Friday, April 9, 2010

Morning Note...

Happy Friday…  Futures +15bps this morning as the rally off yesterday’s weak open continues in earnest, despite conflicting headlines regarding Greece’s woes.  For example, one headline proclaims “Euro Strengthens, Stocks Rise as Trichet Says No Greek Default.”  Another claims “Trichet Thwarted as Greece Erodes ‘Mr. Euro’ Status.”  Huhn?  And UBS is out with a note stating that a Greek bailout is a “distinct possibility” soon: 

Greece may need to seek emergency aid from the International Monetary Fund within days as a surge in financing costs makes funding its budget deficit unsustainable, UBS AG economists said. “The recent market action means that an external intervention may be unavoidable and could happen very soon as the situation is untenable,” UBS economists including Stephane Deo wrote in a note to investors late yesterday. “We think an intervention over the weekend is a distinct possibility.”

In Asia, speculation continues regarding China unpegging the yuan to the USD.  According to the NY Times, this may happen over the weekend, in fact.  Interesting article in the WSJ this morning about banks lowering debt levels just before they report earnings to the public.  There’s also an article about WMT lowering prices across the board to drive consumer traffic.  In other corporate news, JPHQ cut AA ahead of Monday’s earnings.  CVX guides Q1 higher.  STZ posted an earnings surprise but issued downside forward guidance.  Regarding emerging markets, here’s something interesting, especially given the “overheated” opinion held by many analysts:

Emerging-market equity funds attracted the most net inflows in six months amid a strengthening global economic recovery, EPFR Global said. Funds investing in emerging-market stocks drew a combined $3.27 billion in the week ended April 7, the most since the third week of October and taking net inflows for the year to $10.8 billion, according to Cambridge Massachusetts- based EPFR.  (BBERG)

Most pundits agree that markets shook off yesterday’s Greek concerns and instead focused on the impressive same store sales data posted by retailers across the board.  (Or was it?  Very easy comps, no?)  To be sure, market resilience was impressive yesterday as we bounced off the technical support at SPX 1175 and people traded on that “strong consumer spending” sentiment.  Now is probably a good time, then, to post something from Comstock Partners from earlier this week.  Food for thought:

Consumer Spending Rests On Shaky Foundation

After seeing this week's announcement that February consumer spending increased 0.3% the pundits were elated and used the number as proof that the consumer was back and that this virtually assured a typical post-war recovery. What the "experts" failed to do however, was examine the underlying data to determine where all this new-found spending power was coming from. True, consumer spending has risen in eight of the last nine months and has climbed 3.7% in that span. Although those results are far from robust it is, at least, an increase. The question is how this happened in the face of lackluster employment, weakness in housing, flat income and tight credit.

The answer is surprisingly simple once you look at the savings rate. As we mentioned, consumer spending has climbed 3.7% since May; that amounts to $373 billion of increased spending in the period. During the same span consumer savings declined by almost the same amount---$374 billion-while disposable income was basically flat, dropping by 0.1%. It is therefore easy to see that the entire increase in consumer spending for the nine months was due to reduced savings.

For some context let's look briefly at the household savings rate as a percentage of disposable income in the past. From 1955 through 1992 the savings rate stayed mostly within a range of 7%-to-11%, and then began a steady decline. The decline was slow at first, dropping to about 5% in 1998. After that the rate of decline accelerated, first with the bursting of the dot-com boom, and then with the boom in housing later in the decade. By 2007 the rate had dropped all the way to an average of 1.8%. The period of decline coincided with below average growth in wages and employment compared to prior decades. To maintain their standard of living, consumers went heavily into debt, aided and abetted by extremely easy monetary policy, soaring home prices, rising net worth and lax borrowing terms that enabled millions to borrow more than they could afford.

As we know, during the recession consumers were hit by high unemployment, lower incomes, tight credit and rapidly declining net worth. By May of last year they had raised their savings rate back to 6.4% Since then, however, the savings rate has dropped back to 3.1% in February, thereby accounting for all of the increase in consumer spending in that period.

In our view, therefore, the prospect for further substantial rises in consumer spending rests on an extremely shaky foundation. Households cannot continue to decrease savings rates without great harm to both their balance sheets and their retirement. In fact, it is far more likely that consumers will continue to deleverage and start raising their savings rates back to historical levels. At the same time the labor market will remain below par no matter what Friday's payroll employment number shows, while credit is still restrictive and the housing picture still quite weak. We think that the market, as it did in early 2000 and late 2007, is once again discounting a "goldilocks" outlook that is unlikely to occur.

