U.S. stocks snapped a five-day losing streak yesterday, a streak that sent the broad market 10% lower, on news China may be planning on substantially increasing its stimulus program. This allowed traders to get past preliminary labor-market reports that pointed to another large loss in payroll positions – the official jobs report for February will be released tomorrow.
Commodity prices, as measured by the Commodity Research Bureau (CRB), jumped the most this year on that speculation out of China – energy and basic material shares led the broad market as a result.
Market Activity for March 4, 2009
Crude oil jumped 8.5% to $45.16 per barrel, again as a result of the China story. However, that speculation has been dashed this morning as Chinese Premier Wen didn’t mention a word about increasing their stimulus plans in his address on the economy last night.
This China stimulus talk reminds of something we discussed a couple of weeks back. If Geithner was thinking more clearly, he would cut a deal with the Chinese – it seems the administration likes cutting deals, or at least attempting to; the effort to offer a deal with the Russians on Iran didn’t go over so well for those that have kept up on the issue.
Anyway, its seems that offering to stop calling China a currency manipulator (and I’m no Chinese apologists, I feel compelled to state this each time we talk about the Chinese, but look we live in a world of fiat money, all central banks are currency manipulators) in exchange for them upping their infrastructure stimulus package three-fold is a worthwhile action. This way we all benefit from the stimulus. We in the U.S. don’t have to engage in this exorbitant level of fiscal spending (and the damage this will do to the private sector as it saps resources), and by the way is scaring the heck out of business and capital as they know the result of all of this spending is higher tax rates. The Chinese may just be more than happy to play along as this means they are not pressured to take their currency completely off of the dollar peg and watch their exports fall as the production is moved to Vietnam or Thailand. Besides, they are likely to increase their stimulus plan anyway as they’ve got a citizen uprising issue that is growing.
Opportunity missed Mssrs. Geithner and Obama -- or maybe not deliberately, if you know what I’m saying.
Mortgage Applications
Mortgage apps fell for a second-straight week as home-owners wait for sub-5.00% to refi and purchases remain subdued, to put it mildly – this is a weak period for home purchases anyway, we’ll have to wait for May/June for a real sign of whether sales will bounce or not. The labor market will keep it depressed, but hopefully we see some rebound.
Refinancings will drive overall mortgage apps over the next several months as we think there’s a good shot the 30-year fixed mortgage rate will move below 5.00%. If it doesn’t occur more naturally, the Fed (whether right or wrong) will engage in activity to attempt to bring this to fruition.
Challenger Job Cuts Survey
The layoff report out of the nation’s premier outplacement consulting firm stated announcements of job cuts slowed in February, coming in at 186,350 from 241,749 in the prior month. Still, job-cut plans were 158.5% above the year-ago level.
The auto, industrial goods, retail and electronics sectors led the layoffs, or planned layoffs I should say.
ADP Employment Report
In another preliminary jobs report, the ADP employment survey anticipated that 697,000 payroll positions were shed in February – larger than anticipated and meaningfully lower than the January decline of 614,000. (The official number of job losses, as estimated by the Bureau of Labor Statistics, showed 598,000 jobs were lost in January – so ADP seems to be tracking the government’s figures closely).
Service-producing employment fell 359,000 last month, followed by a 338,000 decline in goods-producing industries – manufacturing job losses led the segment, falling 219,000, the worst monthly decline yet in this recession, and construction was down 144,000.
Employment was hardest hit in small and medium-sized businesses (those with fewer than 500 workers) as these firms slashed 576,000 jobs compared to a 121,000 decline at larger firms. Small-to-medium businesses are the main job creator in this economy and some of the policies that appear to be on the horizon will not treat this group kindly – this will make it more difficult, naturally, for the labor market to rebound.
Overall, the ADP report is just an estimate as to what we’ll see on Friday when the official numbers for February are out. Other indicators are also pointing to another large decline in payrolls though, probably the largest decline we’ve seen yet. That’s saying something since we’ve shed 2.4 million positions over the previous five months.
ISM Service Sector
The Institute for Supply Management’s service-sector index remained weak for February, coming in at 41.6 from 42.9 in January. The business activity index (which measures general sentiment among respondents) fell to 40.2 from 44.2 – while down, it is slightly above the fourth-quarter average of 38.9. (For clarity, the headline number – the 41.6 number – equally weights business activity, employment, new orders and supplier delivers; all sub-indices of the overall survey)
The especially important employment index rose to 37.3 from 34.4 (this is above the fourth-quarter average of 35.8).
The fact that this employment number improved is a good sign, although we have so many other indicators going against it – jobless claims, the two reports mentioned above and ISM manufacturing – it’s tough to find a silver lining. In any event, just maybe service-sector employment contraction has begun to slow. We’ll have a better idea of this on Friday when the big numbers are reported.
Have a great day!
Brent Vondera, Senior Analyst
Thursday, March 5, 2009
Daily Insight
Wednesday, March 4, 2009
INTC, ACI, BTU, CAT, JEC, GE
Intel (INTC) +3.91%
Semiconductors got a boost from Goldman Sachs Group saying the group will continue to outperform the S&P 500 Index and profits are likely to start improving, now that the companies have pared back inventory.
Arch Coal (ACI) +4.50% and Peabody Energy Corp (BTU) +7.62%
Coal producers rallied as China considering new stimulus measures. China gets 80 percent of its electricity from coal.
Caterpillar (CAT) +13.22% and Jacobs Engineering Group (JEC) +8.72%
Caterpillar and Jacobs jumped after Transportation Secretary Ray LaHood said there are an ‘enormous number’ of highway jobs coming.
Some of Caterpillar’s gain can be attributed to anticipation of a new stimulus plan in China.
General Electric (GE) -4.56%
GE dropped for the fourth straight day, driven down by selling by sovereign wealth funds anticipating a downgrade of the company’s AAA credit rating, according to PIMCO’s Bill Gross. GE said claims that it needs to raise capital in the near term are “pure speculation.”
Lockheed Martin (LMT)
LMT won a 10-year contract worth up to $5 billion to supply U.S. military commandos with logistics support, a contract that L-3 Communications Holdings (LLL) held for more than 20 years and considered among its most prestigious lines of business.
I will have more on Lockheed and the defense industry tomorrow.
Quick Hits
- More Than 8 Million U.S. Mortgage Holders Are Under Water as Prices Tumble
- Berkshire Hathaway Credit Swaps Rise to Record, Imply ‘Junk’
- Short-Sale Rule Undermined by SEC Data After Bernanke Urges Review
- Trading Tax to Fund U.S. Bailout Would ‘Decimate’ Markets, NYSE Chief Says
- Defense Firms Look to Fill Gaps as U.S. Policy Shifts
Peter Lazaroff, Junior Analyst
Daily Insight
On the banking system, it is certainly more stabilized than it was back in the fourth quarter when it could only be described as chaotic – inter-bank lending rates were sky-high, illustrating the unwillingness of banks to lend to one another; this is not the case today. We shouldn’t confuse lower lending activity with instability; banks always tighten lending standards in a downturn and this was certainly needed coming out of the past few years when there really were no standards.
On the Geithner comments…well, let’s just say he bombed. More on that below.
Basic material, energy and technology shares gained ground yesterday. This is a good thing as we need the commodity players (materials and energy) to pick up as a sign things are reflating. I’ve got a feeling we won’t be worrying about basic material and energy stocks a year down the road as fiscal/monetary policy will spark an inflationary event that will cause its own issues. For now though the market will view signs of reflation as a good thing.
It was also nice to see technology shares gain ground on a day in which most sectors were down. This group has huge cash positions, low debt levels, and is poised to rock when the economy does turn. Now we need to see industrial shares rally, which is another industry we think will outperform over the next few years.
