Monday, October 12, 2009

Morning Note...

Abbreviated this morning – apologies… Futures are 50bps higher on the back of better-than-expected earnings from PHG and USD weakness.  The USD is lower after Friday’s move higher, which came on the back of exit strategy “hints” from Fed Chairman Bernanke.  In fact, there wasn’t much to Bernanke’s comments at all, but just mentioning the words “exit strategy” boosted the buck.  As market players digested this over the weekend, some steam was taken out of the dollar.  Worth noting that Friday’s action was on very light volume.  This may be - in part - due to people taking an extra day relative to today’s bank holiday (remember, the bond market is closed today), the oasys system (trade matching) failures street-wide, and the dollar strength stemming from Bernanke’s Thursday night speech.  Also interesting to note that equities, crude, and the USD closed up Friday, something we not seen in some time.  The DJIA reached new closing high for 2009 and the S&P500 is within 2bps of new closing high for 2009...

Medium week for earnings ahead, as 20% of the DJIA will report.  Tech and financial stocks lead the way, as we’ll see results from INTC, AMD, ALTR, XLNX, IBM, GOOG, JPM, GS, C, BAC, GE, JNJ, ABT, and BAX, to name the bellwethers.  Thursday looms large, given credit card companies will report master trust data for September.  The FOMC minutes will be released Wednesday. We’ll also get retail sales data Wednesday, and a pullback is expected given the fall-off following the Cash for Clunkers program.  Economic data is light this week – Empire Manufacturing, the Philly Fed, and CPI data is expected.  In terms of Washington, the Senate Finance Committee votes on its health care bill Tuesday, and there may be a vote to extend unemployment benefits and action to extend homebuyers credit.  Additionally, Thursday is the final day for US citizens hiding foreign holdings to file for tax evasion amnesty with the IRS.  Finally, research group the Economic Policy Institute is set to unveil a plan to give employers a two-year tax credit if they add jobs or hours.  Also, remember the end of the Fed's $300B Treasury purchases is October 31st...  Looking ahead, will we see more exit strategy talk from the Fed? And would this be bullish for both equities and the USD?  Worth noting that Bernanke highlighted M2 levels as key:  currency, checking accounts, savings deposits, small time deposits, and retail money fund share levels are flat over the last 6 months.  Thus the broad money base has not grown, since banks are not lending out their Fed injected liquidity - the money is just sitting there... so as lending begins, inflationary pressures appear as that base grows. 

DPS downgraded to Hold at Deutsche Bank... PII upgraded to Buy at Citigroup... NOK downgraded at HSBC... CAM downgraded at HSBC... SYMC upgraded at Jefferies... CTXS at Jefferies... PCG upgraded at Jefferies... MDZ downgraded at Jefferies... KR upgraded at JP Morgan... PCL upgraded at JP Morgan.... IFLO downgraded at Roth Capital... TEG downgraded at RW Baird... PPDI upgraded at RW Baird... DWA downgraded at Thomas Weisel...AMD upgraded at UBS... SNDK downgraded at UBS... AMGN upgraded at UBS...MA at Credit Suisse...V upgraded at Credit Suisse… EL downgraded at Goldman... JCI downgraded at Goldman... SGLP upgraded at Wells Fargo... BKCC upgraded at Wells Fargo... BRCD downgraded at Oppenheimer...

Asia lower overnight – Japan closed for holiday.  US Bond mkt closed.  Oil +244bps.  Gold +54bps.  USD -20bps. 

Brightpoint News: 
PreMarket Brightpoint Activity (yest close/premkt/% change/volume):

PreMarket S&P 500 Activity (last/% change prior close/volume): 
BLACK & DECKER            51.25    +8.49% 24643
WILLIAMS COS INC        20.95    +8.05% 300
KB HOME                       15.61    -5.16%  123562
LEXMARK INTL-A            23.70    +4.87% 300
ADV MICRO DEVICE        6.15      +4.59% 1178510
NOVELLUS SYS              21.93    +3.3 %  29735
MCGRAW-HILL COS        28.15    +3.19% 2000
PLUM CREEK TIMBR        32.73    +2.8 %  3862
WW GRAINGER INC        93.24    +2.76% 500
TENET HEALTHCARE       6.14      +2.68% 150
EATON CORP                 58.86    +2.62% 100
AFLAC INC                     46.17    +2.58% 790
FLUOR CORP                  50.00    +2.56% 100
WEATHERFORD INTL      20.01    +2.51% 11882

Today’s Trivia:  Follow on to Friday’s question… Why did Teddy Roosevelt and Woodrow Wilson win the Nobel Peace Prize?

Yesterday's Answer:  Teddy Roosevelt and Woodrow Wilson are the two prior sitting Presidents to win the Nobel Prize.   

