Friday, April 16, 2010

Morning Note...

Happy Friday… Futures -45bps this morning on a mix of earnings news, economic data, and Asian weakness overnight.  In earnings news, GE & BAC were not profitable in Q1, but reported earnings that were better than anticipated, and both are trading in-line to slightly higher pre-market.  GOOG reported last night and is trading lower despite beating estimates on both EPS and revenues.  Note that GOOG makes up roughly 5% of the NASDAQ 100, so it is weighing on the tech sector in general as it trades down ~5% this morning.  AMD is also lower pre-market after last night’s earnings beat but lowered forward guidance.  Toy-maker MAT is higher after beating by 10c.  Elsewhere, the merger talks between Continental Airlines and United Airlines appears to be gathering momentum.  In economic news, Housing Starts for March were 626k vs. the 610k survey estimate (+1.6% month-over-month) and Building Permits for March were 685k vs. the 625k survey estimate (+7.5% month-over-month).  Interesting comment from CNBC’s Rick Santelli on the bullish housing starts data this morning… “the feel of the numbers just doesn’t seem to match the feel of the economy.”   Overseas, note that China’s exchange began trading stock index futures today and Asian markets were weaker across the board.  China actually raised down-payment requirements on second homes in order to dampen the potentially overheated real estate market there.  (Side note:  this may be completely ignorant, but people in China have second homes?!)  In Europe, some headlines splashed this morning regarding Greece’s looming need to tap into the EU aid package (ECB'S NOWOTNY SEES INDICATIONS GREECE MAY ACTIVATE AID PACKAGE), leading to early euro weakness against USD strength.  Note that we’ll get the UofMichigan confidence survey results at 10am, along with the Leading Economic Indicators data.  In other news, the Icelandic volcano and subsequent ash cloud continues to affect air traffic throughout Europe

Regarding Europe, nothing new here, but the most recent edition of The Economist is cautious on the euro and overall prospects for the European Union:

The bail-out for Greece has merely bought some time. Europe’s governments must use it wisely

FOR all her promises to stand firm against a subsidised rescue for Greece, Germany’s Angela Merkel wobbled as soon as financial markets gave off a whiff of serious panic. On April 11th, after spreads on Greek debt had soared and the first signs emerged of a possible run on its banks, euro-area leaders agreed to offer the beleaguered Greek government up to €30 billion ($41 billion) of three-year loans, at an interest rate of 5%. That is not cheap, but it is much less than private investors were demanding. Add in a further €15 billion that the IMF is likely to provide, and Greece has been promised enough help to cover its financing needs for 2010.

Does this mean the Greek debt crisis is over? European Union officials argue that the amounts are big enough to give Greece the liquidity it needs to get it through its fiscal adjustment. Arming Greece with a large financial bazooka may have taken a while to arrange, but the Europeans hope such a show of financial firepower will be enough to deter speculative attacks by dispelling any chance of a Greek default.

Unfortunately this hope does not stand up to scrutiny. The bail-out, which was certainly bigger than the markets had expected, has all but eliminated the risk of default this year. But Greece still faces a deep medium-term solvency crisis. Anyone who looks hard at Greece’s debts and the interest rate it is paying on them can only conclude that, unless growth rebounds unexpectedly strongly, an eventual restructuring of Greek debt remains highly likely (see article). The rescue package has merely bought time—three years, in effect, to contain the adverse consequences of a possible Greek default.

Grim figures
Begin with the numbers. Greece’s medium-term debt outlook is darker than either its government or the EU admits. This newspaper’s calculations suggest that even with a fiscal adjustment worth 10% of GDP over the next five years, Greece will either need more official loans for longer than the current rescue package promises or will have to “restructure” its debts (ie, defer payment on some loans or pay back less than it owes). Even on optimistic assumptions, we reckon Greece will need €67 billion or more of long-term official loans in the next few years. Its debt burden will peak at 150% of GDP in 2014, a level exceeded now only by Japan. If growth turns out to be weaker than expected, or Greece fails to cut spending or raise taxes enough, the figures will be a lot worse.

Such a sombre conclusion invites the question of whether this week’s bail-out makes any sense. After all, the history of emerging-market debt crises, especially Argentina’s in 2001, suggests that, if default is overwhelmingly likely, it is better to get it over with rather than put it off with quixotic rescue packages. But this is not true in the Greek case, for two reasons that have less to do with Greece than with the rest of the euro area.

