Thursday, August 26, 2010

Morning Note...

**Please note that the Morning Note will be going on a brief hiatus… First, I will be in and out of the office with vacation days over the next week or so and that makes it hard to write consistently.  Second, I am struggling to find anything value-added to say this time of year, so it’s better to step back and regroup a bit…  My plan is to return to writing on Tuesday, September 7th.  So, until then…have a great holiday and enjoy what’s left of the summer!  Ben**

Futures are ~40bps higher this morning as Initial Jobless Claims for the week ending August 21st surprise to the upside, coming in at 473k versus the 490k expectation.  However, the prior week’s reading was revised upward to 504k from 500k, and the sobering fact is that 473k is not exactly something to cheer about.  Continuing Claims came in at 4.456k versus the 4.495k expectation.  In earnings news, Guess Inc. (GES) reported record net earnings last night, Hain Celestial (HAIN) reported higher net sales, Jo-Ann Stores (JAS) swung to a Q2 profit and raised guidance, and JDSU reported that it swung to a profit in fiscal Q4 on a jump in sales in optical networking products.  In M&A news, 3Par (PAR) accepts DELL’s increased $24.30 bid for the company.  Asia was mixed overnight and Europe is roughly 1% higher on an 89% increase in profits from Credit Agricole (ACA FP; +3.4%) and despite news of weaker sales from Diageo (DGE LN; -1.5%)  Oil is up 1.25%, the USD is down 25bps, and Gold futures are flat at $1240/oz. 

Short term, the market feels a bit oversold…we’re down about 7% from two weeks ago…but longer term, it’s anybody’s guess.  My two cents is that we may be stuck in a range through mid-term elections, but if anything, the risk is to the downside.  Note that the Q2 GDP release is due tomorrow at 8:30am, along with Personal Consumption data.  Also note that Helicopter Ben speaks tomorrow in Jackson Hole, Wyoming.  Fed-watchers will be looking for signs of a shift toward significant asset purchases by the FOMC. 

Not really new news, but interesting to see this in print from Bloomberg today:

Savers Pay U.S. Banks to Keep Cash as Rates Dip, Fees Multiply 2010-08-26 06:31:19.592 GMT

Aug. 26 (Bloomberg) -- Average interest on savings, checking, money-market and CD accounts fell to 0.99% in July, first decline below 1% in a decade: Market Rates Insight.

For a bit of doom and gloom, here’s a recent summary of the “wall of worry” from John Mauldin:

Where Is My V-Shaped Recovery?

Remember all the bulls and cheerleaders late last year and into this one talking about a V-shaped recovery? They were making their projections based on what had happened in past recessions. I (and others) argued that that data was meaningless, as it did not reflect the fact that a balance-sheet recession requires years of deleveraging, is inherently deflationary, and all the factors that produce the normal "V" are no longer in play. Bank lending is still dropping. Savings rates go up. Debt gets paid down. Governments run into limits as to how much they can stimulate the economy without creating large and destabilizing debt. Central banks push rates to zero, and then what? This is a far different environment than we have had for the last 70 years. Using past performance to predict future results when the future environment is significantly different than the period in which the data was collected is misleading at best and worthless at worst, leading to bad decisions. Much better to deal with reality.

And just to show that I am really the optimist in the room, let's turn to my good friend David Rosenberg, writing this morning under the following headline:

"U.S. RECESSION NEVER ENDED; GDP TO CONTRACT IN Q3… Our suspicions have been confirmed - the recession never ended. Macroeconomic Advisers produces a monthly U.S. real GDP series and it shows that the peak was in April, as we expected, with both May and June down 0.4% in the worst back-to-back performance since the economy was crying Uncle! back in the depths of despair in September-October 2008. The quarterly data show that Q2 stands at a +1.1% annual rate (so look for a steep downward revision for last quarter) and the 'build in' for Q3 is -1.5% at an annual rate. Depending on the data flow through the July-September period, it looks like we could see a -0.5% to -1% annualized pace for the current quarter. Most economists have cut their forecasts but are still in a +2.5% to +3.5% range. What is truly amazing is that despite all the fiscal, monetary, and bailout stimulus, the level of real economy activity, as per the M.A. monthly data, is still 2.5% below the prior peak. To put this fact into context, the entire peak-to-trough contraction in the 2001 recession was 1.3%! That is incredible. Interestingly, and dovetailing nicely with our deflation theme, nominal GDP fell 0.3% in May and by 0.4% in June. This is a key reason why Treasury yields are melting."

Politicians are going to be greeted with a GDP number for the third quarter, right before the elections. Will it be negative like Rosie thinks? I am not sure, but in any event it will not be good. Structural unemployment will still be over 10% and deficits will be high.

…Unemployment and continuing claims have started to rise again. This is not what happens in V-shaped recoveries, gentle reader. The ONLY reason the headline unemployment number has dropped a little is that the Labor Department has dropped so many people from the labor force. Again, if you have not looked for a job for four weeks, they do not count you as unemployed. If you use the labor-force number from just last April, unemployment is 10.5%. Brutal. Who doesn't know too many people without jobs?

…Bottom line? It is going to be a tough environment for the next 6-8 years. That is just what happens when you have a deleveraging / balance sheet / deflationary / end of the Debt Supercycle recession. It is what it is, and no amount of wishing or finger pointing can change the facts.

Let me take a moment and offer some sympathy to President Obama. This recession/slow period is not his fault. Obamacare? A now-trillion-dollar stimulus? Those he owns. But the recession/credit crisis would have happened if McCain had been elected.

And it is not Bush's fault. Did he make some mistakes? Oh yes. Squandering those surpluses is huge in my book. Not vetoing all that excess spending is at his feet. And there are other issues, but that is not my point.

We Have Met the Enemy, and He Is Us

There is a great line from the old cartoon strip Pogo: "We have met the enemy, and he is us." (Ah, I miss Walt Kelly and Pogo. But I show my age!)

Neither Clinton nor Bush forced people to borrow money against their homes. Yes, some of the laws made it easier. Yes, Greenspan pushed rates lower than they should have been. Allowing banks to go to 30:1 leverage was stupid (courtesy of the Bush administration). Repealing Glass-Steagall in hindsight was not wise (Clinton era).

But we the people borrowed and spent. Congress taxed and spent and we voted for the SOBs and collectively asked for more goodies. Maybe not you, gentle reader, because all my readers too smart to have engaged in such reckless activity, but those other guys sure did. Probably the readers of Paul Krugman. (Did I say that?!?)

So, the current problems are not Obama's fault. But how he deals with them is. Raising taxes in what can only be called a soft environment gives him ownership of the consequences. And it is more than just the Bush tax cuts going away. Obamacare gives us a host of new taxes. (If you want to see more, read http://www.atr.org/six-months-untilbr-largest-tax-hikes-a5171)

Here’s one that is a bit beyond the bounds of the “daily markets,” but brings up an interesting trend (especially given our male-dominated business) and is worth a read…from a recent article in The Atlantic Monthly titled “The End of Men:”

Man has been the dominant sex since, well, the dawn of mankind. But for the first time in human history, that is changing—and with shocking speed. Cultural and economic changes always reinforce each other. And the global economy is evolving in a way that is eroding the historical preference for male children, worldwide. Over several centuries, South Korea, for instance, constructed one of the most rigid patriarchal societies in the world. Many wives who failed to produce male heirs were abused and treated as domestic servants; some families prayed to spirits to kill off girl children. Then, in the 1970s and ’80s, the government embraced an industrial revolution and encouraged women to enter the labor force. Women moved to the city and went to college. They advanced rapidly, from industrial jobs to clerical jobs to professional work. The traditional order began to crumble soon after. In 1990, the country’s laws were revised so that women could keep custody of their children after a divorce and inherit property. In 2005, the court ruled that women could register children under their own names. As recently as 1985, about half of all women in a national survey said they “must have a son.” That percentage fell slowly until 1991 and then plummeted to just over 15 percent by 2003. Male preference in South Korea “is over,” says Monica Das Gupta, a demographer and Asia expert at the World Bank. “It happened so fast. It’s hard to believe it, but it is.” The same shift is now beginning in other rapidly industrializing countries such as India and China.