On the downside, utility shares led the declines as the administration seems dead set on cap and trade. I’m laughing as I type this, but I shouldn’t be. This is an inappropriate response to energy efficiency and it will cause home-energy costs to jump 40%-50% at least over the next couple of years if it is eventually passed.
Market Activity for March 3, 2009
So Bernanke and Geithner were on Capitol Hill again yesterday. They talked about several topics, but we found it strange neither touched on one of the biggest news items of the day, which is the latest Fed program – the lack of clarity, or willingness to expound on the various programs Treasury and the Fed are rolling out is one of the main problems right now.
TALF (yet another acronym)
The Fed will finally roll out the Term Asset-Backed Loan Facility (TALF) on March 25 – they’ve been working on this since November. It will be a $1 trillion (we’re seeing a lot of that number lately) program to prop up the market for consumer and business loans.
The TALF will start by offering $200 billion in loans to hedge funds and other investors aimed at jumpstarting lending for consumer-related and small business loans. The program will also help auto dealers finance inventory.
This will target the securitization market, a huge source of credit that is outside of the traditional banking system – a credit source that has basically shutdown following the Lehman shock. Personally, I’m not sure this is the best route as consumer credit simply needs to contract for a while still. And this program may have some difficulty as a result; the consumer has pulled back for a reason. If they are not willing to borrow, you can open up the pipeline all you want but it won’t have the intended efficacy.
Geithner Comments
And then we have the Treasury Secretary. In his testimony to Congress yesterday, explaining to the members of the Spend-Freely Club how the $1.5-$1.75 trillion deficit we’re going to run this year (as he vilifies other economies for being currency manipulators at the same time – governments we’ll need to buy this debt), that the financial-system rescue will cost more than $700 billion. Well, hell yeah it will. The way they’re laying waste to the market by crushing investor psychology, disparaging the holders of capital and scaring the tar out of the business community – the very people we’ll need to bring things back – no amount of government spending will do the trick.
Mr. Geithner also mentioned he would crack down on companies and individuals who try to avoid paying taxes -- now that’s a real peach of a comment coming from him; I’m sure you all remember the FICA tax fiasco. Besides, avoidance is not evasion – the former is legal – and maybe if we were to implement a tax structure that made sense, economic participants wouldn’t find it worthwhile to incur the costs of finding legal ways to avoid tax rates. But no, they will raise tax rates. Well, guess what pal, you’re going to be chasing a lot of people because I’ve got a feeling tax avoidance is going to make a big comeback.
And get this one, the Treasury Secretary also mentioned the administration plans to propose rules that would curb companies’ ability to delay paying U.S. corporate tax on foreign earnings. Um, the issue he is talking happens to be a current law, U.S. firms that have subsidiaries overseas are allowed to defer U.S. corporate tax until they bring the money home – and guess what? The money doesn’t come home, its stays put.
Why do you think this deferral is law right now? Anyone? It’s because no other OECD economy levies their home tax on business done overseas. You see, U.S. firms already pay the country’s corporate tax in which the sales are made, by forcing them to pay the U.S. tax as well means they become unable to compete. Now it seems they will eliminate this rule. That’s grand!
This letter has been calling for the abolition of the “repatriated tax” as the above deferral is often called. Instead though, they seek to make it overtly onerous. These people are like a financial hurricane, destroying anything in its path. One has to believe, for those giving this much thought as have I, that they are purposely attempting to drive the stock market and the economy into the dirt simply so they can control more of it via their highfalutin “fixes.” These people are not idiots, maybe incredibly naïve, but not completely stupid. What else is one supposed to take from the path they are on? It makes zero economic sense.
Pending Home Sales
Pending home sales fell 7.7% for January after the December increase was downwardly revised to show a 4.8% increase, it was initially estimated to have risen 6.3%. Three of the four regions dropped, led by a 13% drop in the Northeast. The South saw a drop of 12% and in the Midwest pending sales were down 9%. Pending sales rose 2.4% in the West.
Pending home sales are considered a leading indicator because they track contract signings. Although, lately an upswing in pendings hasn’t been a great barometer of existing home sales for the subsequent couple of months as there has been a trend of mortgage contracts being signed but then falling apart when it came to closing – existing home sales are not counted until the contract is closed.
It appears we’ve got a while before we find a bottom in housing. We’ve got to be close, but troubles within the labor market will delay the rebound.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries started March in rally mode, benefitting from a pause in supply and a weak stock market. Bonds pulled back today, but yields are still down for the month. Bond prices move inversely to yields.
Treasuries struggled hard out of the gate, but rallied to recover most of their losses at the end of the day as stocks lost their momentum and ended the day in the red. The two-year finished down 1/16 of a point while the ten-year was lower by about 3/8 as the benchmark curve steepened by 1.5 basis points today but stands 3 basis points flatter for the week. A basis point represents .01%.
MBS
Mortgages outperformed Treasuries today, trading around unchanged as U.S. Government bonds were down. MBS widened yesterday but tightened back in today to remain about where they closed before the weekend. FNCL 5s (Fannie Mae 30 year 5% Pools) currently sit at 142 basis points over comparable Treasuries. Just 3 basis points higher than the low we hit on February 8th.
TALF
Today the Treasury announced adjustments to the Term Asset-Backed Securities Loan Facility. The terms were extended to include such things as CDOs collateralized by subprime credit card loans and auto leases. The government won’t be purchasing these assets from institutions, but giving them a loan for up to three years and requiring them to post these assets as collateral. The Treasury will use sizable haircuts, (some as high as 15%), in addition to backing from the Fed to the tune of $100 billion, (increased from $20 billion today), to try and insulate the taxpayer from loss.
These assets that will be used as collateral are not stable by any means. The posted assets could lose significant value in three years, and in the event of default, the Treasury will be left with only the collateral. If the assets have lost value beyond the level of the initial haircut the Fed backstop will kick in.
The Fed backstop is being funded with TARP money. This is the same TARP money that was initially intended to buy bad assets from the struggling banks and hold them indefinitely. There are approaching that model with this version of TALF, but I still don’t understand the Treasury’s disgust with the original TARP. They are putting the taxpayer at no less risk with this program, (they are stilled exposed to the performance of these assets), but they are limiting the benefits. If they just purchased these assets outright, they could leave the banks with the mindset to make valuable long term investments, instead of making them repay the loan in the three years.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Tuesday, March 3, 2009
GE oversold?
General Electric (GE) -7.76%
GE touched below $7 for the first time since 1993 as investors expect GE Capital will need more capital injections. Some estimates see GE’s balance sheet absorbing more than $10 billion in rising consumer credit delinquencies and falling real estate values outlined by the company.
GE Capital has a tangible common equity ratio (a measure of its ability to withstand losses against its total assets) of about 5.3 percent, which is at the high end of ratios amongst large commercial banks. GE Capital’s balance sheet would make the segment the 7th largest U.S. bank measured by assets. This is one reason investors are shorting the stock like other banks.
At least GE’s shareholders (40 percent of which are individual investors) don’t need to worry about the threat of nationalization like the nation’s large commercial banks. GE had $48 billion in cash on its balance sheet at the end of 2008 and can provide additional funds to GE Capital as needed. Of course, dipping into their giant cash pile increases the chance of credit rating downgrades. (Losing the AAA credit rating would not materially impact the company’s profitability, but the rating still carries tremendous psychological weight.)
While shareholders don’t need to worry about being diluted by government ownership, they will take a back seat to GE’s balance sheet when it comes time to decide where to allocate cash flow from operations – a big change from the recent past.
