Friday, February 19, 2010

Morning Note...

Futures are -30bps this morning but have rallied off the early “Fed tightening” lows as CPI data – in contrast with yesterday’s “hot” PPI – indicates little in the way of inflationary pressure.  Month-over-month Consumer Prices were +0.2% (flat against the prior reading) vs. the +0.3% expectation.  Ex-Food & Energy, the result was -0.1% vs. the +0.1% expectation.  Year-over-year Consumer Prices were +2.6% vs. the prior +2.7% and the +2.8% expectation.  Year-over-year ex-Food & Energy was +1.6% vs. the +1.8% expectation.  USD strength is also back in play following the Fed’s 25bps Discount Rate hike (more on that below), and that may weigh on equities.  Consumer Confidence is due at 10am and recall that today marks options expiry.  As a result, expect larger than normal volumes at the open and close.  In earnings news, CBS is trading down 5% after reporting in-line results, and DELL is also down 5% after beating estimates by 1c.  Solar giant FSLR beat by 13c and guided in-line, but us trading down 8% on several downgrades.  On the positive side, INTU beats by 6c and guides higher as the stock trades up 6% pre-market.  JCP also trades up 4% on an earnings beat.  In other corporate news, the WSJ reports that SLB is in talks to buy SII.  Overseas, UK retail sales dropped more than 2x what economists had forecast, largely due to poor January weather, i.e. shopping conditions.  Note that the markets may briefly pause at 11am, as golf-crazed Wall Street stops to watch the Tiger Woods news conference. 

All the talking heads are clamoring this morning over the Fed’s Discount Rate hike at 4:30pm yesterday.  Everyone has an opinion.  Considering the view here from the cheap seats, I would argue that it’s a “non-event-to-slight-positive,” if anything.  First, the Discount Window doesn’t amount to much, and it appears to be a largely symbolic move by the Fed that merely announces, “we’re awake.”  Second, I have my doubts as to whether the government will ever be able to get stimulus withdrawal correct, but this type of clear, calculated, well-thought-out maneuver that indicates less government intervention in the marketplace rather than more reads as a net positive to me.  I don’t often do this, but amidst all the write-ups this morning, I thought Mike O’Rourke’s (BTIG Chief Strategist) was best, so I am basically including it in its entirety:

Over $87,731,000,000 Served.

That is the current amount of outstanding borrowings at the Federal Reserve’s Discount Window - $87.7 Billlion.  Those borrowers are just  about the only market participants who will be influenced by today’s surprise move by the FOMC.  The simple fact is that any institutions still borrowing at the Discount Window have bigger problems than the extra 25 basis points the Fed is charging.  Needless to say, the timing of this move is a surprise, although the move itself was telegraphed just over a week ago.  Now we better understand Chairman Bernanke’s urgency to get his testimony out there last week, despite the blizzard.  “Also, before long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate.”  It looks like “before long” translates to 8 days.  Last month, the NY Fed President told us that “extended period” means 6 months.  Before this process is complete, we will be able to publish a Fed timeframe dictionary.  We will keep an eye out for a translation of dissenter Kansas City Fed President Hoenig’s “some time” timeframe for low rates, which was disclosed yesterday in the release of the January FOMC minutes.

The Fed Chairman wanted to provide a “heads up” to the market regarding “normalization” policy, since it was such a large component of the FOMC minutes released yesterday.  Clearly, the FOMC did not want to wait until the Chairman’s rescheduled testimony next week.  As we noted last week, unless you are a bank in trouble, the Discount Rate is symbolic.  The Fed Chairman was clear to note in his testimony that the raise in the Discount  rate “should not be interpreted as signaling any change in the outlook for monetary policy, which remains about as it was at the time of the January meeting of the FOMC.”  In the January FOMC minutes, the Fed highlighted why it wants to restore the 100 basis point spread, explaining “Setting the spread reflects a balance between two objectives: encouraging depository institutions to use the discount window as a backup source of liquidity when they are faced with temporary liquidity shortfalls or when funding markets are disrupted, and discouraging depository institutions from relying on the discount window as a routine source of funds when other funding is generally available.”  This theme of getting banks to find other sources of funding appears to be repeating in Fed commentary.

The Fed also made certain that the surprise move was accompanied by some explanation.  Less than 2 hours after the Fed increased the Discount Rate from ½% to ¾%, Fed Governor Elizabeth Duke addressed the move in a prepared speech:

“Earlier today, the Board announced that we had approved an increase in the discount rate, and that we are shortening the typical maturity for primary credit loans to overnight. With these changes, we expect that banks will use private sources for normal funding and only use primary credit as a backup source of funds. As I mentioned earlier, the discount rate is the rate we charge banks that borrow at our discount window. It is not the rate we target for monetary policy purposes. I'd emphasize that the changes are simply a reversal of the spread reduction we made to combat stigma and like the closure of a number of extraordinary credit programs earlier this month, represent further normalization of the Federal Reserve's lending facilities; they do not signal any change in the outlook for monetary policy and are not expected to lead to tighter financial conditions for households and businesses.”

