Monday, May 17, 2010

Morning Note hiatus...

Apologies in advance, but the Morning Note is suspended this week. 

I’m “on call” and will be in and out of the office; Brielle is literally due any second…

Hopefully back writing next week or the week after at the latest. 

All the Best,

Friday, May 14, 2010

Morning Note...

Futures are down ~100bps this morning as investors once again consider the broader implications of the IMF/ECB’s bailout and the implications for Europe, the euro, and the European Union.  U.S. futures are taking their cues from the EUR/USD action, which has faded to below $1.25, and from European markets, which are down roughly 2%.  There are all kinds of chatter about Germany shifting away from the euro currency (including a rumor that the German government has prepared a “Plan B” return to the deutschemark as early as this weekend!) and a Spanish paper is quoting French President Sarkozy as threatening to leave the euro during talks last weekend.  Further, DB chief Ackermann made cautious comments about Greece’s ability to meet its debt obligations.  As a result, the USD remains the beneficiary of a “flight-to-quality,” up 25bps against a basket of foreign currencies.  Gold continues to make new highs against all currencies, at ~$1250/oz.  In economic news, U.S. Advanced Retail Sales for April were double the expectation (+0.2%) to +0.4% but down from March’s revised +2.1%.  In corporate news, Mastercard and Visa are lower after the Senate approved an amendment effectively lowering debit-card fees, and NVDA and JWN are lower on earnings.  Industrial Production and Capacity Utilization are due at 9:15am.

Regarding the euro, the tug of war between the bulls and the bears has begun in earnest.  Just as a weak USD helped reflate risky assets in this country, bulls would argue that a weaker EUR will help exporters on a global scale (whose “cheaper” goods will be more competitive) and will mean less debt service to pay (as the currency devalues, you automatically owe “less”).  Of course the bears will argue that the EUR was an ill-fated social experiment from the beginning.  As investor Louis Bacon of Moore Capital said in April (I am paraphrasing here), “investors have long seen the EUR as a proxy for the very strong deutschemark…and they are just realizing that it’s become a proxy for the drachma instead.”  Further, according to Bloomberg:

Talk of a euro breakup is discussed as German-led northern Europe attempts to rectify mistakes made by the euro’s founders in the 1990s and squares off against the south over who will control the currency and the ECB, whether it will be used to prompt growth or curb inflation, and ultimately whether or not some countries “should be disbarred from the monetary union.” Former Federal Reserve Chairman Volker spoke in London yesterday and is quoted as saying, “You have the great problem of a potential disintegration of the euro . . . The essential element of discipline in economic policy and in fiscal policy that was hoped for [has] so far not been rewarded in some countries.”

The interesting action will be in the determination of where the EUR ultimately settles.  Will the EUR sink below its origin-levels (see trivia below)?  Will it drop to parity levels with the USD?  Or lower?  And what are the global repercussions of such?  Judging from recent action, in a unclear world, the only certainty – for the moment – seems to be gold.   Regarding gold and gold alternatives, I found this tongue-in-cheek note from BNY Convergex both amusing and interesting, especially the details on precious metal weight and private plane “portability.”  Somewhat reminds me of the Fall of 2008/Winter of 2009, when NPR ran a feature story on sales of firearms and safes hitting record highs worldwide:

Gold is clearly working as an investment, but perhaps not for the reasons we thought just a few months ago. The dynamics around the ongoing breakout, for example, seem to have more to do with Europe’s recent efforts to salvage the Euro than the ongoing profligacy of the U.S. government. There was a common wisdom that gold would rise as the dollar slackened. In fact, it has been the slow motion collapse of the Euro that has catalyzed gold’s move higher. No doubt other sources of demand, from domestic U.S. buyers to Chinese jewelry purchasers, have helped as well. But press reports of large scale European buying of physical gold correlate too well to the move in the past week to think any other of these more long-standing trends actually caused the breakout. Continental purchasers clearly see gold as a refuge from Euro devaluation.

There is a unique psychology to this “refugee buying” that dovetails with Europe’s experience of a major war every century for a millennium. Suffice it to say that anyone with first or second hand knowledge of what happened in Europe in between World Wars is not surprised by gold’s move higher this week. World War I left the continent in tatters and Germany was pressed into making crushing reparations to the Allies. Part of its efforts to pay those debts included printing currency at an astonishing rate, which led to hyperinflation and an economic collapse that spawned the rise of the National Socialists and Adolf Hitler as leader of the country.

Yes, to Americans that seems like ancient history, but the 1930s cast a long shadow over Europe, and especially across its largest economy, Germany. So since the EU announced its wide-ranging monetary stimulus plans to support the Euro, it is certainly understandable that Europeans have been incrementally hedging their bets with gold purchases. European countries have a strong tradition of minting gold coins and the Swiss also produce easy-to-store one ounce gold bars.

But the question that intrigues us is, “What other asset classes may see increases in demand from the current uncertainty over the value of the Euro?” We don’t think other currencies can be long-term beneficiaries, although the dollar has certainly gotten a tailwind in the last week. Individuals and institutions with concerns over the security of sovereign debt, currency exchange rates and even global taxation policies will more likely focus on portable real assets that carry few disclosure requirements and look for safe places to custody those assets.  So here are some ideas for the follow-on trade to gold:

Silver. Starting with the easiest call, silver is an obvious choice. It has been used in coinage for millennia so it has a similar psychological profile to gold as far as a historic store of value. It is not as portable as gold – $1 million in gold weighs about 57 pounds. The same amount in silver is 3,000 pounds, give or take. Still, if ounce-sized gold coins stay in relatively short supply, silver demand for investment purposes should stay strong as well.

Platinum. This metal has the right profile to be a new third choice for “store of value” metals investing. It is more expensive than gold, used in jewelry, and several countries – the U.S., Canada and China to name three – make bullion coins from the metal. It does have a wide range of industrial uses (as does silver, for that matter), so demand is not primarily driven by investment-oriented buyers. That is a risk to platinum prices if global economies see a “double dip,” but consider that our theoretical $1 million in cash translates into just 37 pounds of platinum. That’s pretty good portability. For the curious billionaire reading this note, your Gulfstream G5 will carry approximately $135 million of platinum (5,000 pounds), leaving space and weight for 2 copilots and 4-5 passengers.