Something else that may have been related to yesterday’s strength and the ability to shrug off Greece’s issues…government intervention into the markets.  I got this from a derivatives desk during the day yesterday…very interesting:

“…not sure if you'd seen this decision out of Greece this morning: regarding repo, it appears that every short position that is not covered at close of business will be forced to cover at whatever price (repo auction) at the end of every day. This means it will be far more difficult to short greek bonds, but the decision affects the market-making desks more than anyone else... could actually lead to many banks ceasing to quote Greek bonds. Our analysts upstairs are still going through the release, but it appears as an effective short selling ban

Please allow me a little editorializing on this Friday morning, given the slight news “lull” ahead of next week’s earnings.  I leased a car last weekend in preparation for the late May “arrival” that my wife and I are expecting.  Cars are a big deal in Miami, more so than in other areas of the country.  Nevertheless, we chose a pretty conservative starter-SUV with no flash, the base package, etc.  But as I drive to work each morning I routinely suffer “car envy” as I note the other SUVs with tinted windows, flashy rims, full trim packages, etc.  And then I realize that the cars “underneath” all that flash are – more or less – a few years old with thousands and thousands of miles on them with (probably) less than stellar repair history or engine performance (i.e. Range Rover?).  The people driving them seem to have chosen the appearance of stability and performance over stability and performance itself.  And then I feel good about my decision to go safe and solid.  What’s the message here?  First, oh my god I think I have become Fred Hickey…yeesh.  But second, is there an analogy to today’s markets somewhere in there?  Does the illusory nature of the flashy expensive trim on an SUV somehow correlate to our ongoing 75% rally?  Sure, I get it – don’t fight the Fed (and ZIRP) and the massive amounts of government stimulus poured into our economy in order to completely reflate the bubbly nature of it all…  But I guess that’s my dilemma – how is this any different from the low-interest rate policies that led us to the proverbial cliff-edge in 2007 and 2008?  I would argue that it’s not very different at all, that the “strength” we’re seeing maybe isn’t very real…and that maybe we’re enjoying the ride in that SUV…enjoying the attention to the rims and the tinted windows and all…until the engine falls out.  Then what?

Looking ahead, here’s the lineup for next week, borrowed from JPM:

·         Mon Apr 12: earnings after the close (AA, PKX). 
·         Tues Apr 13: before the open (INFY, LVMH sales, TLB, FAST).  after the close (CSX, INTC, ADTN, LLTC). 
·         Wed Apr 14: before the open (ASML, JPM, GWW).  after the close (LSTR, YUM). 
·         Thurs Apr 15: before the open (Roche sales, Danone sales, Rio Tinto, Experian, PPG, FCS).  after the close (ISRG, GOOG, KKD, VMI, AMD, PBCT).
·         Fri Apr 16: before the open (GCI, KNL, FHN, MAT, GE, PBR, BAC, GPC, Sony-Ericsson). 

Barron’s defends FRX.  BofAMLCO ups CLI, DEI, MAC.  BMOC ups TSCO.  GSCO ups JCP.  OPCO ups WSM, LINC.  JEFF cuts CELG.  JPHQ cuts AA.  MSCO cuts D.  OPCO cuts STRA.  Soleil cuts MGM, ZLC.  FBRC swaps out TLB for AEO as “top pick.”  UBSS ups CMI, DISH.  Moody’s affirms GNW at stable.  Chinese website apparently reporting that HTC could acquire PALM.  RELL higher on earnings and ups guidance.  RRI cut at MACQ. 

Asia higher overnight.  Europe roughly 1% higher.  USD -10bps.  Oil +37bps.  Gold +32bps. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
MBIA INC                       8.27      +9.54% 273180
FISERV INC                    54.50    +6.32% 884
CONSTELLATION-A         16.00    -5.04%  20856
FANNIE MAE                  1.13      +3.67% 1113202
J.C. PENNEY CO              31.98    +3.23% 49949
MGIC INVT CORP            12.31    +3.01% 3700
FREDDIE MAC                1.38      +2.99% 373044
RANGE RESOURCES        49.75    +2.94% 18230
CABOT OIL & GAS          39.29    +2.34% 1300
KRAFT FOODS INC         30.77    +2.12% 113
CUMMINS INC                66.37    +2.06% 4959
HUNTINGTON BANC        6.02      +2.03% 39329
CITIGROUP INC              4.56      +2.01% 16751140
SPRINT NEXTEL CO        4.08      +2.0 %  176823

Today’s Trivia:  Less a trivia question and more an outright question, as posed by our analyst Marcelo Tenenbaum:  Why is Plum Creek Timber in the XLF (Financial Select ETF)?  Does anyone know this?
Yesterday's Answer:  Top five GLOBAL companies, per market cap (Q4 2009 data):  PetroChina, Exxon Mobil, Microsoft, Industrial and Commerce Bank of China, and Wal-Mart.  
Best Quotes: 

"Reality is merely an illusion, albeit a very persistent one."
-Albert Einstein

Today's reality is that American and European governments are Keynesian. That is, they believe that government spending is the answer to growth, and that government's heavy hand doesn't perpetuate the unemployment they whine about or the inflation that they aren't allowed to talk about.

