barrels. Crude had declined the past few days on the assumption of a much higher inventory build and even though stockpiles are at a 15-plus year high, and demand is down, the much lower than expected build ruled the day.

Mortgage Applications

The Mortgage Bankers Association reported their mortgage applications index rose for the fifth-straight week – this time though the rise in purchases surpassed the increase in refinancings. Purchases jumped 11.1% in the week ended April 3 and refis rose 3.2%. The 30-year fixed mortgage rate fell below 5.00% during the week of March 6 and the index has gained ground ever since.


Refinancing activity remains the driver of the index as this segment makes up 78% of mortgage-loan activity, but the double-digit rise in purchases is a very welcome sign – it will be interesting to watch if the very low mortgage rates will be enough to offset the drag a bad labor market has on sales.

Wholesale Inventories

The Commerce Department reported that wholesale inventories fell at double the rate expected, declining 1.5% in February. The sales data recorded the first increase in eight months, a very good sign that may provide evidence the production needed to rebuild stockpiles is not far down the road – this will work as a nice catalyst to GDP growth by the third quarter if the sales pick up becomes a trend.

Durable goods inventories plunged 2.4% for February, the largest decline on record (the record isn’t that long though, just back to1992) led by a large 7.9% drop in automotive stockpiles.


While the very large inventory declines (down $62.6 billion over the past three months at an annual rate, which means the larger business inventories figure will show a $250 billion decline when we get that reading on April 14) will weigh heavily on the first-quarter GDP reading, this is very good progress for subsequent quarters. Again, we need to see the sales data trend higher.

Inventory Dynamic (but is a sustained economic rebound likely?)

And speaking of inventories, the WSJ ran a good piece yesterday morning touching on how inventories have been liquidated to the point that they’ll need to be boosted fairly soon – that means more GDP-enhancing production as stated above.. This is a topic long-time readers of this letter are familiar with as we have talked many times of inventory trends over the past several years and specifically of the inventory dynamic over the past couple of months.

It’s important to realize that we went into this downturn with a much lower inventory-to-sales ratio than is typically the case. The amount of inventory bloat generally determines the duration of an economic contraction as excess stockpiles must be sold off prior to production ramping up again. The fact that we began at low inventory levels at this point in the business cycle (not to say the inventory-to-sales ratio hasn’t sky-rocketed over the past several months as sales plunged due to the credit event that began in September, because it has as the above chart shows) will help to make this downturn less severe than it otherwise would be,

That said, the problem with this recession is that it is led by a credit event and a very serious contraction in consumer activity as very low interest rates encouraged too much debt – a situation that will take time to work off. And the policy decisions of late do not address this issue -- in fact what we’re doing will only compound issues over time. Simply because overall stockpiles have come down in a large way, it is not a sufficient condition for sales to bounce back in a way that normally occurs to drive the inventory-to-sale ratio much lower. (The most abrupt decline in stock prices since the 1974 bear market may also keep consumer activity somewhat subdued – call it the reverse side of the wealth effect. This move in equity prices has even more meaning today; most consumers did not have their savings in the stock market back then; same is true for the 1987 market crash.)

We’ve spent so much time harping on the need for broad-based reductions in tax rates because this is the surest way to fire up investors’ animal spirits – especially via tax rates on capital. And as goes the direction of the stock market, so goes consumer and business optimism. What’s more, lower taxes on income will drive disposable income higher as we wait for business spending to come back around – and we need businesses to be confident about the future because the business spending segment of GDP will be relied upon to drive things as consumer activity will not be as robust as it had been over the past several years.

We can’t stress this enough – confidence is key. I’ll remind you that during the previous expansion firms managed their businesses in a pretty cautious manner (likely because of heightened geopolitical risks and high energy prices). This will be the case this time as well, but intensified, as firms are surely watching what the government is doing and therefore may lack the confidence that is needed for a serious production ramp up. This caution from business is not all bad as firms will remain extremely streamlined and at some point things will flow again. However, the point in the shorter term is that this is just another reason (along with the time consumers will need to get things right again) the expansion that will eventually come may prove to have a much shorter life than the previous three business-cycle upswings; caution among businesses will have a negative effect on job growth and production.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
The two-year finished the day down 1/32, and the ten-year was higher by 15/64. The benchmark curve was seven basis points flatter on the day, and currently sits at +191 bps. A basis point represents .01%.

$35 billion of three-year Treasury notes were auctioned today with a bid to cover ratio of 2.42 and a yield of 1.385%. The yield on the three-year dropped 10 bps after the rally in stocks was erased by the release of the FOMC minutes at 1pm Saint Louis time. Although equities rallied to end the day up 1%, Treasuries remained strong throughout the afternoon.

FOMC Minutes Released
The minutes from the Federal Open Market Committee’s March 18th meeting were released this afternoon. The minutes detail the discussions behind the Fed’s decision to boost purchases of agency Mortgage Backed Securities from $500 billion to $1.25 trillion, purchase $200 billion in agency debentures (up from $100 billion), and $300 billion in US Treasuries.

The committee’s projections for GDP growth were reduced “with real GDP expected to flatten out gradually over the second half of this year and then to expand slowly into next year.”

The Fed’s decision to buy Treasuries to bring rates down further was not a unanimous one. Some members voted for “very substantial” increases in open market operation, while others recommended less of an increase. The $300 billion allocated to Treasury purchases was probably on the more conservative side of the discussions, but with rates just about where they were before the announcement on March 18th an increase doesn’t seem out of the question.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

PFG

S&P 500: +9.61 (+1.18%)

Principal Financial Group (PFG) +21.28%
The Wall Street Journal reports that the Treasury Department has decided to grant TARP funding to life insurers. No details have been released regarding which companies will receive aid. Life insurers argue that federal capital injections would allow them to buy more bank bonds and stimulate lending – the industry owns about $1 trillion in corporate debt.

AIG’s expanded and drawn-out rescue has played a big role in the delay of a decision on the insurance industry’s requests for aid. Principal Financial Group filed their TARP application back in November 2008. The insurance industry shouldn’t have been as aggressive – hindsight is 20/20 – but that won’t be a problem once the government gets involved and insurance profits are tamed for a long time.