Diamonds. For the ultimate in capital-preserving portability, diamonds have no equal. A super premium one-carat diamond currently trades for $25,000 – check out if you want to see the goods first hand. One pound of these gems would be worth $57 million, if you could even find that many. That one pound sack would contain over 2,000 one-carat stones. Of course, you could go bigger, and a two-carat flawless diamond would fetch $100,000. Diamond prices have begun to tick up in recent months, but are not yet back to inflation adjusted highs from the 1970s. We would note that the diamond market has historically been tightly controlled, first quasi-officially by De Beers and more recently by Russian producer Alrosa. This state-owned firm stockpiled gems during the financial crisis as demand collapsed but has returned to the market in the first quarter of 2010.

Tax haven real estate. With sovereign debt issuance rising in the U.S. and Europe, the next logical step will be to see taxes rise in both areas. That will make for a robust real estate market in countries like Monaco or territories like the Channel Islands. This is less of an issue for Americans – Uncle Sam follows you around the globe, no matter where you live, and asks for his fair share of income and capital gains. Most other countries, however, allow you to pay taxes in your country of domicile if you have legitimately set up house there. We do not have much data on the trends for real estate prices in the tax havens of the world as of yet. But suffice it to say that we suspect Monte Carlo real estate agents are going to have a very, very good year.

WSJ reports wireless carriers are shifting to prepaid segment in order to spur growth.  CITI ups PH.  KBWI cuts FAF.  JEFF ups POZN.  JPHQ ups APC.  UBSS ups CAE.  CITI cuts NFLX.  CSFB cuts BOH.  GSCO cuts EJ, WX.  SUSQ cuts MMSI. 

Asia lower overnight.  Europe down 2%.  USD +25bps.  Oil -1%.  Gold +140bps.

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
MASTERCARD INC-A       210.24  -9.5 %  161141
NVIDIA CORP                 13.75    -6.14%  537004
CA INC                          20.55    -6.08%  10900
DILLARDS INC-A             27.25    +5.95% 18900
GAMESTOP CORP-A        21.45    -5.42%  1643
COVENTRY HEALTH        20.76    -4.51%  386
CAPITAL ONE FINA         43.30    -3.58%  25676
DISCOVER FINANCI        14.26    -3.58%  12346
STARWOOD HOTELS      49.89    -3.35%  250
NORDSTROM INC           40.00    -3.12%  28513
AMERICAN EXPRESS       41.58    -2.87%  103196
FIFTH THIRD BANC         14.44    -2.43%  26134
BROADCOM CORP-A       32.25    -2.36%  7354
KING PHARMACEUT        9.05      -2.27%  813
FREDDIE MAC                1.35      -2.17%  23900
METLIFE INC                  42.14    -2.16%  2139
EL PASO CORP               11.90    -2.14%  2333
GANNETT CO                 16.09    -2.13%  1800
APPLIED MATERIAL         12.95    -2.12%  4900
MICRON TECH                8.95      -2.08%  42830
REGIONS FINANCIA        8.56      -2.06%  93383
YAHOO! INC                   16.47    +2.04% 136013

Today’s Trivia:  When the EUR debuted in 1999, at what level was it priced versus the USD?
Yesterday's Answer:  According to yesterday’s CNBC story, 65% of MCD’s orders are made from a car, i.e. from the drive-through. 

Best Quotes:  If there is one optimistic note to be sounded this morning about the beleaguered EUR it is that some of the nation’s in Europe actually do seem to be learning the truth about their precarious fiscal circumstances. Let’s applaud, then, Portugal and Spain this morning, but let’s do so quietly for what Portugal and Spain have done does not yet deserve resounding applause. Rather, quiet, modest applause shall suffice as their parliaments, with the clear support of the Prime Ministers of both nations… the wonderfully named Jose Socrates in the case of Portugal and Mr. Zapatero, the rather far-to-the-left-of centre Prime Minister of Spain… and the leader of the opposition party in Portugal’s Parliament, Mr. Pedro Passos Coelho, all agreed to raise their VATs, to raise income taxes, to increase the taxes on corporate profits and cut the salaries of many of the nation’s political leaders. These are “baby steps” in the right directions, at least when it comes to trying to bring some balance to their fiscal circumstances, and so we applaud them quietly. What bothers us, however, is that so little was done in the name of spending cuts and so much was done far too quickly in the way of tax increases. Would that they had endorsed huge spending cuts and had “matched” those cuts with tax cuts too… even if the tax cuts were very, very small. Those would be the policies that would allow us to applaud loudly; the stamp our feet, to whistle shrilly and to beat the drum in either nation’s case. That, however, is not going to happen… at least not in Europe.  --TGL

Thursday, May 13, 2010

Morning Note...

Futures down ~30bps on a quiet morning as much of Europe is out on holiday.  (But note the EUR/USD has dropped below $1.26 this morning…)  As a result, the focus shifts back to the U.S. as catalyst:  In economic news, import prices rose slightly versus estimates, and Initial Jobless Claims disappointed somewhat at 444k vs. the 440k estimate.  The prior reading was also revised slightly higher to 448k.  Continuing Claims are 4.627M vs. the 4.590M estimate.  Further, much is being made of foreclosures dropping in April (-9% month/month and -2% year/year), but most experts caution that a massive backlog still remains in the pipeline (see article below).  In earnings news, Cisco (CSCO; -2.5%) reported better-than-expected earnings for its fiscal third quarter last night, and gave in-line guidance for Q4.  Whole Foods (WFMI; +7%) reported Q2 profit that doubled over a year ago, and raised forward guidance.  Restaurateur Wendy’s (WEN; -3.3%) beat earnings estimates but reported lower sales growth; Jack-In-The-Box (JACK) is also lower on earnings.  Further, in M&A news, SAP will pay $65/share – or roughly $6 billion – for Sybase.  In other news, the NY Times is reporting that NY Atty General Cuomo is investigating eight banks over potential misleading disclosures to ratings agencies. In Europe, CDS are slightly tighter as Germany, France, Austria, Sweden, and Switzerland celebrate Ascension Day.  In fact, Europe may be quiet tomorrow as well if investors there take Friday off to make a four-day weekend…  Note that Obama is in Buffalo, NY today – where jobs will be a major focus – for his “White House to Main Street” tour, before returning to NYC for – what else? – a fund raiser.  Looking ahead, we’ll get the results of the 30-yr Treasury auction at 1pm today. 