The Fed will now be able to morally claim it is taking action (in contrast with 2003-2004, but then the spread remained intact at 100 basis points throughout).  The reality is that the action will have little influence on the economy.  Some will say a tightening of any kind is tightening, but even if you take a bucket of water out of a pool, the pool is still full.  This pool is still very full.  By way of example, consider not too distant history in 2007.  Despite the move that ensued over the next couple of months (which was one of the most misguided rallies in history), it was clearly a mistake for investors to buy the market because the Fed cut the Discount Rate on August 17, 2007.  For similar reasons, we believe it is a mistake to sell the market because the Fed has increased the Discount Rate.

KBRO cuts CAN.  APOL earnings miss but increases buyback to $500M.  ARUN beats by 1c.  MSCO cuts ATW.  CBS lower on in-line earnings.  DELL beats by 1c.  ECLP beats by 5c.  HUN beats by 39c.  INTU beats by 6c.  JCP beats by 2c.  LIZ upped at KEYB.  NANO misses by 2c.  CSFB cuts PXD.  SCHW upped at GSCO.  BofAMLCO reinstates WFT at Buy and ups VTR.  CITI ups WBMD.  FBRC ups ADBE.  JPHQ ups GGC.  MSCO ups ESV & RIG.  BofAMLCO cuts WIN. 

Asia lower overnight.  Europe slightly higher and off the session lows.  USD +15bps.  Oil +35bps.  Gold -35bps.

S&P 500 PreMarket (last/% change prior close/volume): 
SMITH INTL INC             37.95    +13.79%           1526632
APOLLO GROUP-A           54.65    -11.07%            619488
INTUIT INC                    32.85    +8.34% 129087
J.C. PENNEY CO              27.42    +5.62% 521162
CBS CORP-B                  13.06    -4.74%  19994
DELL INC                       13.75    -4.71%  2246523
IAC/INTERACTIVEC        20.91    -4.48%  1600
SCHLUMBERGER LTD      63.38    -3.69%  163464
WEATHERFORD INTL      16.27    +3.11% 101529
ELI LILLY & CO               33.35    -3.08%  265
LIZ CLAIBORNE               6.15      +3.02% 3850

Today’s Trivia:  Who was the first President inaugurated in Washington, DC?

Yesterday's Answer:  The 1790 census totals indicated a population of 3.9M. 

Best Quotes:  “Fed Statement:  Like the closure of a number of extraordinary credit programs earlier this month, [discount lending] changes are intended as a further normalization of the Federal Reserve's lending facilities. The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy, which remains about as it was at the January meeting of the Federal Open Market Committee.  That says it all, and that is all that the Fed wanted the market to understand: this is not... repeat NOT… a tightening move of any kind” –Gartman

For the bears, here’s the scary BBERG story of the day:

Buffett’s ‘Dangerous Business’ Ensnares Municipal Bond Insurers
2010-02-19 05:00:00.6 GMT By Christine Richard and Darrell Preston
     Feb. 19 (Bloomberg) -- Forewarned bankruptcies linked to infrastructure projects from Las Vegas to Harrisburg, Pennsylvania, may prove Warren Buffett’s conclusion that insuring municipal bonds is a “dangerous business.”
     Ambac Financial Group Inc., the second biggest bond insurer, faces as much as $1.2 billion in claims if a judge in Nevada allows Las Vegas Monorail Co., which runs a train connecting the city’s casinos, to reorganize in Chapter 11 bankruptcy. The City Council of Pennsylvania’s state capital shelved a plan to sell taxpayer-owned assets to meet payments on
$288 million of debt used for an incinerator funded in part with bonds insured by a unit of Bermuda-based Assured Guaranty Ltd.
Harrisburg is weighing a possible bankruptcy filing.
     With state tax collections last year through September showing the biggest drop since at least 1963, as measured by the Nelson A. Rockefeller Institute of Government in Albany, New York, local governments are seeking concessions from creditors of public projects, including bond insurers. The moves further threaten companies backing $1.16 trillion of public debt that already face $11.6 billion of claims on collapsed securities backed by mortgages.
     “It is a worst-case scenario if the dynamics of the municipal bond market change,” said Rob Haines, an analyst who covers the bond insurance business at CreditSights Inc., an independent research firm in New York. “The companies have modeled in virtually no losses.”

                        Insurer Reserves

     Ambac, MBIA Inc. and Assured Guaranty, the three largest bond insurers, have set aside 0.04 percent of the total public finance debt they insure, or $520 million, to pay claims on municipal securities, according to regulatory filings by the companies.
     Local governments are struggling with depressed property values and sales, 9.7 percent unemployment and a slowdown in consumer spending that has cut tax revenue.
     Last year, 183 tax-exempt issuers defaulted on $6.35 billion of securities, according to Miami Lakes, Florida-based Distressed Debt Securities Newsletter. That’s up from 2008, when
162 municipal borrowers failed to meet obligations on $8.15 billion of debt. In 2007, 31 of them defaulted on $348 million of bonds.
     “In the past, things had a way of getting worked out,”
said Jim Ryan, an insurance analyst with Morningstar Inc. in Chicago. “States might have stepped up and helped out, but bottom line is that the states are in trouble.”

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