In Principal’s case, the Life and Health insurance segment accounted for 45 percent of operating revenue in 2008. Like their peers, Principal has sizeable losses in its investment portfolio that back their policies. Principal, however, avoided guaranteeing minimum returns in their variable annuity business, which is a practice that has exacerbated problems for their peers.

Still, the bigger reason we continue to hold Principal (aside from the tremendous upside) is their Asset Management segment, which accounts for well over 50 percent of operating revenue. The bread and butter of this segment is Principal’s 401(k) business, which is a dominating player in the small to medium-size business market.

Because less than 20 percent of companies with fewer than 100 employees have 401(k) plans, Principal has plenty of opportunity to grow through this underpenetrated market. What may prove to be more important to Principal’s growth is their growing presence in several emerging markets such as Chile, Mexico, Hong Kong, Brazil, India, China and Malaysia.



Quick Hits

• ‘I Want You,’ Uncle Sam Says to Wall Street’s Jobless Financial Analysts
• Energy Prices May Rise on ‘Slingshot’ Effect After Credit Chills Drilling
  
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks declined yesterday as a pull-back was bound to occur after another strong rally last week, which marked the fourth weekly gain.

As mentioned yesterday, stocks may have a rough patch to get through as we’re heading into what will be the worst ex-financial earnings season we’ve seen during this contraction. Bank profits should help overall S&P 500 earnings as interest spreads (borrow near zero and lend at 5-6%) could help this segment post an actual profit increase, which would be the first since Q3 2007 for the group.

But ex-financial S&P 500 profits, which posted their first quarterly decline (since this mess began in September) during Q4 earnings season, will likely fall 30%. This will be difficult for the market to deal with following the strong upswing that took place off of the wicked 666 low of March 9 – up 25% prior to the past two sessions. Since we’re range bound, it will be important to make the necessary pull back short and sweet. If we keep it to a 10-12% decline, our guess is we’ll re-rally in quick order. (This view is somewhat supported by activity during the equally nasty bear market of 1974.) If it’s more than that, it may invoke enough fear to make a quick resurgence difficult.

In terms of economic data, the market will be focused on Thursday’s jobless claims figure and next week’s retail sales number for March. We’ll probably need to see some improvement in jobless claims – at least some sign we’ll trend back to the 500K handle – and it will be imperative for March retail sales to post a gain – too many people are riding on the assumption that consumer activity can rebound in a sustained way so if this number disappoints it may be a rather tough blow for market psychology to absorb.

In terms of the sector trade, the cyclicals took the beating yesterday– industrials, telecom, basic materials, consumer discretionary. The relative winners were the typical safe-havens – utilities, health-care and to a lesser degree, staples.

Financials held up relatively well for the vast majority of the session, but plunged 2% in the final 20 minutes of trading – possibly on news that the Manhattan DA uncovered an Iranian/Chinese money laundering scheme in which they used fake companies to facilitate the purchase of banned materials to make missile systems and nuclear weapons.


Market Activity for April 7, 2009


Crude

Crude oil moved below $50 per barrel yesterday, falling 3.2%, (and off by 10% over the past four sessions) as traders anticipate this morning’s Energy Department report will show stockpiles remain at a 15-year high, or 13% above the five-year average – this is something that has occurred very quickly as stockpiles were in line with the five-year average just three weeks back. Daily fuel demand appeared to be on the rise as the prior four-weeks showed demand increased 1.2% from the year-ago period. However, last week’s report showed demand fell a pretty substantial 4.4% for the latest four week based on year-ago levels.
.
Until global demand picks up oil will continue to trade on the dollar and stocks (that is when doubt begins to rise regarding a global economic rebound, the dollar – the crisis/safe-haven currency – value rises and stocks sell off, in which case oil comes under some pressure, and vice versa).

Some traders hopped onto the oil train as a way to hedge against the inflationary event that is likely to come as the Fed and Treasury (along with other governments) are pumping trillions into the system. This is what made it look like we were headed for $60. However, between pessimism over earnings season and recent predictions that the rally won’t last, that hedge has come off a bit. (Last night’s earnings results out of Alcoa won’t help the commodity trade over the short term either.)


The Old Washington 180

In a dramatic, but typical, political reversal (“Who me, I never advocated that?”) House Financial Services Committee Chairman Barney Frank has proposed legislation prohibiting lenders from extending mortgage loans to those who can’t afford them – one assumes Mr. Frank determines the parameters, which is scary enough. What’s amazing about this is that Mr. Frank was one of the most vocal members of Congress over the past decade demanding that banks offer credit to low-income households – some of you may recall he is also the person quoted as saying, “I want to roll the dice” with Fannie and Freddie. What we’re going through today is yet another serious consequence of government’s social engineering plans –specifically the 1995 modification of the Community Reinvestment Act. (And we shouldn’t let the Fed off the hook by blaming only the members of Congress, for it is their massive monetary policy mistakes that made the whole leverage issue and housing bubble possible.)

As is typical, Congress is behind the curve as the market is already well into this process --- those with low credit scores have largely been shut out of the credit markets for the past six months. The shift in credit standards (and the lack of private sector financing as a result of default rates) has been so dramatic in fact that the Fed has rolled out a series of facilities to address this issue.

Second Thoughts?

In other news involving the government and their attempts to ameliorate credit conditions, Treasury Secretary Geithner seems to be running into some difficulty finding participation in the Public-Private Investment Program (PPIP). The fact that Geithner hasn’t been able to officially announce the participants (which was only five based on the restrictions they place on participation) spells trouble. Now they have come out and extended the time with which to apply, stating the reason for the extension is to allow smaller and minority-led firms into the PPIP.

Call me skeptical, but this looks like a way to disguise a lack of alacrity to participate – gee, the populist wave Congress is fomenting can’t be a cause of this possible hesitation could it? On the current political trajectory, firms can’t be sure they’ll be able to keep the potential profits – especially when the press starts reporting on the degree of profits made and the very attractive terms with which the government extended them loans.