In just 2006 and 2007, GE repurchased $20.9 billion of stock and paid out $21.9 billion in dividends. This $42.8 billion in total value returned to shareholders is more than half of GE’s current market cap. Total GE buybacks and dividends over the past five years amount to over 100% of GE’s current market cap. The fact that such activity will now necessarily be greatly diminished has been weighing on shareholders.
Still, let’s not forget that GE has strong industrial business to offset its financial woes. A recent Credit Suisse report estimates that GE’s manufacturing business (in which they included infrastructure, industrial, and healthcare segments) alone is worth $14 to $15 a share. Given the current stock price, this implies losses at GE Capital would be at least $5 billion to $6 billion. This number seems excessive, especially when you consider that the company expects GE Capital to turn a $5 billion profit in 2009 (although it would not surprise me if this estimate is too high).
Looking into the future, GE’s manufacturing businesses are positioned for solid growth when the economy turns up. They are good franchises with leading market positions and many have high margin aftermarket revenue streams.
Peter Lazaroff
Daily Insight
This move has done additional psychological damage and it may just take some time for the market to form a base as a result.
We’ll open today with the S&P 500 at it lowest level since October 1996, which puts the index at an extremely low P/E of 9.8 based on trailing earnings. This would normally be a level stocks should not move down to, especially with interest rates and inflation this low (even if the levels on both will not remain this low for too very long), but government policy has investors throwing in the towel as it becomes extremely difficult to evaluate shares when we’re all so intensely at the whim of Washington.
Compounding the whole thing is a complete lack of clarity with regard to the plan that would remove toxic assets from bank balance sheets. Dang, get to it! Eliminate mark-to-market, supply low-cost funding to purchase, corral these troubled assets (until the real estate market rebounds and they can then be sold at a level much closer to intrinsic value) and for Heaven’s sake do not punish the very people you’ll need to facilitate these trades. The administration is in the process of raising tax rates on private equity firms, this is just dumb. We need to incentivize these people to come in and buy these assets, lowering their after-tax return expectations will only keep them on the sidelines.
Every major industry group got wacked yesterday, the relative winners were technology and consumer staples, down 3.22% and 2.62% respectively.
The price of crude got clocked as well, down 10.52% to $40.05 per barrel on concerns global demand will remain depressed. As we’ve touched on a couple of times now, domestic demand is not all that bad as we’ve seem it stabilize, according to the latest Energy Department report, but things are trading on perceptions as well as actual economic deterioration. When stocks slide like this, and we’re now 7% below the former multi-year low hit on November 20, few people care about any positives that are out there, they sell out of fear.
The really sad thing is we do have positives like high levels of productivity, enormous levels of cash on the sidelines, businesses that are streamlined and poised to dominate on the global stage and a plunge in energy prices that has caused inflation to flat-line thereby boosting real income growth. If we could just get a couple of policies out of Washington that are somewhat kind to the private sector we could be onto something. But that’s the problem; investors are saying all they see is destructive policy.
Market Activity for March 2, 2009
The Economy
The Commerce Department reported on it personal income and spending figures for January, both of which came in at better-than-expected rates.
Personal income rose 0.4% in the first month of the year, posting the first gain in four months. Although, the increase came solely from the government as transfer payment jumped 3.5% for the month.
Most private-sector segments were flat to down – excluding government payments personal income fell 0.2%. Compensation came in flat, unchanged from December; wage and salaries fell 0.2% -- the third month of decline; proprietors’ income was down 0.7%; rental income (one of the bright spots of the last three months) fell 0.4% and interest income dropped 0.7%. Dividend income was the only private-sector segment that rose, up 0.1%.
Again though, the flat inflationary environment has allowed real incomes to jump, and that’s a good thing.
Personal spending gained 0.6% in January, posting the first gain in six months. The level of real spending stands 0.8% above the fourth-quarter average at an annual rate. We’ll need to see spending rise again in February to offer a more concrete view that the consumer side of things will contribute to GDP this quarter. I suspect we’re a little early here, that boost from the consumer will likely have to wait until the second quarter. We shall see.
The personal savings rate (cash savings) hit 5% a couple of months faster than we thought would occur (something we’ve been watching for as a signal consumers feel better about spending given the decline in asset prices). Although again, the boost to income last month was due to government transfer payments, not private-sector dynamics, so I’m not sure the higher cash savings rate will flow into confidence and thus boost spending in a sustained manner just yet.
The inflation gauge tied to personal spending, the PCE Deflator, continues to pretty much flat line. Core PCE, which excludes food and energy, rose 0.1% in January – the year-over-year core rate slowed to 1.6% from 1.7% in December.
However, I would not expect the inflation figures to remain low for long. Soon enough inflation rates will spike as the Fed has pumped massive amounts of money into the system and huge levels of government spending will combine to send enormous amounts of money into the economy. The Fed’s action has not shown up totally as the velocity of money (the number of times it turns over) has been held back as banks have eased lending. But when lending returns to more normal levels, we will have the classic scenario of too much money chasing too few goods.
Remember, as if you need reminding, production has been weak. What’s needed to absorb all of this money is an upshot in production and the best way to do this is by slashing tax rates, thereby incentivizing producers. Without this action, which we are not getting, troublesome levels of inflation are inescapable, in my view, due to monetary and fiscal policy actions.
Manufacturing Sector
In a separate report, the Institute for Supply Management showed its manufacturing index improved ever so slightly from the month prior, posting a reading of 35.8 last month from 35.6 in January. February’s reading is basically unchanged from last quarter’s average of 36.0. ISM figures are one of the best economic indicators, so what we saw in the fourth quarter is shaping up for this one, according to this measure.
The various sub-indices were not much changed either, although the important employment index fell further, hitting 26.1 from 29.9 in January – for newer readers I should mention that 50 is the dividing line between expansion and contraction.
On a brighter note, this is the second month in which ISM has improved, the problem is the index remains well in contraction mode and the improvements have been very slight. Look for the index to move into the 40s and initial jobless claims to fall back to 500,000 and this should signal we’ve seen the bottom. Until then, those calling a bottom are probably just going on hope. The theme we keep touching on is inventory liquidation, and it is this dynamic that will require higher levels of production that will catalyze economic growth, maybe by next quarter.
Construction Spending
In yet another release, Commerce announced construction spending fell 3.3% in January, marking the fourth month of decline. The public sector will begin to take over during the next…well, I don’t know how long frankly. The public sector numbers have declined for a couple of months now as state and local tax revenues have dried up, but this segment will kick back up when the infrastructure programs begin to take affect.
So, over the next year one should expect the pubic sector side of things to push overall construction spending higher, or at least largely offset declines from the private side. But as we get into 2010 we’ll see private residential construction begin to rise again, if the response we’re seeing from the government doesn’t distort economic decision making and cause the private sector to hold off. The commercial side (or non-residential as it’s technically termed) should remain depressed for some time as this is the last thing firms engage in after the economy rebounds.
Today’s Data and News
This morning we get pending home sales for January, which is a closely watched reading these days for obvious reasons. We’ll also get some testimony from Treasury Secretary Geithner; it will be very important for him to perform better than the last time we heard from him.
Have a great day!
Brent Vondera, Senior Analyst
Monday, March 2, 2009
Afternoon Review
February Recap
The S&P 500 and Dow Jones Industrial Average both posted double-digit monthly declines in February. Lackluster corporate earnings and a sharp downward revision to fourth-quarter 2008 GDP, which declined 6.2 percent, show that the economy deteriorated much faster than previously thought. Still, policy decisions remained the primary force driving the market.
Attractive valuations and defensive reputation helped telecom stocks outperform other sectors. The technology sector was also a relative outperformer. Technology companies are viewed as having relatively solid balance sheets with good cash positions, which is certainly an attractive quality in this tight credit environment.