Regarding the EUR move, I thought the dedicated FX trader commentary this morning was interesting:

EURUSD support 1.2605/10, 1.2510/50, 1.2450, 1.2330 resistance 1.2750/60, 1.2800, 1.2880, 1.2940

EURUSD market appears to have settled for now , and the fireworks of last week have been replaced with price action similar to that seen a lot this year ...a slow grind lower with the buying interest coming from the usual suspects and rallies limited despite improving risk sentiment. This fits with the view that the reasons behind the single currency's demise have shifted since the weekend...what was a 'credit story' has now migrated into an FX story. If this move grinds lower and continues in this way then it can be argued that 1.2800/50 should not be seen again. Currently small short, adding on mini rallies 1.2700/50, reassess above 1.2800.

Gotta love the always-entertaining morning note from the guys at Hedgeye, who remind us that the U.S. has to roll over 40% of U.S. Treasury debt by 2012:

With Ben Bernanke and Jean-Claude Trichet printing moneys from the Keynesian heavens, we thought we'd do some minting of our own this morning and introduce Fiat Fools as our new Hedgeye nickname for politicians running European and American monetary policy.

Adam Smith be damned - there is nothing invisible about the heavy hands of these governments. When it comes to their latest storytelling of a "fat finger" causing volatility in the US stock market, take their word for it. It's a big fat middle finger from the creditors of our broken promises.

In Latin, the word fiat means "let it be done" ... and so our modern day Roman Gods of finance will do exactly that. Let us debauch the value of our currencies and inflate our way out of this colossal mess. All the while, let us hope that our creditors and citizens alike don't notice Main Street inflation while Wall Street gets paid to underwrite it.

Alas, we all know that hope, unfortunately, is not an investment process for anyone other than the Fiat Fools. The inconvenient truth of history reveals that debtor nations who become hostage to foreign lenders are just that - hostages. As David Walker points out in his latest book "Comeback America", "the British Empire learned this in 1956, when Britain and France were contesting control of the Suez Canal with Egypt." All US President Eisenhower needed to do was threaten to sell the British Pound.

What if the Chinese or Japanese imposed that credible threat on the US? Up until Greenspan went global with the Fiat Fool system of US economic policy, US public debt held by foreigners was less than 20%. Now it's pushing north of 50%, and that's the point. The Buck stops there - and don't think for a New York minute that America isn't setting herself up on the trolley tracks to get run right over by the same oncoming train that European pigs have.

Given the light news flow today, here’s some interesting reading from Tony Boeckh of the The Boeckh Investment Letter:

Spending and borrowing excesses of governments and the public have a long and dangerous history, suggesting a deeper malaise is affecting the nation. Moreover, there are other serious signs of long-term decline, and policy and leadership will have to be particularly adroit in steering the U.S. through the difficult few years ahead. It has been documented that the latter stages of a long wave decline are parochial, nasty and politically unstable. People are fed up with the system, their loss of wealth, jobs, and income. Traditional politicians are blamed. People look for quick and easy solutions and are open to simplistic solutions provided by demagogues. It is difficult to sell the austerity, sound policies and pro-growth strategies needed to transition through the long wave trough before really big crises occur. Countries in denial face the prospect of repeating Greece’s calamity.

The risk for the U.S. and other countries is that politicians will cater to populist pressures and impose spending and tax policies that are counterproductive. In the aftermath of the Great Reflation, this could mean more government programs (e.g. health care), failure to raise taxes, where appropriate, out of fear of losing office, and excessive monetary ease because the Treasury bond market cannot absorb government funding on its own.

However, we should avoid the temptation to get too pessimistic. It is important never to underestimate the ability of the U.S. to recover from adversity, rejuvenate itself and get its house in order. Its long-term track record is pretty good, and realistic hope should not be jettisoned too readily. The question remains however, as to whether the U.S. needs an economic Pearl Harbour before serious action is taken. Investors have seen empty promises many times before and hence should be skeptical until they see clear, positive evidence that such action is being taken. Until then, they should take the attitude “show me”.

The Investment Challenge

The great problem for investors in today’s environment is that there is no return on short-term, safe assets yet the higher risk levels on longer‐term, higher return assets are too uncomfortable for most people. There are a number of conservative strategies that investors can employ, which are discussed at length in The Great Reflation and in our Boeckh Investment Letter (, which, for lack of space, cannot be discussed here.

The centerpiece of our own strategy, and outlined in the book, is understanding liquidity flows. They are the single most important force driving investment markets both up and down. Contracting liquidity caused the crash in 2008-2009 and dramatically expanding liquidity since March 2009 has triggered one of the greatest bull markets in U.S. history. The next bear market will also be driven, at some point, by a contraction in liquidity flows. However, as long as the great reflation is doing its work, that day can be postponed. Chuck Prince, if he were to comment today, would probably point out that the music is playing again. People are back out on the dance floor. But, if the great reflation is as artificial as we believe, then this is still musical chairs. When the music stops, there won’t be a chair for everyone, just like the last time.

WSJ reports VZ is in talks with rural carriers to more quickly expand 4G network.  BERN cuts DVN.  RAJA ups S.  MS upped at FBRC.  HAL upgrade at FBRC.  SLB upgrade at MACQ.  MYGN upped at Auriga.  EMS upped at CSFB.  AHL/VR/PRE upped at DBAB.  TEVA cut at OPCO.  KBH/MDC/TOL/COF cut at MACQ.  JACK cut at CSFB.  CRIC strategic alliance with BIDU.  URS higher on earnings.  WRC announces 5M share repurchase. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
PROLOGIS                     13.50    +8.78% 6823
WHOLE FOODS MKT       42.76    +6.24% 130168
EBAY INC                       23.37    +3.82% 82806
CISCO SYSTEMS            25.80    -3.52%  5651006
WENDY'S/ARBY'S-A        4.93      -3.14%  58743
SPRINT NEXTEL CO        4.28      +3.13% 1686434
HALLIBURTON CO           29.92    +2.85% 296026
ALTERA CORP                24.15    -2.42%  18590
US STEEL CORP             56.22    +2.16% 166059
DEVON ENERGY CO         68.13    -2.07%  7650

Today’s Trivia:  What percent of McDonald’s orders are made from a car?
Yesterday's Answer:  The Seven Summits are Kilimanjaro (Africa), Vinson Massif (Antarctica), Kosciuszko OR Carstensz (Australia), Everest (Asia), Elbrus (Europe), Mt. McKinley (N. America), and Aconcagua (S. America). 