Same is true for the Federal Reserve’s TALF program (a program that is largely focused at reducing consumer-lending costs). The goal of TALF is $1 trillion in activity, yet in its first week investors applied for only $4 billion in loans and the Fed received applications for just $1.4 billion in last week’s round – at this rate the $1 trillion goal will be reached by the year 2200. It’s not difficult to understand why investors have become wary of dealing with the government.

Consumer Credit

The Federal Reserve reported that consumer credit fell $7.4 billion in February, or 3.5% at a seasonally-adjusted annual rate, to $2.56 trillion. The decline marks the fourth decline of the past five months. The January reading was revised higher to show a $8.14 billion increase.

This report on consumer credit involves both revolving (such as credit cards) and non-revolving (fixed payment loans such as auto and student loans) – mortgage loans are not included in this data. Revolving credit continues to retrench (down 9.7% at an annual rate), while non-revolving credit was virtually unchanged.

The plunge in the stock market, the continued decline in home prices (for most regions) and rising unemployment have sent a clear signal to consumers to reduce credit card balances, or at least reduce transactions. This is an event that simply needs to run its course. Over the next several months, it means a sustained rebound in consumer spending is unlikely.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
The two-year finished the day up 1/16, and the ten-year was higher by 7/64. The benchmark curve was unchanged on the day, and remains at +198 bps. A basis point represents .01%. Treasury prices traded within a tight range throughout the day but ended higher on the weakness in equities.

$5.7 billion of ten-year Treasury inflation-protected securities were auctioned today with a bid to cover ratio of 2.25 and a real yield of 1.589%. TIPS are purchased with a fixed coupon that pays interest on a principal amount that is adjusted every month for inflation.

The Fed will buy 1-2 year Treasuries tomorrow.

FDIC Expansion
If the Public-Private Investment Program (PPIP) ever gets off the ground, and that is still a pretty big “if”, the FDIC may begin to look a lot like Fannie and Freddie. The FDIC is being summoned by the Treasury to provide guarantees for the leverage used in the PPIP; a situation similar to Fannie Mae and Freddie Mac being used by the government to absorb the risk that private investment is currently shedding in the housing market. A PPIP refresher.

Sheila Bair, chairwoman of the FDIC, was quoted in Monday’s NY Times estimating “Zero risk for insuring the PPIP.” That’s an interesting viewpoint considering that they are providing non-recourse leverage for the purchase of securities collateralized with auto and credit card loans on a 6-to-1 debt to equity basis while splitting the profits down the middle with the private investor. “Zero risk”? Not exactly the words I would use to describe such a plan.

As if the risks (sans reward) associated with the government’s involvement in PPIP aren’t alarming enough, it’s difficult to listen to the person at the helm of it all flat out denying any risk. Mispricing of risk (think Angelo Mozilo), and in some cases flat out denial of it (think Jimmy Cayne), are at the heart of the credit crisis. It’s astonishing to me that decision makers still believe that wishing risk away is the answer.

The deadline for private institutions to apply for participation in the PPIP was extended yesterday to April 24th and many are speculating the Treasury is struggling to find participants. This is thanks in large part to a change in FASB guidance on mark-to-market accounting that makes the program much less effective. Maybe the Chairwoman was referring to the program never really coming to fruition when she described the FDIC’s commitment as “zero risk”.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

EMR, WLP, UNH, earning season will be the X-factor

S&P 500: -19.93 (-2.39%)

There seems to be a bit of profit taking ahead of profit season. Corporate earnings are the big X-factor in determining the sustainability of the most recent rally. The first quarter was likely a huge stinker and earnings will likely carry less weight in the market than the outlooks companies are giving. Are things the same, getting worse or getting better? What are companies saying about jobs? Are there any real surprises? While there are some big names releasing earnings this week, next week is when things really start getting interesting.

Emerson Electric (EMR) unch
Emerson cut its profit forecast for the year, citing falling demand and inventory reductions by customers. The company now expects earnings between $2.40 and $2.60 per share, down from $2.70 to $2.95 per share.

The company said the weak economy has taken a toll on Emerson’s residential, nonresidential and capital businesses.


WellPoint (WLP) +2.27% UnitedHealth Group (UNH) +6.93%
Insurers with U.S. Medicare-backed health plans for the elderly and disabled advanced after Centers for Medicare and Medicaid Services announced a rate increase of 0.8 percent in 2010, higher than originally proposed.


Quick Hits

• Gates Cuts to Boeing, Lockheed Spur Fight in Congress
• Cisco Forges Ahead With Acquisitions as Technology Companies Cut Spending
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks broke a four-day winning streak as traders took some profits ahead of today’s kickoff to first-quarter earnings season – although a nice move in the defense sector helped the Dow and S&P 500 pare losses (aerospace and defense shares jumped 3.6%.)

Frankly, I thought yesterday would prove to be a rough session following the North Korean launch of a multi-stage rocket. Not only because North Korea showed they’re inching closer to a long-range deliver system, but also because of the known relationship with Iran and knowledge (no matter how far behind industrialized nations) sharing between the two. And we propose cutting slashing our missile-defense budget a day later? It’s very dangerous to send the wrong messages. Traders totaling brushed it off, however.

Banks took the brunt of yesterday’s losses following comments from Treasury Secretary Geithner on Sunday. He makes these statements about being prepared to force the removal of bank executives and boards – even if some should be removed all it does is increase doubt over how far they’ll go or what ruse they’ll use to invoke more power within the banking system. As if the government is capable of finding competent replacements anyway. What’s their goal; to overtly direct lending to the channels of the economy that they see fit? It’s troubling to think of the direction they’re taking.

A pessimistic report from a major bank analyst also pushed the shares lower -- financials fell 2.93%.

Basic material, energy and consumer discretionary stocks were among the other drags, as is generally the case on these days in which the market wonders that maybe the economy has yet to bottom. (Odds are it has, but to say so with conviction is not possible at the present. Even if it has it’s difficult to see a sustained expansion – consumer activity as a share of GDP will be curtailed for quite a long time and policy isn’t exactly giving businesses the confidence to boost expenditures, which is already weak simply because of the languid economy.
(What’s needed is policy that fires up business optimism. Policymakers need to acknowledge that it will take some time for the consumer --in the aggregate -- to become healthy/comfortable again. This is why they should be focusing on the business side instead of vilifying the private sector.)