First, a Greek default now would carry a serious risk of triggering debt crises in Portugal, Spain and even Italy, the other euro-area countries suffering from some combination of big budget deficits, poor growth prospects and high debt burdens. The EU does not have the firepower to cope with these.

Second, a default now could also have calamitous effects on the fragile European banking system. Euro-area banks hold €120 billion of exposure to Greece, of which we reckon perhaps €70 billion is Greek sovereign debt. French and German banks account for 40% of the total. Many European banks might well require more government help if they lost a lot on Greek debt. Indeed, the sums involved might easily be greater than the German and French contributions to the Greek rescue loans. And if contagion then pushed Spain and Portugal to a crisis, the entire European banking system could implode.

No time to lose
This prospect is sufficiently worrying to make it right to buy time by providing a bail-out for Greece. But that calculation could change rapidly if the time is not used well—by Greece and, even more, by other euro-area countries.

Greece’s to-do list is now well-known. A country that spent years mismanaging and misreporting its public finances must tighten its belt dramatically for a long time. To boost competitiveness and growth, as well as improve the budget, it must embrace radical tax changes, cuts in public-sector pay and pension reforms. Bold adjustment, which to its credit the new Greek government has already begun, will reduce the risk of Greece finding its debts unpayable in three years’ time.

Even then, it is not hard to see circumstances in which the Greeks might think they would be better off defaulting. So the euro area’s other vulnerable economies must also use the next few years to convince the markets that they are not like Greece. That will also demand fiscal austerity. But even more important are structural reforms to improve competitiveness and boost growth. Without the option of a currency devaluation, countries such as Spain, Portugal and Italy have no alternative but to restrain labour costs and bring in supply-side reforms that raise productivity, especially through the freeing of labour markets. These reforms, long overdue, are now essential. It would be a mistake for the leaders of Spain and Italy to assume that if they got into trouble they might be bailed out like Greece: neither the EU nor the IMF could afford it.

Nor is the to-do list confined to Europe’s southern rim. Germany must help by doing more to boost its domestic demand. Financial regulators everywhere must push banks to clean up their balance-sheets and bolster their capital. The European Central Bank must avoid creating an incentive for banks to load up on Greek debt and then offer it as collateral for liquidity from the ECB, by (controversially) offering less cash for government bonds with lower credit ratings. And governments must start putting in place a mechanism for managing sovereign-debt restructurings within the single-currency zone.

This to-do list is alarmingly long, which is why European politicians are deluding themselves if they think the Greek crisis has been resolved with this week’s rescue. Because Greece was small enough to bail out, they have bought a temporary reprieve. Now they must use the time wisely.

Interesting blurb on emerging market bond in-flows in case you missed it:

Emerging Bond Inflows of $10.4 Billion Surpass 2005 (Update2) 2010-04-16 04:33:49.471 GMT
April 16 (Bloomberg) -- Emerging-market bond funds received an unprecedented $1.8 billion in the past week, lifting 2010 inflows to a record, as high-yielding debt attracted global investors away from stocks, according to EPFR Global. Currencies in emerging markets have appreciated this month, boosting returns on debt, and at the same time helping to curb inflation and preserve the fixed payments on bonds. Investors in global equities pulled out $6.2 billion in the week to April 14 on prospects accelerating economic growth will prompt policy makers to withdraw stimulus measures. Investment in developing nations’ bonds reached $10.4 billion, exceeding an all-time high in 2005, the Massachusetts- based research company said in an e-mailed statement. Inflows into U.S. floating-rate notes were also a record and all bond funds took in $5.6 billion, EPFR said.

Finally, in geopolitical news, here’s a follow-up to that South Korean ship sinking from three weeks ago that really spooked markets:

            South Korean Ship Likely Sunk by External Explosion 2010-04-16 05:30:32.960 GMT
April 16 (Bloomberg) -- South Korea said an external explosion likely sank one of its warships close to the disputed border with North Korea last month, killing at least 38 sailors. “There is a high possibility of an external explosion, rather than an internal one,” Yoon Duk Yong, the lead investigator into the March 26 sinking, said at a briefing in Seoul today. His team is still exploring all possibilities before drawing a conclusion, he said. The sinking of the 1,200-ton patrol ship Cheonan created a “grave national security situation,” Defense Minister Kim Tae Young said at the same briefing. “We will respond in a very clear and firm manner” once South Korea determines what caused the explosion, he said. Today’s finding was the strongest indication of possible North Korean involvement in the blast off the peninsula’s west coast, which witnessed naval skirmishes between the two nations in 1999, 2002 and November last year. Yoon and Kim didn’t mention North Korea in their statements and the communist nation’s state media has made no reference to the incident. “While this increases the likelihood of North Korea’s involvement, the South Korean government would have to collect concrete evidence to draw that conclusion,” said Baek Seung Joo, an analyst at the Korea Institute for Defense Analyses in Seoul. “It may take months until it can be concluded that the external blast was either caused by an intentional, provocative attack or was an accident.”

