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

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