The breakdown of the deal between IBM and Sun Microsystems, as Sun did its best impersonation of Yahoo! by demanding a higher bid among other things, hurt the tech sector. Sun shareholders will wish they took IBM’s price.


Market Activity for April 6, 2009


Even though we lost a little ground activity certainly seemed to be quite positive yesterday – rallying in the afternoon session in front of today’s start to first-quarter earnings season; however, one should not expect this rally to continue unabated and big down days are probably going to with us for an extended period. Yes, stocks typically rebound 4-5 months ahead of an earnings recovery but we have at least two really tough quarters to get through first and we may have to wait until the fourth-quarter to see a meaningful profit rebound.

Financial-sector profits should be much improved for Q1 earnings season – thanks to rising interest margins – but we’ll have to endure depressed results from industrial, technology and consumer-related sectors that will push S&P 500 profits down between 30-35%. And the profit improvement within the financial sector may prove short-lived as a nicely positive yield curve, which is what delivers higher interest income, may not be able to offset rising credit-card delinquencies (simply a result of rising unemployment) and an acceleration in commercial real-estate default rates. Thus the sector may not offer the help some expect regarding Q2 and Q3 overall earnings results. It may take another nine months for the overall profit rebound to unfold.

So, this rally has been a very welcome event, and one could certainly feel it coming as we mentioned in the March 5 letter, but it’s been a strong upswing and traders will eventually look around and find stocks nicely higher from the low, yet many of the same macro (along with economically exogenous) problems remain in play. A degree of caution and a refrain from chasing these rallies is probably the main thing to keep in mind. During normal downturns you don’t want to have these shorter-term tendencies, but this is not normal and we could be range-bound for an extended period; buying at the higher-end of this range should be accompanied by a willingness to accept several stints of continued weakness.

The Week’s Economic Data

We will have to wait another day for a meaningful release. This afternoon we do get consumer credit for February, but this is not one of the big readings.

Tomorrow we get mortgage apps and wholesale inventories. We’ll look for mortgage apps to rise for the fifth-straight week, fueled by refi activity. Wholesale inventories will likely provide additional evidence that the degree of inventory liquidation last quarter was significant. I think we also get the minutes from the Fed’s last meeting – although Bernanke has been so vocal lately I’m not sure there will be anything new to take from the minutes.

Thursday we get the trade balance for February, import prices for March and initial jobless claims. On Friday markets are closed.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
The two-year finished the day flat to where is ended last week, and the ten-year was lower by 3/8. The benchmark curve was 4.7 basis points steeper on the day, and remains at +198.7 bps. A basis point represents .01%.

Treasury prices see-sawed throughout the day but were mostly down by the end of the afternoon. Concerns over this week’s coming supply ruled the day, but a small rally appeared late in the morning after the Fed announced the results of their Treasury bidding. The Treasury will auction $6 billion of the 10-year TIP on Tuesday, a new 3-year issue on Wednesday and reopen the on-the-run 10-year nominal note.

The Fed purchased $2.53 billion of Treasuries today in the 10-17 year area. As expected, buying was concentrated in the shorter end of the maturity range with 65% of the buying in 2019 and 2020 maturities. The Fed will buy more Treasuries on Wednesday.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

Daily Insight

U.S. stocks were able to shrug off another bad employment report (largely because the numbers came in at expectations and the prior month’s reading was not revised lower) to extend the weekly rally. The 3.26% rise on the S&P 500 last week marks a month of gains that has moved the broad index 26.5% above the March 9 low.

Stocks did begin the session lower Friday but rallied mid-morning following Fed Chairman Bernanke’s comments explaining their programs to unfreeze credit markets is working.

(Now let’s hope that Treasury Secretary Geithner doesn’t use their bank stress tests as a way to force financial firms to participate in the PPIP (Public-Private Investment Program). For new readers who may not know, this is the Treasury plan to remove toxic assets from bank balance sheets. The PPIP is not needed now that FASB has voted to allow modification to mark-to-market – banks can hold these assets on their own balance sheets now that those that do not have the liquidity to make a market, and thus are trading at distressed prices even if they are performing on time, wont’ necessarily have an effect on regulatory capital. If Geithner chooses to use the stress tests as a cudgel I don’t see how this doesn’t completely offset the beneficial effects of the accounting change.)

Most of the 10 major industry groups gained ground on Friday with financials leading the way. The only two that declined were health-care and consumer staples.


Market Activity for April 3, 2009

Economic Releases

The Jobs Report

The Labor Department reported that 663,000 payroll positions were lost last month, which was in line with expectations. While the whisper number expected a loss of more than 700,000 it’s still tough to see a bright spot – the March reading marks the fifth-straight month in which we’ve lost at least 600,000 payroll positions; 5.1 million jobs have been lost over the past 15 months, 73% of which have occurred in the past six months (as we often state, everything changed in September.)

Goods-producing payrolls shrank by 305,000 in March, a slight acceleration from the -285,000 for the prior month. Construction lost 126,000 (slightly worse than the 107,000 decline in February) and manufacturing lost 161,000 (a slight improvement relative to the 169,000 decline in February).

Service-sector payrolls sank by 358,000, a bit less than the -366,000 in the prior month. Trade and transportation payrolls fell 112,000, slightly better than February’s reading of -121,000. Business services lost 133,000, meaningfully better than the 178,000 decline in February. Job losses in the leisure and hospitality segment accelerated, which is what kept total service-sector job declines pretty much in line with the previous month’s decline.

Health-care services remains the only employment segment that has yet to show a monthly decline during this contraction, adding 14,000 jobs last month.


The unemployment rate jumped to 8.5% (as expected) from 8.1% in February. The unemployment rate runs off of the household employment survey (the number mentioned above, and the figures you read and hear about in the news come from the payroll survey – also called the establishment survey).