Again, the financial sector was the weakest performer in the S&P 500 as investors mulled over the possibility of some large banks becoming nationalized. There is still a great deal of uncertainty with regard to the government’s plan for troubled banks. The Federal Reserve, Treasury and White House all tried to squash nationalization rumors, but there is a growing feeling that at least temporary nationalization may be necessary.
Despite a pick up in merger and acquisition activity, the historically defensive healthcare sector felt some pain after the Centers for Medicare and Medicaid Services said private Medicare plans would see a modest 0.5 percent increase in the 2010 fiscal year – a growth rate well below industry estimates of 2 percent to 4 percent. Also hurting the sector was fears that President Obama’s reform plans may carve into the profits of drug makers, medical devices and insurers.
Given the poor performance of the financial and healthcare sectors, it is not a big surprise that growth outperformed value. More surprising was the fact that emerging markets were the best performing asset class this month. The worst asset class was REITs, with the Vanguard index tracking REITs losing over 20 percent this month.
Record issuance during the month of February drove prices down and yields up in the Treasury market. The market weathered the large increase in supply very well, thanks to the large flight-to-safety trade. The benchmark curve was 11 basis points steeper for the month as the longer end of the curve underperformed the shorter.
Quick Hits
- Buffett Says Economy ‘In Shambles,’ Promises Best Days Ahead
- ‘Leave It to Beaver’ Savings Lifts U.S. Bond Holdings
- Decremental? Fitting Word for Ugly Times
Peter Lazaroff, Junior Analyst
Daily Insight
Friday’s decline pushed the broad market down for the third-straight week – down 4.54% last week, which followed declines of 6.87% and 4.81% in the prior two weeks, respectively. The S&P 500 closed below the Asian Contagion low, hit in May 1997, to the lowest level since December 1996.
There are undoubtedly awesome long-term opportunities out there in the stock market, as valuations sit at the lowest levels in more than 20 years. However, investors remain spooked as the Obama administration has an overt disdain for business, makes clear they will raise tax rates – and in some ways has already begun to do so, continues to engage in policy that freezes private capital and sends signals regulations are going to much higher – instead of simply enforcing current regulations. The equity investor will need a lot of patience, but patience will pay off – in the meantime caution is the rule.
Financial and health-care shares got drubbed again on Friday as the latest government “help” to Citigroup simply put the “short banks” trade back in place and the Obama health plan puts the screws to private care and drug discovery.
The relative winners were consumer discretionary, technology and consumer staple shares.
Market Activity for February 27, 2009
On the Citigroup news, the Treasury Department will convert as much as $25 billion of preferred shares into common stock as long as private investors agree to the same terms. The government does not currently intend to inject additional money.
So let me get this right. Bernanke comes out and assuages concerns on Tuesday by saying nationalization is not in the cards. Then Geithner does an interview on PBS stating the administration has no intention of nationalization. Now, just two days later, the Treasury effectively makes a move in that direction – the decision to convert Treasury’s preferred shares to common is more an accounting change than anything (why not just eliminate mark-to-market?) -- but what if investors do not want to tender their shares, will the government force it upon them. And even if they do not need to force investors’ hands, you’ll still have the government holding nearly a 40% stake in the bank and in the meantime “encourage” them to do things like suspending foreclosures. And people wonder why the market is in disarray; there’s little wonder why capital is on strike.
And speaking of government rescues, the Treasury Department is into its fourth rescue plan for AIG, as the insurance giant will receive another $30 billion in TARP funds and interest rate modifications on government loans will ease borrowing costs.
On the Economic Front
The Commerce Department reported fourth-quarter GDP was revised down big to show the economy contracted at a 6.2% real annual rate – it was initially estimated to decline 3.8%. This figure is much closer to the -6% we were expecting when the initial reading was released a month ago as personal consumption showed a very big decline and inventories building was revised substantially lower.
The 4.3% decline in real PCE (personal consumption adjusted for inflation) occurred at the fastest pace since the 1980 recession, business fixed investment fell 21.1% (specifically, business equipment fell 28.8%, the most since 1958), residential fixed investment (housing) fell 22.2%. These are all quarter-over-quarter at an annual rate.
The main reasons for the large downward revision came from the personal consumption decline, originally estimated at -3.5%, and the change in inventories, down $19.9 billion -- originally estimated to have increased $6.2 billion. This downward revision in inventories accounted for 1.2% point of the 2.4% points of the revision to overall real GDP.
So what we have here is the worst decline since the spring of 1982 (a period with which the Volcker Fed was quashing the insidious inflation of the 1970s by the necessary jack-up in rates). We are indeed looking for GDP to contract at a 5% pace this quarter, although it is too early to truly gauge, which will make this the deepest recession since the 1957-58 contraction (a 4.2% decline in Q4 1957 followed by a massive 10.4% contraction in Q1 1958).
The export data shows the nature of the global downturn (yes, global growth remains dependent upon U.S. activity – those piping about “decoupling,” or how the emerging markets do not need U.S. growth need a lesson in how the global financial and economic world works, to say the least). U.S. exports declined at a 24% annual rate.
Such large back-to-back declines (fourth and first quarter GDP) should signal a bottoming out process. Personal consumption should begin to rebound, a bit, by the second quarter (we may be a bit optimistic here) as we see the cash savings rate approaching 4.5% by that time. As we’ve discussed for a couple of months now, since the two primary savings vehicles (homes and stocks) have been hit hard consumers will need this level of cash savings to feel better about spending.
Also, the inventory liquidation dynamic should provide a production boost by late spring/early summer and housing activity has become so weak it should stop subtracting from GDP – at the least it will not cause such a drag on the figure as this segment makes up just 3% of GDP, down from just about 7% back in 2005.
In a separate report, we also received the Chicago Purchasing Managers’ Index (the most important regional manufacturing gauge that gives us a look at what nationwide ISM will post) and the index improved a bit to 34.2, but only from the very weak level of 33.3.
We really need to see the index rise to the 40s before feeling strong that the economy will bounce by mid-year. ISM and these PMI indices (again ISM is the manufacturing gauge for the nation and PMI surveys should be viewed as preliminary report for ISM) are great initial indicators as to the direction of economy activity so we’ll continue to watch them closely.
This morning we get personal income and spending for January and the ISM manufacturing reading for February. The previous ISM report led many to believe the economy had hit bottom – and who isn’t looking for evidence of a bottoming process – as the figure improved mildly. However, the preliminary factory reading (figures such as the Purchasing Managers’ indexes – like the Chicago survey touched on above) show we’re not there yet. This morning’s ISM number should take another turn down.
Again though, inventory levels went into this recession at a low level and businesses have scaled back stockpiles even more over the past two quarters. It should not be long before this inventory dynamic offers a boost to growth as firms must ramp up production. However, the government has to stop scaring the tar out of the private sector, and unfortunately we see no evidence of this waning just yet.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
February was a huge refunding month and the market is certainly taking a depth breath as it all comes to an end. Concerns over supply should subside for now as March’s schedule appears relatively light.
Treasuries were mixed today as the long end of the curve underperformed the shorter. The two-year traded up one-eighth of a point while the ten-year was lower by about a quarter as the benchmark curve steepened by 11 basis points today and stands 17 basis points steeper for the week. A basis point represents .01%.
MBS
Mortgages continued to outperform comparable Treasuries today, tightening 2 basis points.