Best Quotes:  U.S. Home Seizures Reach Record in Sign Recovery Is Delayed 2010-05-13 04:00:00.5 GMT By Dan Levy

May 13 (Bloomberg) -- U.S. home repossessions rose to a record level in April while foreclosure filings dropped in a sign mortgage lenders are working off a backlog of seized properties, according to RealtyTrac Inc. data. “Right now it appears that the banks are focusing on processing the loans already in foreclosure, and slowing down the initiation of new foreclosure proceedings as a way of managing inventory levels,” Rick Sharga, RealtyTrac’s executive vice president, said in an e-mail. “We’ll probably see this trend continue for a while.” A record 92,432 bank repossessions were reported in April, up 45 percent from a year earlier and 1 percent from March, Irvine, California-based RealtyTrac said today in a statement. Foreclosure filings, including default and auction notices, were 333,837. One out of every 387 U.S. households got a filing. Unemployment of 9.9 percent and a rising percentage of U.S. homes worth less than the mortgages on them are combining to thwart a housing recovery, according to RealtyTrac. About 5 million delinquent loans will probably end up in the foreclosure process in addition to the 1.2 million homes already taken back by lenders, Sharga said.Foreclosure filings fell 2 percent from a year earlier, the first decline since the company began issuing annual reports in January 2006. Defaults may not peak until 2011 depending on how lenders process them, Sharga said. “The underlying conditions -- mostly unemployment and millions of ‘underwater’ loans -- haven’t improved,” he said.

                        ‘Very High Level’

Monthly foreclosure filings will remain “at a very high level that will not drop off in the near future,” James J. Saccacio, RealtyTrac’s chief executive officer, said in the statement. April marked the 14th straight month that foreclosure filings exceeded 300,000. More than a fifth of U.S. mortgage holders owed more than their homes were worth in the first quarter, according to The proportion rose to 23 percent from 21 percent in the previous quarter, the Seattle-based property service said this month. Home prices may fall as much as 5 percent through the first quarter of 2011, according to forecasts from IHS Global Insight of Lexington, Massachusetts. Still, economist Patrick Newport said foreclosures may not get much worse. “The key thing is fewer problem loans are going into the pipeline,” he said.

                          Defaults Drop

Default notices went to 103,762 properties, down 27 percent from April 2009 -- the peak month with 142,000 -- and down 12 percent from March, RealtyTrac said. The numbers show fewer properties entering the foreclosure process as those that fell into delinquency earlier in the housing crisis finished the legal cycle. Nevada had the highest foreclosure rate for the 40th straight month. One in every 69 households got a notice, more than five times the national average. Bank seizures rose 57 percent from a year earlier and filings were little changed, RealtyTrac said. Arizona had the second-highest rate, at one in 169 households, or more than twice the U.S. average. Filings fell 1 percent from a year earlier. Florida ranked third, with one in 182 households. Filings there dropped 25 percent. California had the fourth-highest rate, at one in 192 households, and Utah was fifth at one in 221, RealtyTrac said. Idaho, Michigan, Illinois, Georgia and Colorado also ranked among the 10 highest rates.

                          Five States

Five states accounted for more than half the total filings in the U.S., led by California’s 69,725. That was down 28 percent from a year earlier and 25 percent from March. Florida ranked second with 48,384 filings, down 25 percent from April 2009 and 18 percent from March. Michigan was third at 19,173, a 77 percent increase from a year earlier. Illinois had 18,870 filings and Nevada had 16,217. Arizona, Georgia, Texas, Ohio and Virginia rounded out the top 10, RealtyTrac said. The company sells default data collected from more than 2,200 counties representing 90 percent of the U.S. population.

Wednesday, May 12, 2010

Morning Note...

Futures up ~60bps this morning as markets react to word of a new coalition government in the U.K., positive economic data in Europe & Germany, Spanish austerity promises, and a successful Portuguese bond sale.  In Europe, Q1 Eurozone GDP was better-than-expected, at +0.2% vs. +0.1%.  Additionally, German Q1 GDP was +0.2% vs. the flat expectation.  Greece’s Q1 GDP also fell 0.8%, which was better than analysts expectations.  Spain announced budget cuts and austerity measures in an attempt to stave off the potential to go the way of Greece.  (And of course, the head of Spain’s unions was outraged…honestly, haven’t unions outlived their usefulness at this point? In an era of abuse and Child Labor, they surely made sense…but now? Can someone make a solid argument for the value-add of unions in this day and age?)  In the U.S., the March Trade Balance was in-line with expectations, at -$40.4 billion.  Disney is trading lower pre-marker despite beating earnings estimates by 2c.  Macy’s is also trading slightly lower despite posting a strong quarter.  Electronic Arts is trading lower on its earnings release as well.  In other news, Morgan Stanley is trading ~5% lower premarket as the WSJ reports that U.S. prosecutors have begun to did into that banks CDO sales and whether – a la Goldman Sachs – they misled clients as well.  Blackstone, TH Lee, and TPG Capital are also on the tape with a $15 billion bid for FIS, which would equate to roughly $32/share.  Looking ahead, note that Cisco reports earnings tonight – that report, along with CEO John Chamber’s commentary, will be closely watched by the Street.  Also keep an eye on Gold as it continues to set new record highs…

Excellent trader commentary from RBC this morning…summarizes the broad tone nicely:

Both Asia and Europe are mixed with no discernable trend; similar situation with the Euro as it's essentially flat at 1.267.  The headline news centers around the UK, and relief over a smooth transition within their government.