The household survey includes the self-employed and we mentioned last month that we saw a silver lining with regard to this figure as losses eased substantially, down 351,000 in February compared to a 1.24 million decline in January. Well, that appeared to be wishful thinking as the household survey showed another big job loss of 861,000 in March.


The average duration of unemployment rose to 20.1 weeks in March from 19.8 in February. The median duration of unemployment rose to 11.2 weeks from 11.0.

It will really be tough to see consumer activity rebound in a sustained way so long as this level of labor-market deterioration continues, especially since the availability of credit is not there for those with less than auspicious credit scores, as it had been for a number of years. While more appropriate credit standards are helpful for the longer-term health of the economy, in the short run the degree with which the consumer has catalyzed GDP over the past several years will diminish.

This is yet another reason we advance the notion that broad-based tax cuts are key to getting the economy back on its feet in a sustained manner. What this does for the consumer is boost disposable income as we wait for the business side of things to kick in again. And on the business side, slashing tax rates boosts their confidence in the future and provides the incentives to produce. Substantial reductions in the corporate tax -- along with a huge reduction in the repatriated income tax rate, currently set at 35%, (the tax that must be paid when U.S. firms with overseas subsidiaries bring that capital back home – which means it doesn’t come back home ) would boost corporate profits and provide a huge capital boost that would fuel business-equipment spending. Alas, such proposals are anathema among the current political class.

ISM Service Sector

The Institute for Supply Management’s service sector index fell in March to 40.8 from 41.6 in February – a reading of 42.0 was expected. (The index tracks service industries such as real estate, wholesalers trade, management and support services, education, professional and scientific, utilities, health-care, fishing and hunting, transportation and finance and insurance.)


The business activity sub-index (this is a general sentiment index – and for clarity, the headline number cited above equally weights the sub-indices business activity, employment, new orders and supplier deliveries) rose to 44.1 in March from 40.2 in February, bringing the reading almost back to where it was in January. A pick up in sentiment in the real estate sector pushed the sub-index higher.

New orders contracted for the sixth-straight month, registering 38.8 in March from 40.7 in February and the degree of contraction increased for a second-straight month.

The employment sub-index fell to 32.3 from 37.3.


We have seen the manufacturing sector improve ever-so-slightly, which is hopefully a sign this segment of the economy has bottomed. Cautious optimism is the appropriate approach as we do not yet know the extent to which the auto sector will continue to weigh on this sector. The service sector though is not showing signs of a bottoming. Possibly, the Fed’s work in reducing mortgage rates will incrementally boost the real-estate segment of this ISM report and we will see some mild improvements from here.


Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
The two-year finished the day down 1/8, and the ten-year was lower by 1&1/8. The benchmark curve was 7 basis points steeper on the day, and remains at +194 bps. A basis point represents .01%.

Although the employment numbers were ugly, Treasuries were down at the open and got worse as the day wore on due to renewed concerns over next week’s supply. The Treasury will auction $6 billion of the 10-year TIP on Tuesday, a new 3-year issue on Wednesday and reopen the on-the-run 10-year nominal note.

The Fed will purchase 10-17 year notes on Monday and 1-2 year notes on Wednesday of next week.

Fed Purchase Programs
The Fed purchased $32.9 billion in agency MBS during the period ending Wednesday April 1st. The weekly average has moved to about $32 billion since they announced the increase a few weeks ago, from about $18 billion before the increase.

Fed Chairman Bernanke spoke today about how the Fed purchase programs are having their desired effect. Something that was not possible through the traditional method of lowering the Fed Funds Target Rate.

The Fed’s balance sheet, which stood at $870 billion before the collapse of Lehman Brothers, currently stands at $2 trillion with 45% of that being short term liquidity programs implemented by the Fed. Five Percent of the Fed’s balance sheet consists of loans to AIG and Bear Stearns. The Chairman noted that although some portions of the balance sheet carry more risk than others, the Fed intends to be made whole on all its outlays.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

REITs

S&P 500: +8.12% (+0.97%)

REITs
Shopping center developer Kimco Realty Corp (KIM) joined the growing list of REITs that are slashing dividends and issuing shares to shore up their balance sheets. Although these actions are dilutive to current shareholders, investors are applauding actions taken by REITs to stabilize their balance sheets.  Perhaps investors will finally return their focus to leasing fundamentals rather than balance sheet deficiencies.

One of the flaws with the REIT model is that companies pay out most of their earned cash, so they need debt or equity to continue growing. With the capital markets still tight, companies have resorted to selling new shares despite the fact that most are trading well below intrinsic value. Still, adding cash greatly improves a company’s chances of meeting debt maturities and surviving the recession.

REITs may also be benefiting from FASB’s change to the mark-to-market, which should provide lenders with regulatory capital relief. This, in turn, should free up more capital and make it easier for REITs to get financing.

Things are definitely improving for REITs.




Quick Hits

• Dell, Ingersoll-Rand Pay Up as Recession Lifts Borrowing Costs
• GE Threatens Phillips Leadership With Push Into Home Healthcare Business
• Buffett Back in the Money on Goldman Sachs Warrants After Rally

Peter Lazaroff, Junior Analyst

Fixed Income Recap

Treasuries
The two-year finished the day down 9/64, and the ten-year was lower by 49/64 on strength in the stock market (S&P +2.87%). The benchmark curve was 3 basis points steeper on the day, and remains at +187 bps. A basis point represents .01%.

FASB Releases New Mark-to-Market Guidance
The Financial Accounting Standards Board revised the rules associated with how financial institutions must value certain “difficult to price” assets. The new rules give institutions the opportunity to price some assets based more on their own judgment rather than relying on prices from fire sale transactions.

Banks have been writing this stuff down pretty extensively now and this rule change doesn’t reverse any of the losses taken to date. However, fears of more write-downs have haunted investors for the past 18 months and profitability and regulatory capital ratios stand to look much better in the future thanks to this ruling.

Treasury Purchases by the Fed
The Fed purchased $7.5 billion in 4-6 year Treasury notes today. The Fed will purchase 10-17 year notes on Monday and 1-2 year notes on Wednesday of next week.