Up to a point, the reasons behind this shift are obvious. As thinking and communicating have come to eclipse physical strength and stamina as the keys to economic success, those societies that take advantage of the talents of all their adults, not just half of them, have pulled away from the rest. And because geopolitics and global culture are, ultimately, Darwinian, other societies either follow suit or end up marginalized. In 2006, the Organization for Economic Cooperation and Development devised the Gender, Institutions and Development Database, which measures the economic and political power of women in 162 countries. With few exceptions, the greater the power of women, the greater the country’s economic success. Aid agencies have started to recognize this relationship and have pushed to institute political quotas in about 100 countries, essentially forcing women into power in an effort to improve those countries’ fortunes. In some war-torn states, women are stepping in as a sort of maternal rescue team. Liberia’s president, Ellen Johnson Sirleaf, portrayed her country as a sick child in need of her care during her campaign five years ago. Postgenocide Rwanda elected to heal itself by becoming the first country with a majority of women in parliament.

In feminist circles, these social, political, and economic changes are always cast as a slow, arduous form of catch-up in a continuing struggle for female equality. But in the U.S., the world’s most advanced economy, something much more remarkable seems to be happening. American parents are beginning to choose to have girls over boys. As they imagine the pride of watching a child grow and develop and succeed as an adult, it is more often a girl that they see in their mind’s eye.

What if the modern, postindustrial economy is simply more congenial to women than to men? For a long time, evolutionary psychologists have claimed that we are all imprinted with adaptive imperatives from a distant past: men are faster and stronger and hardwired to fight for scarce resources, and that shows up now as a drive to win on Wall Street; women are programmed to find good providers and to care for their offspring, and that is manifested in more- nurturing and more-flexible behavior, ordaining them to domesticity. This kind of thinking frames our sense of the natural order. But what if men and women were fulfilling not biological imperatives but social roles, based on what was more efficient throughout a long era of human history? What if that era has now come to an end? More to the point, what if the economics of the new era are better suited to women?

Once you open your eyes to this possibility, the evidence is all around you. It can be found, most immediately, in the wreckage of the Great Recession, in which three-quarters of the 8 million jobs lost were lost by men. The worst-hit industries were overwhelmingly male and deeply identified with macho: construction, manufacturing, high finance. Some of these jobs will come back, but the overall pattern of dislocation is neither temporary nor random. The recession merely revealed—and accelerated—a profound economic shift that has been going on for at least 30 years, and in some respects even longer.

Earlier this year, for the first time in American history, the balance of the workforce tipped toward women, who now hold a majority of the nation’s jobs. The working class, which has long defined our notions of masculinity, is slowly turning into a matriarchy, with men increasingly absent from the home and women making all the decisions. Women dominate today’s colleges and professional schools—for every two men who will receive a B.A. this year, three women will do the same. Of the 15 job categories projected to grow the most in the next decade in the U.S., all but two are occupied primarily by women. Indeed, the U.S. economy is in some ways becoming a kind of traveling sisterhood: upper-class women leave home and enter the workforce, creating domestic jobs for other women to fill.

The postindustrial economy is indifferent to men’s size and strength. The attributes that are most valuable today—social intelligence, open communication, the ability to sit still and focus—are, at a minimum, not predominantly male. In fact, the opposite may be true…


DBAB ups PAYX.  HSBC ups CHA.  Longbow ups POL, SHLM.  BofAMLCO cuts LFC.  MSCO cuts NDAQ, SCHW.  UBSS cuts MDT. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 

Today’s Trivia:  For all you 80’s buffs…what does Atari have in common with Chuck E. Cheese’s?