Higher coupon MBS are outperforming lower coupons as many analysts are paring back their expectations for refinance activity. The programs established by the Obama administration, (easier LTV standards and subsidized rates), are certainly going to speed things up, however some analysts on the street believe the boost to refinancing will be short lived. Higher coupon mortgages, which trade at high premiums, underperformed lower coupons a month ago when the market expected prepays to skyrocket. Now that expectations are reversing a little, the market is just adjusting.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Friday, February 27, 2009
Afternoon Review
Hansen Natural Corp. (HANS) +7.32%
Hansen reported impressive earnings that came in ahead of expectations and, even more importantly, the Monster energy drink brand continued to take market share from competitors.
Despite weaker consumer spending trends, the company increased revenues more than 3 percent year over year, primarily as a result of higher prices. Gross margin expanded more than 3 percentage points, as greater volume of the firm’s new energy shooter drinks provided a more favorable product mix.
Hansen has performed very well in this economic climate because energy drink consumers don’t have good substitutes – most people drink these products because they don’t like coffee. Sales have also been helped by the fact consumers can not make comparable energy drinks at home the way that a coffee drinker could easily make their own cup. Also helping Hansen is their younger consumer base, which is less adverse to the economic climate and likely to spend more discretionary income.
Dell (DELL) +3.90%
Dell had a positive earnings report in which cost discipline saved an otherwise difficult quarter.
PC revenues declined 22 percent on a 12 percent decline in units. Gross margin performance was likely the most important factor for investors this quarter. Cost and pricing discipline allowed Dell to post gross margins of 18.1%, which should be viewed positively in this environment.
Dell’s unit declines coupled with Hewlett-Packard’s poor numbers last week, supports the fear that demand conditions continue to deteriorate in the PC and enterprise segments. The next several quarters should be remarkably challenging for Dell, but there is growing sentiment that the shares can’t fall much lower without a significant deterioration of market share.
General Electric (GE) -6.48%
GE is finally cutting its annual dividend in a move to preserve cash and protect the company’s top credit rating. GE’s stock price has reflected the assumption that the company would have to cut its dividend for quite some time. Now yielding 4.5 percent, GE shares may offer even more upside potential than before since the company will have an extra $9 billion annually to invest in future growth of their business.
Quick Hits
- Debtors’ Prison: Companies Made a Fashionable Mistake
- Citi Gets Third Rescue as U.S. Plans to Raise Stake
- February was another record month for corporate bond offerings
- Golden Parachute
Peter Lazaroff, Junior Analyst
Daily Insight
The market appeared to give the Obama budget – some of which we touched on yesterday – a thumbs down but I’m not sure it’s fair to blame yesterday’s activity on the fact that the relationship between the federal government and the private sector is in the process of being altered. This has been a major reason the market is down 25% since Election Day– per yesterday’s session, we’ve known the agenda for a while so it’s not like what was announced was much of a surprise. We’re going to see government spending as a percentage of GDP move from the 18%-20% range of the past quarter century to something closer to 30%, and this will have an effect on longer-term growth rates simply because the private sector allocates resources in a much more efficient manner than government, period.
Financials and telecoms were the only winners yesterday – telecoms have been on a nice little run of late. In terms of financials, it’s a rarity these days to see the overall market decline on a day the banks gain ground, but the broad market was weighed down by the drubbing health-care stocks took – the budget was not kind to this sector as a push to universal health care, a proposal to lower Medicare Advantage payments to managed-care firms and requiring drug-makers raise rebates (you want to crush drug discovery, this is the way to do it) pushed the group lower.
Market Activity for February 26, 2009
Well, let’s get to the economic data.
Initial Jobless Claims
The Labor Department reported initial jobless claims for the week ended February 21 rose 36,000 to 667,000 -- the expectation was for a decline. Claims just keep rising and we’re approaching the all-time high hit in 1982. However, while one shouldn’t downplay this event, when adjusting for payroll position growth claims would have to hit one million to match that 1982 level. There are 135 million payroll positions today compared to 88 million in 1982.
The four-week average of claims – a less volatile figure -- jumped 19,000 to 639,000.
Continuing claims rose 114,000 to 5.112 million in the week ended February 14. The insured unemployment rate – which tracks the overall jobless rate – rose 0.1 to 3.8%.
I think it’s pretty clear payrolls will show another huge 600,000 loss for February when the data is released next Friday. The unemployment rate may hit 8.0%, currently it is 7.6%. I’ve got to believe the degree of monthly job losses will ease a couple of months out as firms may have gone too far in job cutting, scared by the combination of the credit freeze last quarter followed by policy that has not exactly offered a boost to confidence.
Durable Goods Orders
The Commerce Department announced durable goods orders dropped 5.2%, following an almost equally large 4.6% decline in December. A decline in transportation orders of 13.5% led the decline as defense aircraft and auto bookings dropped.
Excluding transportation, durables orders fell 2.5%, following a big 5.5% decline for December that was revised down to show double the damage of the initial estimate. There were no silver linings in the data. Primary metals orders fell 4.6%, industrial machinery was down 2.0%, computer orders fell 5.0%, electrical equipment was down 6.1%, autos were down 6.4%.
The component of the report we watch most closely (as longer-term readers are aware) is nondefense capital goods ex-aircraft, this the proxy for business equipment spending. This figure dropped 5.4% last month and 5.8% in December – down 34.3% at an annual rate the last three months. This as well as anything explains the level of caution with which businesses are operating. This gets the business equipment side of GDP off to a horrible start for the first quarter.
New Home Sales
Wow! The Commerce Department reported new home sales declined 10.2% in January to 309,000 units at an annual rate from an upwardly revised reading of 344,000 for December – first reported at 331,000.
The supply of new homes fell 3.1% in January – the 21st straight month of decline – to 342,000 to the lowest level since April 2003. The population was 19 million lower back in 2003; I think this shows how the supply glut has been completely erased, new home prices are down 26% from the peak.
It will take some economic confidence, however, for this to flow through in sales. The supply of homes relative to sales rose to 13.3 months’ worth.
By region, sales in the Northeast rose 12.5%, but the Midwest and South fell roughly 6% and the West saw new home sales plunge 28%, for the month! This depressed activity in the West is quite different from existing home sales data as we’ve seen activity rebound to a decent degree for existing.
New home sales are down 65.8% at an annual rate over the past three months and have yet to show any sign of bottom, but we’ve got to be close.
Have a great weekend!
Brent Vondera, Senior Analyst
Thursday, February 26, 2009
Daily Insight
Dividend cuts from a number of insurance names, as they get hammered by mark-to-market and a falling stock market and thus have to put additional money aside to support annuity guarantees, kept financials down even as Fed Chairman Bernanke reiterated bank nationalization is not in the cards.
It appeared those comments from Bernanke, along with some clarity with regard to the Treasury’s “bank stress test” and future capital injections plan, is what helped stocks rally in the afternoon session. The S&P 500, for instance, jumped 3.5% after lunch until it all fell apart again in the final 30 minutes of trading.
Industrial shares led the market lower, the index that tracks these shares fell 2.86%, with health-care and basic material stocks not far behind. Worries the economy will take quite a while to bounce back put pressure on material and diversified manufacturing shares. The sole winner was telcom, which added 1.01%.
Market Activity for February 25, 2009
Crude
Crude oil rose to a three-week high, jumping 6.36% yesterday, after the weekly Energy Department report showed gasoline inventories fell 3.32 million barrels to 215.3 million last week. Motor fuel consumption averaged nine million barrels per day over the past four weeks, up 1.7% from the same period last year. The price of crude is up 25% since February. While half of this move is due to the March contract expiring on the 20th (the April contract traded higher than that expiring March contract) the rest is due to gasoline fundamentals.
Refineries have also reduced production, which is normal for this time of year as they retool to shift from heating oil to more gasoline production.