FDIC Insured Corporate Bonds
The FDIC’s Temporary Liquidity Guarantee Program (TLGP) was extended to December of 2012, (the previous limit was June of 2012). In addition to the term extension, an increase in fees will begin in June of this year in an attempt to dissuade borrowers from using the program while recapitalizing the FDIC’s reserves. The original fee of 100 basis points annually will be increased 25 basis points for debt maturing by June of 2012 and 50 basis points for debt maturing after that. For non-bank entities like GE Capital the fee increases will be larger.

I’m not sure if the fee increase will really deter any bank from issuing debt under the program. Even considering the fee increase, issuing debt under the TLGP program is still vastly cheaper than issuing debt without the FDIC’s guarantee. About $350 billion dollars worth of debt has been issued under the program to date, while program participants have brought only 2 non-TLGP issues to market over the same period. Goldman, B of A and Citi are going to continue to take advantage of this program as long as it remains cost effective.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

Daily Insight

U.S. stocks posted another very good session yesterday, as the rally from the wicked low of 666 continues. News that FASB voted to modify the accounting rule that has done undue damage to regulatory capital within the banking system offset a jobless claims figure that shows no sign of improvement within the labor market.

Yesterday the Financial Accounting Standards Board (FASB) approved changes to fair-value (mark-to-market) accounting that will allow financial firms to use “significant” judgment in valuing assets to reduce write downs on certain investments – namely those in which there is not sufficient liquidity to make a market.

The key here is that “relaxing” the rule at least partially breaks the link between these assets and regulatory capital and this will help to ease the impact the November 2007 accounting change has had on banks’ ability and willingness to lend (it has unjustifiably been vaporizing capital). This will also allow firms to mark an asset to the underlying cash flows instead of having to price to distressed levels even for securities that are performing on schedule.

This likely helped yesterday’s rally, although we should acknowledge that the bounce off of the March 9 low is at least partially a result of the market pricing this event in as it’s been telegraphed for a couple of weeks now.

It was really nice to see something other than the financial sector lead the overall rally for a second-straight day now. This could be a sign a broader-based leadership is occurring. Transportation stocks are on a tear as well, which is essential to see if we’re going to add onto this upswing – the Dow Jones Transportation Average jumped 7.9% yesterday and is up 38% from its March 9 low.

To throw a guess out there, I think we can add another 10% or so to this rally, which will put the broad index at 20 times our low-end earnings range estimate. Beyond that it’s going to be tough to keep going as there are still tough job numbers to get past, a first-quarter earnings season that will be ugly (banks will show improvement but industrial, tech and consumer sector profits will be weak), legislative risks and rogue regime activity that no one is really talking about right now.

A really good session could have been a great session yesterday, but we lost some momentum in the afternoon and failed to hold above 842 on the S&P 500, which may be a level technicians are viewing as resistance -- that was the October 10 intraday low. October 10 marked the first true low put in during this six-month stock-market debacle; then we had the penultimate low hit on November 20 and the latest devilish low of March 6.


Market Activity for April 2, 2009


G-5, G-7, G-8, G-20, G… whatever

I’m not going to waste much time on the G-20 show-- and the fact that it involves so many members should alert people to the high probability that its ideas are going no where. Heck, the G-8 (formerly the G-7, and before that the G-5) hadn’t agreed on anything since the Plaza Accord of 1985 – and a good thing too as the agenda from these groups are as anti-American as those of the UN.

The farce of this latest gathering (not to be confused with the farce of all of those rock-wielding miscreants outside the event pretending to be anti-capitalists, the majority of which cannot even define the term, but are actually nothing more than delinquents who never miss an opportunity to spur chaos) is that they are leaning on the IMF to spark an economic revival.

The IMF, as its 65-year history proves, is not capable of profound economic incitement, but unfortunately they are quite adept at transferring wealth from the American taxpayer to all kinds of indecorous regimes. But fear not, as the addition of another 12 members (and thus 12 more competing self interests) to the G means it’s highly unlikely even a fraction of their agenda will be accomplished.

(The hilarious aspect of the convocation – well hilarious if it we weren’t talking about so much money and this wasn’t the fraction of the G-20 agenda that will be accomplished – is that the group agreed to add $1 trillion to the IMF. Where do people think this money comes from? It’s sapped directly from the private sector; so someone please tell me how this boosts anything. The Keynesians in charge incessantly focus on their precious “aggregate demand” but how exactly is aggregate demand boosted when you take $1trillion from the private sector and hand it to the IMF to distribute as they wish. Reality is it doesn’t boost anything, but rather does damage as the IMF can hardly allocate these resources in the efficient manner the market is capable of.)

Jobless Claims

The Labor Department reported initial jobless claims for the week ended March 28 jumped to the highest level since September 1982 and sits just 25,000 below the all-time high. (Still, when you adjust for employment growth -- there were 88 million payroll positions in 1982 vs. 132 million today -- claims would have to be higher by 300,000 than they are currently to compare to the labor market conditions in the early 1980s).

Initial claims rose to 669,000 from 657,000 in the prior week (that prior week’s reading was revised higher by 5,000). The four-week average of claims rose 6,500 to 656,750.


Continuing claims hit the highest level since records began in 1967, rising 161,000 to 5.728 million.


The insured unemployment rate (which tracks the direction of the overall jobless rate) rose to 4.3% from 4.2% in the prior week. This insured unemployment rates has hit the highest level since May 1983, when the overall jobless rate hit 10.1%.


This data continues to signal the job market will continue to worsen. We’ll note, the unemployment rate is a lagging indicator – it will continue to rise and will peak even as the business cycle returns to expansion mode. But this claims data is what is known as a coincident indicator, meaning it’s a real-time look at economic conditions. This figure has to show some easing, along with ISM hitting at least the low 40s (currently at 36), before signaling the economy is truly rebounding.

Factory Orders

The Commerce Department reported that factory orders rose for the first time in seven months, mirroring the direction the durable goods report showed roughly a week ago – factory orders also include non-durable goods orders, or those goods that are not necessarily meant to last at least three years.