For a day when everyone was wondering if the market would/wouldn't confirm Monday's big move up, yesterday was a bizarre day.  The market opened lower, rallied all day only to give it all back and close flat.  Volume was pathetic; 2nd lightest day on the NYSE in the last 11, with global US volumes being the lightest in the last 20 sessions.  So yesterday told us nothing.

Gold made a new high as more and more begin to view it as a currency.  The problem is people are unsure what new highs in gold mean.  If it's a new investible asset class, then new highs are likely a good sign for the market.  In de-risking atmosphere, we've often seen gold knocked down with other risk assets.  Yet when things hit the fan in Europe recently, many are buying it as a new form of currency.  So the goldilocks scenario likely continues- it's a hedge in bad times, and asset class in good times.

Otherwise today's quiet as earnings begin to trail off.  No major economic releases are scheduled, but our London desk points out watching a Portuguese bond auction later today as a barometer for investor demand.  Portugal is in the process of a reverse auction for a bond maturing in 8 days and is aiming to raise between EUR300M and EUR1B, so worth watching as a metric for risk appetite.

Given the relative lull in macro-news today, commentary from the usual suspects is making the rounds.  As expected, investor Jim Rogers is bearish on the whole Eurozone and the EUR currency:

May 12 (Bloomberg) -- Investor Jim Rogers said Europe’s bailout of indebted nations to overcome the sovereign-debt crisis is just “another nail in the coffin” for the euro as higher spending increases the region’s debt. The 16-nation currency weakened for a second day against the dollar after rallying as much as 2.7 percent on May 10, when the governments of the 16 euro nations agreed to make loans of as much as 750 billion euros ($962 billion) available to countries under attack from speculators and the European Central Bank pledged to intervene in government securities markets. “I was stunned,” Rogers, chairman of Rogers Holdings, said in a Bloomberg Television interview in Singapore. “This means that they’ve given up on the euro, they don’t particularly care if they have a sound currency, you have all these countries spending money they don’t have and it’s now going to continue.”  All paper currencies are being “debased,” with the euro currency union at risk of being “dissolved,” Rogers said, adding that he continues to own the dollar, the Swiss franc, the Japanese yen and the euro. “It’s a political currency and nobody is minding the economics behind the necessities to have a strong currency,” Rogers said. “I’m afraid it’s going to dissolve. They’re throwing more money at the problem and it’s going to make things worse down the road.”  Investors should instead buy precious metals including gold or currencies of countries that have large natural resources, Rogers said. Among other asset classes, he favors agricultural commodities as the best bet for the next decade as well as silver because prices haven’t rallied.

Not to be outdone, Nouriel Roubini is also making news today:

May 12 (Bloomberg) -- New York University professor Nouriel Roubini said Greece and other “laggards” in the euro area may be forced to abandon the common currency in the next few years to spur their economies. A “real depreciation” in the euro is needed to restore competitiveness in nations including Spain, Portugal and Italy, he said in an interview on Bloomberg Television today. The euro will remain the currency for a smaller number of countries that have “stronger fiscal and economic fundamentals,” Roubini said. The European Union and International Monetary Fund last week approved a 110 billion-euro ($139 billion) lifeline for Greece to arrest the country’s fiscal crisis and stop the turmoil from spreading. Europe’s debt woes may push it into a “double-dip” recession, growth in advanced nations will be “anemic” and China’s overheating economy risks a slowdown, Roubini said, adding that Greece may still eventually need to restructure its debt. “The challenge of reducing a budget deficit from 13 percent to 3 percent in Greece looks to me like mission impossible,” Roubini said. “I would not even rule out in the next few years one or more of these laggards of the euro zone might be forced to exit the monetary union.”  The fiscal changes Greece needs to undertake as part of an international bailout will be an “ugly” process that will only get worse, Roubini said. Public opposition to the plan sparked riots in Athens last week that led to three deaths. “They are not going to be able to raise taxes and cut spending that much,” he said. “As you raise taxes and cut spending in the short run, output is going to fall even more. The IMF expects another two to three years of recession in Greece. How much austerity and recession can a country take?”

Regarding sovereign debt and deficits, Byron Wein summarized U.S. debt-servicing concerns nicely in his May note:

The budget deficit in the United States is about 12% of gross domestic product (GDP) and the Federal debt is 84%.  In the U.K. the deficit is 13% and the total debt is 71%.  Greece has a budget deficit of 13% and the total debt is 113%.  The numbers are not that different.  The difference is that both the United States and the U.K. can currently finance their deficits at attractive interest rates and Greece cannot.  The big question is whether the financing difficulties will converge if little or nothing is done about the deficits in England or America.  For some time I have been wrestling with the deficit problem, having seen the Federal debt rise for most of my lifetime.  I have never bought into the argument that our grandchildren will have to pay the debt back because I am somebody’s grandchild and I haven’t paid a penny of the World War II debt back that was incurred when I was young.  What I am worried about is servicing the debt.  The United States is expected to run a budget deficit of $1.6 trillion this year and the deficit is unlikely to drop below $1 trillion anytime in the next several years.  Debt service on the national debt will be about $250 billion this year or less than 2% of gross domestic product of $15 trillion.  If interest rates rise and we keep running trillion dollar deficits, the debt service might be as much as $750 billion on a $20 trillion economy or almost 4% by the end of the decade.  A condition where the debt service is growing faster than the economy is threatening because it puts the country in an economic spiral where it is always having to raise taxes or cut spending just to service its financial obligations.

BCAP upgrades Canadian banks.  AONE -6% on earnings.  HMY higher on earnings.  ING higher on earnings.  SPWRA misses by 3c.  CSFB ups RT.  DBAB ups STZ.  FBRC ups CCIX.  GSCO ups MCK.  JEFF ups BPZ.  JPHQ ups NLC.  MSCO ups ICA.  BARD ups CRL.  OPCO cuts APC.  UBSS cuts ATMI.  WEFA cuts DCAI. 