CSFB ups PPG.  MSCO ups XEL.  ACH won regulatory approval for private placement.  AMD beats by 16c but lowers guidance for Q2. BSX higher on news that it will resume distribution of Cognis and Teligen drugs.  GSCO cuts CAH, ADS.  GOOG beats on earnings and revs.  IRE higher on news it will sell off assets.  ISRG beats by 44c.  OPCO cuts JACK, CADX.  Carl Icahn confirms increased tender offer to $7 for LGF.  MAT beats by 10c. NVDA cut at NEED.  PFWD to be acquired by ORCL for $17/share.  BofAMLCO positive on RBS.  BARD cuts CFNL, MBFI, SBIB, STEL, TITN.  WEFA cuts EXC. 

Asia down ~2% overnight.  Europe lower.  USD +40bps.  Oil -175bps.  Gold -1%. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
ADV MICRO DEVICE        9.58      -5.71%  475855
BOSTON SCIENTIFC       7.51      +5.18% 614356
GOOGLE INC-CL A           565.89  -4.94%  186976
FIRST HORIZON NA        14.70    -4.05%  26505
MATTEL INC                  24.50    +3.16% 25870
GAMESTOP CORP-A        25.18    +3.11% 3052
GANNETT CO                 18.70    +3.09% 29380
CIENA CORP                  17.53    -2.99%  800
NVIDIA CORP                 17.48    -2.94%  50130
INTUITIVE SURGIC         378.00  -2.58%  11486

Today’s Trivia:  What is the difference between “poisonous” and “venomous?”  (Hint, think about whether you would say “I was bitten by a poisonous snake” or “I was bitten by a venomous snake.”) 
Yesterday's Answer:  The dinosaurs roamed the planet 44,000 times (!!) longer than we have.  Think about that for a second.  For every day man has been on Earth, dinosaurs were here for 120 years.  Amazing when you consider the scale in those terms. 
Best Quotes:  “Currently, a great deal of market focus is on technical and sentiment indicators hitting extreme levels, i.e. RSI, low Vix, low Put/Call, New Highs, etc.  Some solace can be taken in the fact that AAII’s 62% Bullish reading while optimistic is still not in “Sell” territory, but as we noted a few days ago we expected it to get there in coming months.  Another fact in which investors may also find some comfort is that despite the S&P 500’s 8.6% gain year to date and a 16+% rally off the February 5th low, in the 71 trading days year to date, the S&P 500 has not registered a single up 2% day.  In fact, there were only 2 sessions where the index added more than 1.5%, and one of those was the first trading day of the year.  For context, of the 252 trading days in 2009, 27 posted gains greater than 2% and 28 sessions posted losses of greater than 2%.  In both cases, 11% of sessions accounted for larger moves.  In 2008, 12% of sessions registered gains in excess of 2%, and 16% of sessions registered losses greater than 2%.

When market participants consider the contraction of the Vix to the lowest level in over 2½ years, concerns of complacency rise.  Simultaneously, memories of 2006-2007 emerge.  That was a financial liquidity fueled environment and to highlight just how calm it was, let us remind you that there were only two sessions which posted gains larger than 2% and none where the S&P 500 lost 2%.  Interestingly, 2007 was nearly as mild with 6 sessions posting 2+% gains and 11 posting 2+% losses.  In February 2007, New Century started to fail.  In June, the Bear Stearns credit hedge funds imploded, and by August, the credit crunch erupted.  One difference between now and then is that back then, nobody had their guard up.  Despite the sentiment indicators, today most market participants still have their guard up.  When encountering a low volatility environment, especially one following a cathartic long bear market, investors should keep in mind that coming out of the last ugly bear market from March 2003 until July 2007, the S&P 500 never posted a 10% correction.”

--Mike O’Rourke, BTIG

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