Oil supplies went in the other direction (although as you can see the supply of gasoline can drive the price of crude) as supplies at Cushing, Oklahoma (where traded West-Texas Intermediate crude is delivered) rose 34.5 million barrels to the highest level since April 2004.
Oil trades in contango right now, meaning you can buy the front month contract and sell later month contracts at a higher price. This means oil is being delivered to Cushing for storage. The opposite of contango is backwardation, the situation in which the front month trades higher than months forward.
Mortgage Applications
The Mortgage Banker’s Association reported that mortgage applications fell in the week ended February 20 as the 30-year fixed mortgage rate moved above 5.00%. We’ve talked about how activity bounces when that rate moves into the 4% handle and vice versa when it moves back above 5%, and this seems to be the case.
The outlier to this view is the rebound that occurred in the week ended January 30 even as the 30-year mortgage rate hit 5.29%, but this may have been because the prior week’s decline was so large. Therefore, the bounce was a function of coming off of that low level. A rate below 5.00% is still the target and if we can get below that level for an extended period we may begin to see some sales and refi activity that helps to absorb supply and lower servicing costs.
Purchases fell 2.6% last week and refinancings dropped 19.1% after a big 64.3% jump in the prior week.
Existing Home Sales
The National Association of Realtors (NAR) reported that existing home sales fell 5.3% in January (that was weaker-than-expected and the increase in December was revised lower) to 4.49 million units at an annual rate. Multi-family activity led the decline as sales for this segment slid 10.2%. Single-family existing home sales fell 4.7% last month.
In terms of region, sales in the Northeast fell 14.7%, the Midwest and South both declined 5.7% and the West was flat (the West region has endured the largest foreclosure activity and thus the largest price decline – sales seem to have found a bottom for now as a result).
On supply, the number of existing homes on the market continues to come lower – which is a good thing for when sales do bounce back, supply (relative to the sales pace -- the month’s worth of supply figure) will come lower quickly. The issue right now is the job market and general lack of confidence. We get those two things turned around and this housing correction will have run its course rather quickly.
On that last point, this is why we’ve argued the way to go is to focus on economic growth and let the housing market correct as it will. Policy makers keep talking in terms of doing the opposite (focusing on housing and allowing hope for a rebound to spur economic activity), which will only prolong the housing correction as the consequences of their actions have adverse effects. We cannot turn jobs around on a dime, but by focusing on incentives (lowering tax rates on capital, labor income and profits -- and thus raising after-tax returns on these activities) we can stop the bleeding and allow the growth in economic activity take care of the rest. That’s when confidence turns and that’s when we’re back in business.
Unfortunately, the administration is out with next year’s budget and they are wasting no time raising taxes. It’s not that this is a surprise, but the fact that they are moving, even if incrementally, so quickly on this front is very concerning to me. In this budget proposal, there will be limits on deductions for those in the top two income tax brackets and higher tax rates on hedge funds.
We’ll then see the current income tax rates rise across the board as they revert back to the pre-2003 levels; the capital gains and dividends rate will revert as well (end of 2010). And you watch, the middle class will be hit hard as well – not just from the perspective of lower economic growth and stock market activity as higher tax rates are destructive to after-tax returns, but more directly via their paychecks. Anyone who believes that payroll taxes (FICA) will not be increased is not in tune with the agenda, in my humble opinion.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
Treasuries were down across the board today as the long end of the curve underperformed shorter Treasuries. The two-year traded down one-eighth of a point while the ten-year was lower by about 1.25 points in price as the benchmark curve steepened by 5 basis points. A basis point represents .01%.
MBS
Mortgages outperformed comparable Treasuries on Wednesday, tightening 7 basis points to remain at the bottom of the range we have established. I would expect FNCL 5’s, 30-year Fannie Mae 5% MBS, to maintain a spread over Treasuries of about 145 to 160 basis points for the next couple weeks.
Municipals
Highly rated municipal bonds have tightened in considerably and many cities, counties and states in all parts of the country are taking advantage of the opportunities at these lower rates. I would expect AA- rated or better munis to tighten more from here.
From an investor’s perspective shorter munis still look attractive on a relative basis, assuming the investor is in the top tax bracket for tax exempt issues. For investors who can take additional liquidity risk in smaller blocks, odd-lot munis look especially attractive.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Wednesday, February 25, 2009
Afternoon Review
Stress Test Details Unveiled
The market obviously welcomes any details they can get their hands on regarding the government’s plans for the financial system. It is not a surprise that the market took off this afternoon when these details were released. The good people in Washington also provided us with some FAQs. Gosh golly, how did they know we would have questions?
Bernanke’s comments today also seemed to lift sentiment for financials.
AT&T (T) +1.98%
AT&T rallied on a U.S. Supreme Court ruling in the company’s favor, which makes it tougher to sue companies for antitrust violations. Bloomberg reported the justices unanimously rejected a claim that an AT&T subsidiary engaged in a “price squeeze” aimed at driving out competition in the market for digital subscriber line (DSL) service.
Also boosting shares was an analyst upgrade at JPMorgan, citing the growing number of iPhone customers spurring sales growth. The report estimates that iPhone customers will boost AT&T’s the average monthly bill 1.2 percent this year by paying extra for plans that support the phone’s web-surfing features.
Last quarter, AT&T posted subscriber gains that exceeded estimates as consumers scooped up web-capable phones and projected that their decision to subsidize the iPhone (which cut into profit margins) would begin to pay off in the upcoming quarters. This analyst report supports AT&T’s projections.
Positive prospects for PC sales
Reports that Microsoft’s Windows 7 may ship as early as September, sent PC makers Dell and Hewlett-Packard higher on hopes the release may spur sales of PCs amid the global recession.
Intel (INTC) also moved higher, despite reports that global chip sales will decline in 2009, as the company could benefit from higher PC and netbook sales. Unlike Vista, Windows 7 is also designed to run on the increasingly popular netbooks that run on Intel’s lower-priced Atom chips.
There has been a large concern that these cheaper chips would erode profits, but Intel said today at Goldman Sachs Technology and Internet Conference their margins in netbooks are better than cheap notebooks.
Principal Financial Group (PFG) -6.68%
Labor federation Change to Win has made a direct request to Geithner that Principal’s $2 billion TARP application be denied due to its lobbying activities, specifically regarding it’s opposition to Employee Free Choice Act.
Principal later in the day released this statement, denying any stance on the Employee Free Choice Act.
Quick Hits
- Bank Nationalization is Done Deal, Let’s Move On
- Signs of Life
- Obama in Canada Finds World’s Best Financial System
Peter Lazaroff, Junior Analyst
Daily Insight
The Chairman came through yesterday in his best performance I’ve seen. In his testimony to Congress, Bernanke smoothed things over (after the administration along with Senator Dodd scared the heck out of the market again via its lack of clarity) by explaining that additional capital injections and more government control over banks would only occur if absolutely necessary. That helped things out enormously in yesterday’s trading; thank you Mr. Ben.
Regarding the administration, it’s like they’re afraid to say anything terribly concrete for fear a policy will fail and they’ll have to take responsibility – this is a major issue for stocks right now; we cannot afford additional uncertainty.
Financials led the rally; the index that tracks these shares jumped nearly 12%. Consumer discretionary and energy shares also outperformed.
It’s tough to get excited though as the political environment is costly right now. We have higher tax rates on the horizon (and I can’t even believe the President’s comment last night that he’ll raise corporate tax rates), way too much government involvement and much more regulation coming down the road.
There are reasons stocks now trade at these low levels. Yes, one is earnings are weak. Yet another factor is massive selling pressure due to de-leveraging. But there should be little doubt that valuations also reflect the fact that after-tax return expectations have been diminished and a coming regulatory burden that always crimps growth. We do not need more regulation we need enforcement, along with sound monetary policy that does not encourage excess credit expansion. Higher tax rates are the worst thing we can do right now, they must be driven lower.