Asia mixed overnight.  Europe trading over 1% higher.  USD +17bps.  Oil -27bps.  Gold +130bps. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
FIDELITY NATIONA         30.40    +5.34% 309021
ELECTRONIC ARTS         17.85    -5.05%  159253
MARSHALL &ILSLEY        9.39      +4.45% 46198
MORGAN STANLEY         27.14    -4.37%  1080689
HUNTINGTON BANC        6.73      +3.86% 239845
WALT DISNEY CO           34.60    -3.24%  274531
MGIC INVT CORP            9.65      +2.99% 8591
GANNETT CO                 17.08    +2.95% 200
TEXTRON INC                23.29    +2.87% 200
EBAY INC                       23.01    +2.81% 25392
PRAXAIR INC                 82.59    +2.74% 885
KEYCORP                       8.79      +2.45% 12965
AETNA INC                    28.89    -2.43%  5000
MCKESSON CORP           67.52    +2.15% 2835
FIRSTENERGY CORP       36.62    +2.09% 200

Today’s Trivia:  Apparently a 13-yr-old kid is currently climbing Mt. Everest in an attempt to become the youngest person to achieve the “Seven Summits” challenge – climbing the highest mountains on the seven continents.  Can anyone name the summits? 
Yesterday's Answer:  May 11th, 1820 marked the launch of Charles Darwin’s trip aboard the HMS Beagle.

Best Quotes:  Late Sunday night, the EU leadership pulled out all of the stops in combating the sovereign debt crisis that has taken hold in Southern Europe.  There are three important ways to view the announced plan.  First, as we stated in a morning note yesterday, the FOMC’s announcement to resurrect the crisis Dollar liquidity Central Bank swap lines is akin to another round of easing in the United States.  In the current context of the announcement, the FOMC did not say these actions would be sterilized.  The move will lead to a further expansion of the Federal Reserve’s balance sheet, the size and amount will be dependent upon how strong the global demand for Dollars remains.  In December 2008, the peak level of the Fed’s Central Bank swaps outstanding was $583 Billion.  Today, Richmond Fed President and FOMC non-voter Jeffrey Lacker said the Fed should consider sterilizing the swaps.  This was undoubtedly a move by the Federal Reserve to attempt to short circuit the transition from a European sovereign debt crisis into a global banking crisis.  As is well known, U.S. Banking exposure to Southern Europe is relatively small.  The key risk U.S. banks face is counterparty exposures to large Northern European banks.  These swap lines insert the two respective central banks into the equation as counterparties to their respective local financial institutions for currency transactions.  This was a smart and appropriate action by the Fed to help insulate U.S. institutions as much as possible in a global economy.  As we noted, the expansion of the Fed’s balance sheet is equivalent to getting a shot of adrenaline when your neighbor is sick.  It may not be necessary, but it is to be expected as the Fed seeks to mitigate the downside related to exogenous events.  As U.S. markets calm, and if the economic recovery remains on pace, this does open the door for the FOMC to start asset sales sooner than anticipated simply just to offset the swap lines.  That being said, the key imperative to remember about this Fed and Chairman Bernanke is that at all costs, they do not want to relive the Fall of 2008 again. Therefore, if further actions need to be taken to insulate the U.S. financial system, they will take them.  If sterilization or asset sales need to wait, then they will wait (probably longer than necessary).

The second key aspect is the EU-IMF €750 Billion European financial stabilization mechanism.  Approximately one third of the funding for the $1 Trillion war chest is coming from the IMF.  The €500 Billion coming from the EU members is a maneuver straight out of the Bernanke-Geithner playbook.  The EU will supply €60 Billion and in essence, those funds will be levered through Special Purpose Entities to create another €440 Billion.  The original architecture for the TALF here in the United States was $20 Billion of TARP funds being transferred from Treasury to the New York Fed, which then levered that amount into $200 Billion of buying power.  At the heart of the crisis in March 2009, the Fed and Treasury jointly announced they were ready to take the program up to $1 Trillion if necessary,  In retrospect, we know it was not necessary.  Now that we know where the architecture for the plan came from, the question is whether it makes it any easier for Europe to implement?  No, it does not.  Here in the U.S., Bernanke and Geithner took immense personal risk in adopting such a plan.  Had it failed, the repercussions would have been devastating.  Over the past 18 months, both men have been ridiculed by Congress, yet their strategy for handling the crisis has been nothing short of an astounding success.  Imagine their treatment if the U.S. continued to sink into the abyss.  It bears repeating - the U.S. is one nation, one common cause and TARP and the related interventions were tough to pull off.  In Europe, there are different sovereign entities, with different economies and tax structures making it that much more challenging to succeed.  What is clear is that the EU has taken a combination of the “whatever it takes” and “failure is not an option” attitude, which means anything and everything is on the table should this package stumble.

The third and most interesting aspect of the EU announcements was that which came from the ECB.  The first line of the first bullet read, “To conduct interventions in the Euro area public and private debt securities markets (Securities Markets Programme) to ensure depth and liquidity in those market segments which are dysfunctional.  The objective of this programme is to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism.”  The ECB has chosen to combat speculation with speculation.  The outrage among European politicians against speculators is equivalent to U.S. politicians against bankers.  This violates the long standing taboo of targeted Government intervention in private markets.  The traditional risk is that consistent policies of intervention in market prices undermines market confidence out of the fear the Government is manipulating price levels for political purposes.  The argument that ECB and European politicians will make is that until this week, the market pricing mechanism for Greek bonds has not been working.  In the United States, we have witnessed a large scale government intervention in the credit markets but the difference is programs were announced, well telegraphed and transactions were disclosed in real time.  The ECB’s response is very different in that they are planning a crisis response to defend different sovereign debts as they come under siege from market forces.  Without debating the ideology of whether this response from the ECB is right or wrong, one must consider the potential consequences.  Do investors shy from European sovereign debts out of fear of manipulated pricing or do speculators keep their respective wagers on only the weakest of the weak?  We suspect the most manipulated pricing will occur in the weakest of the weak, and in that case, speculators should be enthused about the opportunity to sell at artificially high prices.  The benefit of the European governments is that speculators will likely avoid the marginal bets against sovereign debt.  We have advocated throughout that while this crisis is legitimate, it is not on the level of the global crisis a year ago.  We have also noted our opinion that there is some speculative flare to the situation and the real crisis is the one of confidence that has been created (and still remains) in the Euro currency itself.  As such, without condoning the ECB’s approach, this targeted strategy may have a higher likelihood of success at a lower price than the implementation of the Trillion dollar war chest.  In the meantime, the mess and the uncertainty in the EU prevail.  As a result, the S&P 500 looks relatively better and better every day.