Orders rose 1.8% in February after falling 3.5% for January, which was revised down from the 1.9% decline estimate when the January report was first released.

The damage witnessed in factory orders over the past six months has been harsh, falling 33% at an annual rate since September (that’s with this latest increase). This latest reading showed nice increases in construction materials, machinery, and computer and electronics orders. The key figure we watch is nondefense capital goods ex-aircraft (a proxy for business-equipment spending). This segment of the report jumped 7.1% for February after plunging 46% at an annual rate in the previous six months.


Now let’s add to this rebound and we may be onto something.

Big news today is the release of the March jobs report. We’ll likely see a decline of 700,000 payroll positions, the consensus estimate is for a 670,000 decline. The market should be able to look past this reading though as it has already factored it in. It may take a decline that approaches 750,000 to drive a substantial sell-off in stocks.

We’ll also get the ISM services-sector reading which has moved slightly above the low put in in November – although the February reading did decline relative to the January number so the improvement hasn’t been consistent. If this reading inches higher, and the jobs loss stays within expectations, stocks may just rally again.


Have a great weekend!


Brent Vondera, Senior Analyst

MON, WAG, PFG, GE+INTC

S&P 500: +23.30(+2.87%)

Monsanto (MON) -0.40%
Monsanto reported second quarter profit that topped analysts’ estimates, but issued downside earnings guidance for the full year.

Increased prices for genetically modified seeds and Roundup weed killer helped boost revenues 8.3 percent year-over-year. Higher prices also lifted margins 5 percent in the quarter.

Sales in the seeds and genomics segment jumped 20 percent, helped by strong adoption of a higher-margin corn seed in the U.S. Sales from the agricultural productivity products dropped 16 percent on lower volumes of Roundup and other herbicides.

Despite the downside earnings guidance, CEO Hugh Grant said Monsanto is “on track for more than 20 percent growth in earnings for the full fiscal year.”


Walgreen (WAG) +3.36%
Walgreens reported impressive March sales numbers, with total sales increasing 6.8 percent and same-store sales (stores open at least 12 months) rising a modest 1.5 percent. Pharmacy sales, which accounted for two-thirds of total sales for the month, were up 10.2 percent. Same-store pharmacy sales increased 5.7 percent, but were negatively impacted by 2.8 percent due to generic drug introductions in the last 12 months.


Principal Financial Group (PFG) +7.60%
Insurers Left Hanging as Treasury Stalls


Intel (INTC) +4.46%
GE and Intel Team Up in Health Care


Quick Hits

• FASB Eases Fair-Value Rules Amid Lawmaker Pressure
• Geithner’s Non-Recourse Gift That Keeps on Giving to Bill Gross
• S&P ‘Dividend Aristocrats’ May Fall Below 40 as Payouts Are Cut
  
  

Peter Lazaroff, Junior Analyst

Daily Insight

U.S. stocks rebounded from a poor start after a key manufacturing gauge showed mild improvement, rising for the third-straight month from the 28-year low hit in December, and an unexpected increase in pending home sales for February boosted the belief that housing has bottomed.

Stocks began the session lower after two preliminary jobs reports suggested the official employment survey for March will show a decline that’s even worse than the 650,000 loss for February. The broad market fell roughly 2% in early trading, but rallied when those factory and housing reports were released at 9:00CT.

I’m still a bit skeptical manufacturing and housing has troughed. For manufacturing, we’ll still have the auto sector weighing on things and production levels for the industry will likely decline from here.

On housing, as we mentioned when the existing home sales data for February was released, we need to think about the weather-related event. Conditions were harsh for most of the country during January, which is why we saw one of the worst monthly sales declines during this contraction for that month. Conversely, weather was very mild in February, which brought people out to hunt for homes; in addition, the bounce in February was also a function of things snapping back from that 12-year low in existing sales in the prior month (the level of sales remains below where it was in December). Odds are we have seen the worst, but it’s just too early to tell right now, especially with the labor market in the condition it is in. More on this below.

Telecom, basic material (commodity-related stocks), financials and tech shares all performed very well yesterday. Utilities and health-care were the laggards.


Market Activity for April 1, 2009

Economic Releases

Mortgage Applications

The Mortgage Bankers Association reported its mortgage apps index rose for a fourth-straight week as refinancing activity increased and purchases didn’t weigh on the figure – purchases were virtually flat relative to the prior week.

Mortgage rates remain extremely attractive, the 30-year fixed rate hit 4.61% in the week ended March 27 (although the actual rate is a bit higher as it includes fees) and this should keep refis going, albeit at a lower pace coming off of the very strong bounce of the previous couple of weeks. Purchases will continue to be held back as a result of the very weak labor-market environment, although the super low rates will help to ease this drag.


Challenger Job Cuts Announcements

The Challenger Job Cuts report, a survey out of Challenger, Gray and Christmas – the country’s top outplacement consulting firm, stated job cut announcements by U.S. firms nearly tripled in March from the year-ago level.

Firing announcements jumped 181% to 150,411, compared with 53,579 in March 2008 – employers in state and local government along with nonprofit organizations led the increase. The financial and industrial goods sectors showed a nice easing in layoff announcements – that’s a really good sign that should have received more attention that it did.


ADP Employment Report

The ADP Employer Services gauge (Challenger and ADP are always released two days prior to the official monthly jobs report) came in at a larger-than-expected decline for March, suggesting 742,000 payroll positions were shed in March. We get the official reading from the Bureau of Labor Statistics on Friday and a loss of 660,000 positions is the consensus expection. The ADP figure has been an accurate indicator of the official reading over the past six months (understating the loss a bit actually, but very close).

We figured to be headed for a 650,000 loss in payrolls for March based upon jobless claims and ISM employment readings, but this ADP report may be saying a number above 700K is more likely. Expect the unemployment rate to hit 8.5%, which would be a 25-year high.

Medium-to-small sized businesses continue to cut the most jobs. Firms with 50-499 employees slashed 330,000 positions last month, according to ADP. Firms with fewer than 50 employees cut 284,000 positions. Large firms eliminated 128,000 jobs.