In the end, nearly the entire universe of stocks offer great return potential over the next decade – even if the next couple of years will be tough; the more the government does, the longer the rebound will take. Beyond that, assuming we snap back and do not go the way of Western Europe, which is one of the questions the market is dealing with, the potential in stocks is huge.
The really sad thing about all of this is that U.S. firms are streamlined, energy prices are very low, stock multiples are compressed (S&P 500 trades at the lowest P/E since 1986 on a 10-year average earnings basis) and there are mounds of cash on the sidelines. If we could just get policy that drives incentives and offers some economic confidence we could really be on to something. Of course, there is no magic bullet, only time can correct for the credit excesses fostered by mistaken monetary policy and government involvement in the housing market (Congressional demands to offer easy credit to poor credit-score borrowers). But bold action with regard to after-tax returns on capital, incomes and profits would be a huge jolt to the American spirit – this is what’s missing. We’ll find that groove again. For now though, ebullience is absent.
Market Activity for February 24, 2009
Home Prices
The S&P Case/Shiller home price index continues to show rapid deterioration, the year-over-year decline sped up to 18.5% for December from 18.2% in November – setting a new record.
The table below speaks for itself, so not much reason to expound on its figures. All in all, I don’t like this indicator as it only follows the 20 largest metro areas, about half of the index involves the cities in which speculation was most rampant. Housing market traders would set up consortiums, and spec houses using no money down (because they didn’t have to) and simply walked away when prices began to fall. Hence, foreclosure rates are hitting this index harder than any other.
Another look is the Federal Housing and Finance Agency’s (FHFA) home price index, which offers a very broad look at the housing market. Its results for December were out yesterday too, showing prices actually rose 0.1%. This marks the first monthly increase since February 2008 and only the second since April 2007.
Unfortunately, it’s too early to get jazzed just yet as price increases in the West region is what drove the number into positive territory. Prices have been so wrecked in the West that some sort of increase was bound to occur. The Northeast, Mid Atlantic and Southeast continue to show robust declines. This index has home prices down 9.5% over the past 12 months.
Consumer Confidence
The Conference Board’s consumer confidence survey dropped to a stunning reading (even in this environment) of 25.0 in February from 37.4 last month – this is a record low. The expectations index got slammed, coming in at 27.5 after posting 42.5 in January. The survey was taken after the announcement of the stimulus plan.
Consumers’ assessment of the labor market conditions is dirt – no surprise there. The percentage of those judging jobs as “plentiful” fell to 4.4% in February from 7.1% in January, while those viewing jobs as “hard to get” rose to 47.8% from 41.1%. Thus the net “plentiful” less “hard to get” index fell to -43.4% last month from -34.0% in January. (That January reading improved a bit, giving some people hope, but this latest look will crush that feeling, if last Thursday’s jobless claims data hadn’t already.)
The market will have its eye on mortgage applications and existing home sales data for January today. Existing home sales rose 6.5% last month, so we’ll be looking to build on that and get some kind of trend going. Fixed mortgage rates are very low, but a positive trend is probably a ways out still simply because the weak labor market will delay a rebound in sales. We shall see.
Have a great day!
Brent Vondera, Senior Analyst
Tuesday, February 24, 2009
Afternoon Review
United Natural Foods (UNFI) +20.16%
United Natural Foods soared as earnings exceeded expectations on lower fuel costs, expense control and the continuing integration of Millbrook Specialty business.
For the quarter that ended Jan. 31, United Natural managed to increase sales by 2 percent. This is very impressive given the trade-down trend the more expensive organic/natural foods are facing.
Lower costs stemming from new distribution centers as well as the Millbrook Specialty business helped boost gross margins by 50 basis points. The Specialty business has unique products that serve niche markets and affluent customers, which might explain why it has held up in this weak consumer environment. The Millbrook’s integration appears to be going smoothly and margins in this segment should continue to improve. United Natural’s improved network of distribution centers will also contribute to margin expansion in the future.
The company lowered revenue guidance and widened earnings guidance to reflect lower sales growth and greater uncertainty surrounding the impact of the recent peanut recall. The company also lowered its capital expenditure guidance for fiscal 2009.
H.J. Heinz Company (HNZ) +5.63%
Heinz reported quarterly earnings rose 12 percent on increased pricing, currency hedges and a lower effective tax rate.
Revenues declined 7.5 percent because of the stronger dollar, but sales increased 3.9 percent excluding currency fluctuations as price increases more than offset weaker volume.
The company indicated that the trade-down trend hurt sales results, but the company has been offering different size packages with different price points to better compete against generic products. Also slowing sales were lower orders from retailers that are trying to work down inventory.
Heinz last year enacted price increases as commodity costs rose and they do not plan to roll those increases back, noting the increases weren’t enough to cover the sharp spike in most commodities.
The takeaway from the report today is that Heinz’s business remains fundamentally sound, which is evident in its strong cash flow and balanced portfolio of leading brands.
Quick Hits
- Bernanke Says U.S. Will Acquire Bank Ownership Stakes Only as Losses Occur
- U.S. Bailout, Stimulus Pledges Total $11.6 Trillion (Table)
- Dividends Falling Means S&P 500 Is Still Expensive
- NYSE May Relax $1 Share Price Requirement to Prevent Delistings
Peter Lazaroff, Junior Analyst
Daily Insight
The Dow Industrial Average closed at its lowest level since May 1997 and the broad S&P 500 at its lowest point since April of that year.
Stocks engaged in a brief rally during the initial hour of trading, apparently on news the government would inject more capital into banks. However, possibly after traders had a chance to think about it sentiment did a 180 – oh, talk of raising tax rates didn’t help either; good job!
The administration delivers a new plan each week, and absent of detail to boot. Then we have Senator Dodd popping off, making statements that increase market confusion. It’s hard to see how they could screw up anymore. More on the capital injection and policy response thing below.
Basic material, information technology, industrial and energy stocks led the broad market’s decline as expectations of an economic rebound occurring anytime over the next six months deteriorated, at least for now. A gloomy forecast for the PC market from Morgan Stanley certainly didn’t help things, especially for tech names.
Market Activity for February 23, 2009
Please Stop
Well, here we go again. Policymakers chose to engage in essentially more of the same by proposing a plan to pump additional capital into banks, and the current preferred shares they own via former injections would convert to common shares – this conversion will help capital adequacy as what is known as tangible common equity (TCE) will improve financial health since that health is based in part on common share-based capital. Problem is this is just another step toward nationalization – and if some form of nationalization is not swift (take the troubled institutions over, clean them up, and summarily send them back out to the private sector) such action only exacerbates the capital strike.
But assuming, on the surface, that more capital injections from the government is a good thing, what happens when current “toxic” assets continue to fall in price, or assets acquired by writing new loans are dragged down by distressed pricing as mark-to-market accounting demands? You’ll get more capital injections and thus greater government control over banks -- that can’t be good, only need to look at Fannie and Freddie for that one. (Regulators say major banks have capital ratios that exceed requirements, but as we’ve seen all we need is a couple of quarters of distressed-pricing write-downs and suddenly more capital is needed. The more capital that comes from the government, the longer private capital will sit on the sidelines.)
Public-sector injections can make things even worse in two ways (the freeze it puts on private capital is the result):
One, does anyone really believe Washington can manage the banking system? This of course is a rhetorical question – to ask is to answer --, as we all know politicians are not at all capable of this task. You think things are highly politicized now, just wait.