Mike O’Rourke, BTIG

Tuesday, May 11, 2010

Morning Note...

Futures down ~1.2% this morning as markets pause to consider whether yesterday’s “euro-phoria” was truly justified and whether we may see more tightening out of global demand-driver China given their strong economic data last night.  Regarding EuroTARP, a rift appeared yesterday as Germany’s Weber warned of the risks surrounding the bailout.  Also see the Wall Street Journal’s headline Stocks Surge on $955 Billion Plan, but Economists Question Long-Term Burden and John Mauldin’s comments below…he notes that you cannot solve a debt problem with more debt, and that probably says it all.  There are also renewed rumblings of Spanish and Portuguese debt downgrades.  Moreover, has anyone noted the FNM/FRE need for more funds amidst all the macro-news?  After already accepting $145 billion between them, now Fannie Mae needs another $8 billion??  Keep an eye on Gold (+1.8%), which appears to be making new highs in all currencies today.  In other news, BP, RIG, and HAL will testify before Congress today on the Gulf oil spill.  Here’s a good volume update from BTIG: “With some 1.8 billion shares exchanging hands on the NYSE this session, trading volume surpassed its 200-day moving average for the fifth time in a row.”  Regarding China, here are some red-hot numbers as summarized by Hedgeye (and note that China is now down 19% for 2010):

Here is a summary of the most important (inflationary) Chinese economic data released in the last 48 hours that took the Shanghai Composite down another -1.9% overnight to -19.2% for 2010 YTD:

1.       Chinese imports spiked to +49.7% year-over-year growth
2.       Chinese loan growth up +51% sequentially (m/m) in April to 774B Yuan (versus 511B Yuan in March)
3.       Chinese property prices (70 cities) +12.8% year-over-year representing the largest jump since 2005
4.       Chinese inflation (CPI and PPI) up again sequentially to +2.8% and +6.8% y/y, respectively
5.       Chinese Industrial Production (April) +17.9% versus +18.1% y/y in March
6.       China's Money Supply (M2) for April slowed month-over-month by 100bps, but is still up +21.5% y/y!

Regarding Europe, it’s always a good idea to peruse The Gartman Letter, which previewed today’s “caution” from the markets in yesterday’s note and wrote on the “loss of ECB independence” apparently echoed in the Financial Times this morning:

The most important decision was that mandating that the ECB accept a mandate to buy European debt directly from the governments in question. The ECB has said time and time and time again that it would never monetize anyone’s debt obligations, but that is precisely what it has agreed to do. We note that it was only last weekend… only last weekend… a mere eight or nine days ago!!!... that Mr. Trichet said emphatically that the ECB’s authorities had “absolutely no intention” of buying government debt. However, when the bank agreed to accept any and all Greek debt as collateral for future borrowing by the Greek government from the Bank the die was cast. This decision tells us unequivocally that the independence of the ECB has been utterly and completely compromised and that the political will of Brussels has trumped the economic will of Frankfurt.

Yes, the Bank has said that it will “sterilize” the long term effects of this monetisation policy and in so doing modify somewhat the long term inflationary impact of the decision. However, the plain and very simple truth is that the ECB’s supposed “independence” has now been shown to be nothing more than a sham… a chimera… a willow-the-wisp, and in the end the ECB and the EUR will be punished for this decision to stand down from what had previously been considered sacred. In the end, gold will triumph for this decision is a very plain and very simple abrogation of all that the Bank has stood for previously. But the “end” might well be some while into the future and the need for a “bounce” trumps all other concerns at the moment.

Usually level-headed John Mauldin also vented a bit regarding the ECB decision in his note last night:

Was it only last week I was expressing outrage that US taxpayers would have to pick up the check for Greek profligacy in the form of IMF guarantees? This morning we wake to up the sound of $250 BILLION in IMF guarantees for a European rescue fund, most of which will go to countries that are eventually (in my opinion) going to default. That is $50 billion in US taxpayer guarantees. Not sure what that translates into for Britain or Canada or Australia.

I can swallow the Fed dollar swaps to the ECB. Don't really like it, but I can deal with it, as I don't think it will ultimately put US tax-payers at risk, as long as the swaps are in dollar terms. But the IMF bailout is just wrong.

Interestingly, the euro shot up on the announcement in what was now clearly short covering. As I write this, it is almost back down to where it started. That seems to me to be a vote of "I don't believe you." We will see. But if the ECB actually goes ahead and floods the market with liquidity, that will be very good for all types of risk assets.

Note that in last Friday's letter I quoted Trichet where he said we would not do what he agreed to do over the weekend. What a turn-about. So much for ECB independence. The European leadership must have realized the wheels were coming off and brought out the nuclear option in order to stave off a very serious crisis. In my opinion, this buys time but does not solve the problem.

The eurozone leaders assume that this is a liquidity problem. It is not. It is a solvency and balance sheet problem. You do not solve a debt problem with more debt. This only shoves the football a few yards (or maybe I should say meters) down the field. And it is going to cause a MASSIVE misallocation of capital once again which will create more imbalances that will have to be dealt with. Ugh.