Yesterday’s Question:  Remember Ted Kaczynski?  Why was he known as “The Unabomber” anyway?
                                                                                                                                                             
Yesterday's Answer:  Kaczynski was known as the “Unabomber” because his early mail bombs were sent to universities (UN) and airlines (A). 

Best Quotes:  A mix of summertime quotes…

“Happy Thursday – may time pass quickly for us all!”  --KBW note

“Real quiet. Don't read if you’re busy.”  --BCAP note

“Good Morning - A string of weak economic data that started a few weeks ago continued to shake investor confidence in the past few sessions. Starting with a jump in initial jobless claims last Thursday, followed by a drop in Philly Fed index on Friday, onto a significant miss in existing home sales on Monday, and rounded up with a precipitous decline in durable good orders yesterday, each data release appears to be adding more dark colors to an already bleak picture of economic recovery. Equity markets have reacted violently, having sold off by 3.7% over the past week alone, bringing their cumulative decline to 7% since mid-August.  Cash is holding up much better, with HY and loan indexes sitting roughly unchanged for the period, and HG Master edging higher, mostly on the back of strength in Treasuries. (taken from Oleg Melentyev)  Today's Initial Jobless number will be up in lights, ahead of tomorrows GDP.   If the trend remains, markets will get hit hard after numbers are released.  I guess you can't price in fear.  Even after yesterdays bounce, I still feel like they'll sell any rally.  Have a good day.”  --BofAMLCO

Wednesday, August 25, 2010

Morning Note...


Futures are down ~65bps this morning as the 8:30am U.S. Durable Goods Orders release came in below expectations and essentially outweighs a surprising business confidence reading in Germany.  Europe is also lower on a Moody’s downgrade of Ireland to AA- (its lowest rating since 1995, sparking sovereign debt default concerns yet again – see MSCO fixed income research piece in quote section below), and Asia was weaker overnight while the Yen weakened on intervention comments from the Japanese Finance Minister.  Regarding Durable Goods, July orders were +0.3% month-over-month, versus the +3.0% expectation and the -0.1% prior reading.  MBA Mortgage Applications grew 4.9% for the week ending August 20th, with represents a slow down from the prior 13% gain.  Note that Initial Jobless Claims are due tomorrow and 490k are expected.  (Recall that we broke the headline-round-number of 500k last week.)  Q2 GDP data will be released Friday.  In Germany, the Ifo Business Sentiment Index unexpectedly rose to a 3-year high.  Bond prices continue to rally, and ten-year yields now stand at 2.44%.  Oil -65bps.  Gold +40bps.  EUR/USD 1.2638 and USD/JPY 84.30. 

In case you missed it yesterday (and I ran out of room…), GSCO put out a cautious macro piece that is worth a look ahead of Friday’s GDP release (bold is mine):

Forecasters Need to Cut GDP Estimates a Lot Further (Hatzius)

·        Over the last few months, the US economic indicators have shown a broad-based slowdown.  Such a slowdown around the middle of 2010 has long seemed likely given the dependence of growth over the prior year on the boost from the inventory cycle and fiscal policy.  Our forecast is that real GDP will grow at a 1½% (annualized) rate in the second half of 2010 and in early 2011, and the risks to it are tilted to the downside.

·        But the forecasting community has only partially caught up with the deterioration in the numbers.  Last week’s FOMC statement suggests that Fed officials still expect the economy to grow at a slightly above-trend rate over the next year or so.  Likewise, most private forecasters predict that GDP will grow at roughly a trend rate in the second half of 2010 and a somewhat above-trend rate in 2011.  If our view is correct, substantial further downward revisions are coming.  In turn, these are likely to trigger downgrades to consensus earnings forecasts toward our strategists' more cautious views, as well as a return to large-scale asset purchases or other forms of "unconventional" monetary policy by the Fed.