Two, what happens to the thousands of banks that have not needed government assistance? What is the fall-out from the appearance that government funded institutions are stronger. Does money run from those that did not engage in poor decisions to those that did as the perception is your money is safer at the government-backed bank?
These are the types of consequences that result from government action and we’re seeing Washington involved on such a grand scale right now that no one can contemplate the magnitude of consequences that will bring about their own problems.
We have argued for mark-to-market accounting to be abolished. For one thing, pro-cyclical accounting rules are extremely damaging. In good times, banks can hold less capital and in bad times they are forced to build more – either way you look at it such behavior is destructive.
The second reason to abolish this 15-month accounting regime (and more appropriate to today’s discussion) is because the longer we wait it means that government engages in a plethora of programs that have huge economic costs – not just from a perspective of money but simply because the market is at the whim of Washington; in which case, capital freezes (as the rules are changed weekly), essentially going on strike.
Eliminating mark-to-market is not an elixir that heals all, but it stops the self-affliction, with the former accounting standard in place I am convinced we would not have been this damaged – the credit chaos would not have occurred (not to the extent with which it did last quarter) and thus economic deterioration and job losses would not have been so substantial.
I believe when the history is written readers two decades hence will be bewildered why we chose to engage in various highfalutin ideas when abolishing mark-to-market was staring us right in the face.
The other thing readers of history will be astonished by is how we let the Federal Reserve off the hook for so long – without their mistakes earlier in the decade, none of the damage from credit expansion, with little standard, would have occurred. I do believe though that it won’t be too long – five years or so – in which setting major constraints on the Fed’s monetary policy decisions will be a consensus view. The Fed has been responsible for the largest economic distortions since its inception in 1913. Certainly Congress plays its role in causing havoc, but substantial policy mistakes from the FOMC are the origin of the major crises over the past 96 years.
Have a great day!
Brent Vondera, Senior Analyst
Fixed Income Recap
The Federal Reserve Bank of New York is now $134.8 billion into their $500 billion dollar MBS buying plan to keep mortgage rates low. The Fed announced last week that it purchased $19.9 billion in agency MBS during the seven day period ending last Wednesday, bringing the weekly average to $19.25 billion.
Mortgage spreads over Treasuries have normalized in the past week into the 145-160 basis points range. With all the demand from the Fed it’s hard to imagine MBS widening anytime soon. If demand for U.S. Treasury debt doesn’t keep up with issuance as it continues to grow in order to fund the ever growing deficit, I would expect MBS to tighten, keeping yields on MBS fairly constant. The government remains dead-set on keeping mortgage rates low and its ability to create artificial demand in order to do so is being felt in the market now.
Links
Hillary Clinton, Treasury Sales Rep
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
Monday, February 23, 2009
Afternoon Review
Capital adequacy ratios
Until now, the most popular ratio in determining a bank’s capital adequacy was the amount of Tier 1 capital it had as a percentage of total assets. Tier 1 capital is used to measure a bank’s ability absorb losses without a bank being required to cease trading.
Today, attention has been refocused on banks’ tangible common equity, or TCE. TCE is a bank’s assets minus all its liabilities and, most importantly, all of its preferred shares and intangible assets like goodwill, brand names and patents. In short, tangible common equity shows what common shareholders would get if the company was liquidated.
Banks’ TCE ratios had historically been between 3 percent and 5 percent before the credit crisis. Today, Citigroup’s TCE ratio is 1.5 percent, Bank of America’s ratio is 2.83 percent and J.P. Morgan’s ratio is 3.8 percent.
Companies have some discretion as to what their TCE ratios are, but those with a TCE below 3 percent of assets should consider raising more capital. Because these companies would have difficulty raising capital in a stock sale, some (like Citigroup and AIG) are asking the government for assistance.
The government’s injections so far have been through buying preferred shares, which increase a bank’s Tier 1 capital but does not increase its TCE ratio. To help bolster banks’ TCE, it sounds like the government plans to convert some of its preferred shares into common shares.
What is troubling about this “reclassification” of balance sheet items is that the government is, in effect, changing the accounting rules. This leads me to wonder, why not just adjust the fair-value, or mark-to-market, accounting rule? While I understand the merits of fair-value accounting, it seems to me that there must be a better valuation methodology that is less volatile.
Garmin (GRMN) +7.32%
Garmin, maker of GPS devices, reported earnings that missed analyst expectations and opted not to give 2009 guidance until the “outlook for the year becomes clearer.”
Revenues fell 13.9 percent year-over-year and operating margins slipped 200 basis points compared to the third quarter and 310 basis points from the prior year.
Garmin’s Outdoor/Fitness segment had revenue increase 5 percent in the quarter, but Automotive/Mobile revenue plunged 17 percent, Aviation revenue was down 5 percent and the Marine segment turned in flat revenue for the quarter.
Still, the stock managed to rally today on reduced inventory. Garmin said it reduced its inventory by $274 million in the quarter, up from expectations of a drop of about $150 million in inventory levels by the end of the year.
UnitedHealth Group (UNH) -14.87%
Health insurers took a beating after Humana Inc. said the 2010 preliminary rates for the U.S Medicare Advantage program would have a “significant adverse impact” on premiums and benefits for plan members.
Bloomberg reports, that Humana, UnitedHealth Group and other insurers with U.S. Medicare-backed health plans for the elderly and disabled would get a rate increase of 0.5 percent in 2010, far less than premium growth projected by analysts that ranged as high as 2 to 4 percent growth.
Quick Hits
Peter Lazaroff, Junior Analyst
Daily Insight
Market Activity for February 20, 2009
Economic data
The Consumer Price Index (CPI) rose 0.3%, showing the cost of living in the U.S. rose in January for the first time in six months. The CPI year-over-year rate remained unchanged for the first time since 1955, according to Bloomberg.
The core rate, which excludes food and energy items, advanced 0.2% last month and was up 1.7% on a year-over-year basis. Both measures came in slightly above expectations. These increases were largely due to higher prices for autos, clothing and medical care.
Bank nationalization
After Citigroup’s shares fell below $2 to an 18-year low, reports surfaced over the weekend that Citigroup is in talks to have the government take a larger stake in the company by converting a substantial portion of its preferred shares into common stock. The government holds $52 billion of preferred shares in Citigroup, five times the bank’s market value as of Friday.
Multiple reports say that the government could wind up holding as much as 40% of Citigroup’s common stock, which would dilute the stakes current Citigroup shareholders. The positive for U.S. taxpayers is that such a move would not cost them any additional money. Citigroup is also encouraging Government of Singapore Investment Corp, Abu Dhabi Investment Authority and Kuwait Investment Authority to convert their preferred stakes into common stock, which will only further dilute current shareholders’ stake more.
The idea behind Citigroup’s strategy is that converting preferred shares to common stock will bolster the company’s tangible common equity (or TCE) ratios – one of several gauges of a bank’s financial strength. Until this point, banks and regulators have referred to the Tier 1 capital ratio to determine a bank’s ability to absorb future losses. I will talk about these ratios in more detail in today’s Afternoon Review, which you can access by visiting our blog at http://www.acropoblog.com/ (the Afternoon Review is usually posted around 4PM CST).
Looking ahead
Futures are up this morning, which may be a sign that investors would embrace a temporary nationalization. The news of government’s potentially increased stake in Citigroup overshadowed the Obama administration’s announcement that they will seek to cut the deficit in half by 2013, through tax increases and spending restraint. The idea of raising taxes during a period of economic weakness makes a lot of people cringe, but it is likely the market has already priced in the expiration of the Bush tax cuts in 2010.
This is a big week for economic data, and Brent will be back tomorrow to guide you through it all.
Have a great day!
Peter Lazaroff, Junior Analyst