Getting back to fundamental economics (easy to forget amidst all the European news/headlines), I thought Dennis Gartman was also spot-on in his review of last Friday’s jobs number, quoting the work of David Rosenberg at Gluskin Scheff:

Finally, regarding the US and Canadian employment data released Friday, we, like former Sec’y of State Warren Christopher, shall “urge caution.” The data at first blush was strong, and was especially so in the latter’s case. No one anywhere does a better job of tearing apart the employment data than does our old friend, Mr. David Rosenberg, the Chief Economist of Gluskin Scheff in Toronto. Yes, non-farm payrolls rose in both instanced, with the Canadian data rising far more positively than did that of the US… which itself went beyond the most bullish numbers on Wall Street. We needn’t get into too many details here this morning, but David notes that the broad U6 measure of unemployment, rose to a stunning 17.1% in April, up from 16.9% previously, and although this is not a new high, it is important to understand that U6, until this cycle, had never been above 12% in the post-World War II era. Too, David notes that the “median duration of unemployment rose to 21.6 weeks from 20.0 in March… more than 50% higher than a year ago… [and a] new all time high.” To put this in perspective, in previous recessions, the median duration of unemployment peaked at 7%, 10%, 12%,10% and 11% respectively (rounded to the nearest whole number). 21.6% trumps them all… plus some! Worse still the average, as opposed to the median, duration of unemployment is now nearly 33%, with the previous record being 20% seen in the aftermath of the twin recessions in the early 80’s. This knowledge helps us to be somewhat “under-whelmed” then by the headline non-farm payrolls which came in higher than expected, but which got lost amidst the panic of late last week.

MBIA down 12% on earnings.  BofAMLCO ups LM.  DBAB ups PCS.  BARD ups CAKE.  CSFB cuts TSN.  UBSS cuts DF.  WEFA cuts SXE.  MFB beats by 11c.  PCLN -10% on earnings.  ADY misses by 6c.  BEE announces 40M share offering.  Cramer bullish on CRUS.  GFI announces new gold discovery in Peru.  JASO beats by 6c.  JAZZ announces 7M share offering.  BTIG initiates VIA/B and DIS with Buy. 

Asia lower overnight.  Europe -2% across the board.  The EUR is holding $1.27.  USD +50bps.  Gold +180bps.  Oil -140bps.

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
MBIA INC                       8.15      -12.65%            233748
J.C. PENNEY CO              28.36    -4.25%  2950
MGIC INVT CORP            9.20      -4.07%  200
TYSON FOODS-A            17.50    -4.06%  7985
CME GROUP INC             320.00  -3.9 %  344
LEGG MASON INC           31.10    +3.84% 6350
JOHNSON CONTROLS     30.66    -3.83%  420
SUPERVALU INC             13.26    -3.63%  500
WILLIAMS COS INC        20.70    -3.63%  1095
KEYCORP                       8.05      -3.59%  26860
AMERICAN CAPITAL        5.64      -3.59%  21196
FIDELITY NATIONA         28.65    -3.31%  2500
MARSHALL &ILSLEY        8.77      -3.23%  1186
KB HOME                       17.00    -3.19%  1800
ALTERA CORP                23.6800 -3.11%  300
SLM CORP                     11.7100 -2.90%  200
PRINCIPAL FINL              29.36    -2.88%  152
FANNIE MAE                  1.04      -2.8 %  157572
FLUOR CORP                  47.60    -2.78%  6500
US STEEL CORP             54.05    -2.77%  24170
GENWORTH FINANCI      15.9200 -2.75%  4974
EXPEDIA INC                  23.05    -2.54%  900
MICRON TECH                8.86      -2.53%  12110
STARBUCKS CORP          26.36    -2.51%  3904

Today’s Trivia:  On this date in 1820, the ship taking Charles Darwin on his scientific voyage (which yielded his theory on evolution) was first launched.  What was the name of the ship?
Yesterday's Answer:  The currency of Haiti is the gourde.  Never knew that.

Best Quotes:  SEC Meeting With Exchanges Yields No Cause for Plunge 2010-05-10 21:37:05.194 GMT By Jesse Westbrook

     May 10 (Bloomberg) -- Heads of the biggest U.S. trading venues could provide no clear reason for last week’s stock- market selloff in meetings today with the Securities and Exchange Commission, two people familiar with the matter said.
     The chief executive officers of NYSE Euronext, Nasdaq OMX Group Inc., Bats Global Markets Inc., Direct Edge Holdings LLC, International Securities Exchange Holdings Inc. and CBOE Holdings Inc. saw no evidence that a mistaken order caused the plunge, according to the people, who asked not to be named because the discussions were private.
     The Dow Jones Industrial Average fell as much as 9.2 percent on May 6, its biggest tumble since the crash of 1987, before paring losses and closing down 3.2 percent. Almost $700 billion was erased from American equity markets over one eight- minute span, according to data compiled by Bloomberg.
     The CEOs earlier took a step toward aligning trading rules to prevent conflicting systems from worsening stock-market plunges. The group meeting with Chairman Mary Schapiro agreed on a framework for “strengthening circuit breakers and handling erroneous trades,” according to a commission statement.
     Regulators and exchanges face pressure from lawmakers and President Barack Obama’s administration to offer proposals aimed at preventing future crashes even though the SEC hasn’t determined what caused last week’s free-fall. Schapiro and exchange officials gave Treasury Secretary Timothy Geithner an update on progress they’ve made at a briefing today.

                        Circuit Breakers

     At the two-hour meeting at the SEC, Schapiro and representatives from the NYSE, Nasdaq and other trading venues discussed the need to revise market-wide circuit breakers and implement halts for individual stocks, the people said.
     The New York Stock Exchange currently has circuit breakers that pause trading when the entire market falls 10 percent before 2 p.m. New York time. The NYSE also uses so-called liquidity replenishment points, which slow trading in companies that experience sudden price moves.
     The triggering of liquidity replenishment points on May 6 encouraged orders to flow to alternative platforms with few if any buyers, worsening the decline, NYSE Euronext Chief Operating Officer Larry Leibowitz said last week.
     Schapiro and exchange heads discussed specific percentage figures that would trigger new circuit breakers, said the people. Plans will be refined over the next day, according to the SEC statement.

                         Swamped Demand

     The May 6 plunge swamped demand, pushing share prices of companies from Accenture Plc to Exelon Corp. to pennies. Nasdaq announced it would cancel trades on all exchanges that were more than 60 percent above or below prices at 2:40 p.m. New York time, just as equities plummeted.
     Proposing regulations to handle such erroneous trades was a focus of Schapiro’s meeting with executives, with discussions focusing on how to best define what constitutes a false trade, said the people. The exchanges agreed that new rules are needed.
     Schapiro, Commodity Futures Trading Commission Chairman Gary Gensler and executives from the NYSE, Nasdaq and CME Group Inc. will testify on the market rout before a House Financial Services subcommittee tomorrow.