Retiring Fed Head, Donald Kohn, made comments in San Francisco last night that summarize the illusion that he needs to create: "I expect unemployment to come down only slowly from its current elevated level"... and... "inflation will remain low for a while."

Now, let's set aside that Kohn has been at the Fed forever and missed seeing any of this mess coming since he joined the Fed's Board of Governors in 2002, and consider the reality of this two-factor Fear Mongering Fed Modelthat he and his always dovish friends, Janet Yellen and Bill Dudley, have recently echoed:

1.      Unemployment: At +9.7%, its high. Anyone with an internet connection gets that. It's also the most lagging economic indicator we have, and it's rolling over sequentially versus its peak where some at the Fed were forecasting the Great Depression.

2.      Inflation: Headline inflation (CPI) rolled over in February on a month-over-month basis to +2.1% year-over-year (yes, even the calculation that they have changed 9x since 96' to numb it down is up), and is setting up to shoot up again, sequentially, in March.

Yes, there are forecasts embedded in my considerations. This is what people who manage risk proactively call "making a call" before something happens and you can hold me accountable to it (March CPI will be reported next Wednesday).Reality's Illusionis that Washington group-thinkers still thinks that "core" inflation is benign, because the Fed model is a reactive one that's based on yesterday as opposed to today and tomorrow.

I talked to the Chairman of MFS and author of "Too Big To Save", Bob Pozen, about this last night on Bloomberg TV. I asked Bob if the real problem with the Fed and the said leadership of American finance is whether or not the Fed operates with an ideology rather than a proactive risk management process. He said yes. Coming from a leader who is marked-to-market every day by his clients, the answer here was not surprising.

I understand that 2008 seems like forever ago, but the realities of what created this crisis are not illusions. In 2008, on the topic of ideology versus empirical process, Rep. Henry Waxman asked Alan Greenspan, "do you feel that your ideology pushed you to make decisions that you wish you had not made?"

Greenspan: "Well, remember that what an ideology is, is a conceptual framework with the way people deal with reality. Everyone has one. You have to - to exist, you need an ideology. The question is whether it is accurate or not. And what I am saying to you is that I found a flaw."

So there you have it Mr. Bernanke and Mr. Kohn. What have you learned from the crisis and why are we still managing go-forward market risks based on a failed ideology? Markets change and so do facts; what do you do Sirs?

The reality is that Glenn Stevens at the Reserve Bank of Australia, Albert Einstein, and Darwin for that matter, would never sign off on individuals garnering so much political power that they allow their ideologies as to a way something "should" work override the data. It's lunacy.

A persistent illusion that Keynesian economics is the written gospel of God is what brought us the inflation of the 1970s, and for whatever reason now all the Keynesians out there think "it's different this time" because they can print moneys from the heavens. Food in India may indeed by falling from Ben's helicopters right now, but its +18% more expensive than it was last year!

While the US Federal Reserve and European Central Bank mark their ideologies to their political models, the inflation data continues to roll in. And yes, inflation is marked-to-market.

Anyone who needs to put gas in their car or food in their children's mouths around this good world get that, but now were even seeing inflation spikes on conflicted government data.

While I am still forecasting here, I'm also staring down the latest data on my sheets from this morning's global macro run:

1.      British Producer Prices (input prices, as in the price of things someone needs to pay to make something they want to sell) were up +10.1% year-over-year for the month of March. That was the highest reading since May of 2008, when Bernanke didn't think $150/oil was inflationary.
2.      Oil prices are trading in a Bullish Formation (bullish across all 3 of our risk management durations: TRADE, TREND, and TAIL) at $86.16; that's up +12-21% from the WTIC oil price that was imputed into the February CPI and PPI reports don't forget.
3.      The US Dollar Index continues to make a series of higher-highs and higher-lows at the same time as US Treasury yields continue to make a series of higher-highs and higher-lows.

Suggesting that the both Mr. Bond Marketand Mr. Currency Markethave this wrong alongside Dr. Copper (who is trading up at $3.61/lbs this morning; up +26% from the February lows that the Fed is straight-lining as their "benign inflation" assumption), and that the Fed's flawed ideology is right, is something for analysts far braver than I to accept as an illusion that will be this debt laden world's long term reality.

My immediate term support and resistance lines for the SP500 are now 1178 and 1194, respectively.

Best of luck out there today,

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