ISM Manufacturing

The Institute for Supply Management stated its manufacturing index rose slightly in March, coming in at 36.3 from 35.8 in February. The fact that the figure remains below 50 means that factories continue to trim output but the bounce from the 28-year low may be a signal of a bottoming process. If we can get this improvement to extend into the low 40s that will signal we’re onto something. The question really is the degree to which auto-industry woes will continue to weigh on the sector. Nevertheless, business spending on electrical and heavy machinery equipment may be enough to more than offset the auto weakness.


The new orders index was the real bright spot and hopefully this indicates a manufacturing rebound will occur over the next couple of months. The sub-index of the report jumped to 41.2 in March from 33.1 in February. This segment has been in contraction mode for 16-straight months (and remains that way since its takes a reading of 50 to mark expansion). But this is a nice improvement from the all-time low hit in January and looks to illustrate we’ve hit a bottom – cautious optimism.


The ISM employment index rose slightly from the all-time low hit in February.


In two other reports:

The National Association of Realtors stated pending sales for existing homes rose 2.1% in February, which suggests March existing home sales may show an increase. However, this pending number tracks contracts that are signed (actual existing sales count when a contract is closed) and since we’re in an environment in which borrowers have run into trouble between signing and closing the pending figure has not been as accurate as usual.

And finally, the Commerce Department stated construction spending fell 0.9% in February (the sixth-month of decline), led by a 10.9% drop in private-sector residential construction. Private-sector commercial activity rose 0.5%, the first increase since November. Public sector construction spending, which will clearly drive the overall reading over the next year at least, rose on both measures. Public residential construction rose 2.2% and public commercial was up 0.8%.

This morning all eyes will be focused on the initial jobless claims report. Stocks index futures are up big this morning and a worse-than expected jobless claims print may erase this euphoria.

No doubt we’ve got performance chasers rushing in as the S&P 500 has jumped 22% from the nefarious low of 666 of March 9. The market seems to have priced in a 700,000 payroll decline for March and is looking past last month’s data and to April and May, which is why the jobless claims figure is so important. If this morning’s jobless claims reading comes in meaningfully worse than expected stocks will sell off – a super bad jobless claims reading will suggest big job declines will continue for April. On the other side, if claims come in much lower than expected, stocks will be off to the races – kind of obvious I know.

Overall, in order to get really excited about the labor market, specifically with regard to the worst being behind us, we need to see jobless claims trend back to the 500,000 handle and I don’t see much evidence of this just yet – but that’s what you look for.

Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Recap

Treasuries
The two-year finished the day down 1/64, and the ten-year was higher by 3/64. The benchmark curve was 2 basis points flatter on the day, and remains at +184 bps. A basis point represents .01%.

MBS
In yesterday’s recap I mentioned that “as the duration continues to creep lower on 5.5% and 6% pools, the comparison [between higher coupon and lower coupon pools] is almost becoming inappropriate.” I apologize for being so vague; let me explain what I meant a little further.

Mortgage rates currently sit at historic lows, thanks to government plan to purchase 28% of the agency MBS outstanding. LTV (Loan to Value) restrictions will be relaxed through President Obama’s “Make Home Affordable” initiative, qualifying many more “underwater” borrowers for a conventional refinance. The market considers these new variables when building consensus speeds, but opinions differ greatly and most likely err on the faster side of prepayments. These are driving valuations far from the historical norms.

Historically, prepayment speeds on higher coupon MBS are faster than lower coupon MBS. This follows the logic that when rates drop, homeowners are more likely to refinance a mortgage with a higher rate to save on interest costs, and faster prepayments on the underlying loans result in shorter average lives and durations.

The spread between the ten-year Treasury and new 30-year MBS is often quoted because historically they both have a duration of around 8 years, making it an “apples to apples” comparison. While the duration of the ten-year remains at 8.57, new issue 30-year 6% pass-throughs currently have a duration of 1.48. This is obviously no longer an “apples to apples” comparison. When the durations differ so greatly the relationship doesn’t carry the same weight, and claiming that one coupon outperforms another based simply on its change in spread over the ten-year treasury isn’t as effective.

Treasury Purchases by the Fed
The Fed purchased $6 billion in 3-4 year Treasury notes today, in line with expectations. Tomorrow the Fed will purchase notes ranging from four to six years to maturity.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst

March 2009 Recap

The market fared much better in March than they did in the first two months of the year. The S&P 500 hit a new low on March 9, but was lifted by optimism within the financial sector as Citigroup, Bank of America and JPMorgan said they were profitable in January and February. The Treasury’s plan to remove toxic assets from banks’ balance sheets as well as the Fed’s pledge to buy Treasuries and bonds backed by mortgages helped extend the gains.

All sectors in the S&P 500 finished the month higher. Defensive sectors such as utilities, telecom and consumer staples lagged as investors favored beaten down sectors with more upside potential. Financials, materials, consumer discretionary and technology were the best performing sectors in the S&P 500 this month.

Materials were boosted by inflation expectations as well as speculation that stimulus packages throughout the world will increase demand. Consumer discretionary benefited from bargain hunters hoping the worst of the economic decline is near. The technology sector finished the quarter in the black and continues to be viewed positively by investors for their healthy balance sheets with tons of cash and strong growth prospects.

International shares saw gains similar to those in the U.S., but the MSCI Emerging Markets index gained 14.27 percent in March and is up 0.69 percent year-to-date. Investors anticipate emerging markets will to continue growing at better rates than most developed nations, even if their growth rate is slower than in years past.

Alternative asset classes trailed stocks. REITs continue to struggle as investors shun their high debt levels. In addition, a slowing economy is keeping rents and occupancy down. Commodity posted modest gains on improved economic outlooks and orderly supply control. Nearly all commodities rose on long-term inflation expectations relative to recent fiscal policy actions.

Fed programs aimed at purchasing $300 billion in Treasuries drove yields down across the entire curve in the month of March. Yields on the two- and ten-year dropped 17.4 bps and 35 bps respectively, to leave the benchmark curve at +186.3 bps.


Peter Lazaroff, Junior Analyst