Best Quotes:   “Big Ben’s Balance Sheet

The strength in the Dollar Friday was attributed to Chairman Bernanke’s Thursday night speech highlighting that the Fed has an exit strategy.  The fact is that is nothing new, and the Dollar was due for a bounce in the midst of the rampant Dollar pessimism.  Chairman Bernanke started the exit strategy section of his speech with “My colleagues at the Federal Reserve and I believe that accommodative policies will likely be warranted for an extended period.”  That is definitely not the type of statement that precedes hawkish activity. 

The speech was good in the sense that it provided the latest update from the Fed Chairman as to how he sees the situation developing.  Discussing the balance sheet in detail gave the Chairman an opportunity to highlight the wind down of targeted emergency measures.  Bernanke showed slides illustrating that short term emergency lending to financial institutions is down 77% from the end of last year.  In addition, Targeted Lending Programs to help the dysfunctional credit markets are down 75%.  Considering those programs contracted so much, one must ask how the Fed’s Balance Sheet has sustained its ballooned $2 Trillion size.  The answer is Treasury and MBS purchases, which now make up 75% of the Fed’s Balance Sheet.  Those holdings are up 220% since the end of last year, but are only up 100% since the summer of 2007.  You may remember that when the Fed announced the creation of the Term Auction Facility (TAF) in late 2007, the Central Bank began selling half of its $800 Billion in Treasuries to provide the cash that would be loaned to institutions.  Since they were repurchasing securities they previously held, that was why the Fed was willing to add the $300 Billion in Treasuries to the Quantitative Easing (QE)  program in March ($294 Billion of those have been purchased).  The real QE juice comes from the $1.25 Trillion in MBS purchases that Bernanke re-affirmed the Fed plans on making into March next year (only 55% of those have been purchased).

M2 is the Key Indicator for the Exit Strategy

Bernanke provided the important clues as to what to watch for during this “extended period” for signs that the exit strategy will need to commence.  “Currency and bank reserves together are known as the monetary base; as reserves have grown, therefore, the monetary base has grown as well.  However, because banks are reluctant to lend in current economic and financial circumstances, growth in broader measures of money has not picked up by anything remotely like the growth in the base.  For example, M2, which comprises currency, checking accounts, savings deposits, small time deposits, and retail money fund shares, is estimated to have been roughly flat over the past six months.”  M2 did see a big jump (10%) this time last year as the Fed began the emergency programs, but as this year draws to a close, unless banks start turning those reserves into currency, that year over year growth in M2 will drop to 1.8%. 

Fed issues warning, “Don’t fight me.”

As this early recovery begins to move forward, bank confidence in making loans to achieve that conversion should increase.  Bernanke spelled it out pretty clearly Thursday night explaining, “The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans or buy other assets. Such purchases should in principle both raise asset prices and increase the growth of broad measures of money, which may in turn induce households and businesses to buy non-money assets or to spend more on goods and services.”  On a sidenote, it’s not often that you see a Fed Chairman so blatantly  emphasize that the intention of policy is to raise asset prices.  Transparency and “don’t fight the Fed” have risen to a whole new level. 

The Fed Chairman described policy success noting, “As the economy recovers, banks could find it profitable to be more aggressive in lending out their reserves, which in turn would produce faster growth in broader money and credit measures and, ultimately, lead to inflation pressures.”  The Chairman highlighted a number of measures that would comprise the exit strategy.  The Chairman believes that the Fed paying an attractive  risk free interest on reserves would be the first measure to convert excess currency back into reserves.  Some other measures are reverse repo’s and asset sales, and permitting obligations to mature at a rate of $100-$200 Billion per year. 

An Exit Strategy is Good, but the Entrance Strategy has not concluded.

In summary, as targeted programs have matured, they have been replaced will permanent liquidity via asset purchases.  When the time comes to exit, temporary measures such as interest on reserves and reverse repos will be used to “test the waters” of how much liquidity should be removed as the recovery progresses.  The benefit of such an approach is it can obviously be quickly reversed if the economy regresses and circumstances force the Fed to reverse gears quickly.  Then, when the economy is finally stable (our view is that this is years away), permanent measures such as asset sales and debt maturation will be used to contract the Fed’s balance sheet. 

Lastly, it is important to remember that, as Bernanke noted, beyond last year’s initial bump up in M2, the measure is “roughly flat” over the past 6 months, which means we are not even close to implementation of the temporary measure of liquidity removal.  In fact, permanent liquidity will still be added through the MBS purchase program.  Another way to view it is that this intervention is a 4 step process: 

Step 1. Temporary liquidity;

Step 2. Replace temporary liquidity with permanent liquidity. 

Step 3.  Temporarily drain liquidity; and

Step 4. Permanently drain liquidity. 

As it stands now, we are expected to be in Step 2 into March of next year.”  --BTIG’s Mike O’Rourke

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