·        Will the economy in fact return to a technical recession, marked by declines in real GDP?  We think the odds are still against such an outcome, but the risk is a substantial 25%-30%.  In our view, this exceeds the likelihood of the trend/above-trend growth scenario envisaged in the consensus forecast.

            Over the last few months, the US economy has shown signs of slowdown across a broad range of indicators:

1. GDP and its components.  We estimate that the Commerce Department will announce on Friday that real GDP grew just 1.1% (annualized) in the second quarter.  We do not yet have much “tracking” information for the third quarter, but we believe that the sparse data released so far are consistent with our forecast of a 1½% growth.

2. Business surveys.  At present, the ISM surveys for the manufacturing and nonmanufacturing sector—at 55.5 and 54.3, respectively—are still consistent with trend or above-trend growth.  However, other indicators such as the NFIB small-business survey and regional surveys such as the Philly Fed index look a lot softer.  We expect the ISM indexes to fall sharply in coming months, to around 50 in the manufacturing sector and to the low 50s in the nonmanufacturing sector.

3. Labor market indicators.  Both the establishment survey and the household survey of employment have shown a sharp slowdown in underlying job growth over the past few months (see US Views, https://360.gs.com/gs/portal/home/fdh/?st=1&d=9485521).  Moreover, initial jobless claims have crept up in recent week and hit 500,000 in the latest week, with only some of this increase attributable to temporary factors.  Although we do not have a forecast for the August employment report yet, the early indications are that private sector job growth may have stalled (or possibly gone into reverse) in the last month.

A slowdown around the middle of the year has long seemed likely given the dependence of GDP growth since mid-2009 on the boost from the inventory cycle and fiscal policy.  Over the last four quarters, the swing from inventory liquidation to accumulation has contributed 1.9 percentage points to real GDP growth, and overall fiscal policy—federal, state, and local—has contributed a little over 1 percentage point to real final demand growth.  These two numbers are additive, which implies that almost all of the 3.2% growth in real GDP over the past year was due to temporary factors, and that final demand excluding the impact of fiscal policy grew by less than ½% over the past year.  (Final demand excluding the impact of federal fiscal policy but including the impact of state and local policy has declined slightly.)

Given these relatively easy-to-measure factors—and given that it is difficult to tell a compelling story for why underlying final demand growth should accelerate sharply from here—we find forecasts that do not look for GDP growth well below trend quite implausible.  If the inventory and fiscal effect in combination are zero, which is a relatively generous assumption in our view, underlying final demand growth would need to accelerate by more than 1 percentage point to reach even our 1½% growth pace for real GDP growth.

Nevertheless, most official and private forecasters still expect trend or above-trend growth.  Last week’s FOMC statement noted that “…the Committee anticipates a gradual return to higher levels of resource utilization…,” which we interpret as growth of around 3% coupled with a modest decline in the unemployment rate to 9% or a bit below over the next year.  And according to the August 2010 survey by Blue Chip Economic Indicators, Inc., the average private-sector forecaster still expects real GDP growth of 2.4% in the third quarter, 2.7% in the fourth quarter, and 3% in 2011 (on a Q4/Q4 basis), as well as a drop in the unemployment rate from 9.5% now to 8.8% at the end of 2010.  We believe that the GDP forecasts will need to fall by at least 1 percentage point and the unemployment rate forecast will need to rise by at least 1 percentage point.  As we discussed recently, such GDP revisions are likely to trigger downward revisions to the consensus forecast for corporate earnings toward our strategists' more cautious views (see Andrew Tilton, "Reconciling 'Micro' Strength with 'Macro' Weakness," US Economics Analyst, 10/32, August 13, 2010).  They are also likely to persuade the Federal Reserve to resume large-scale asset purchases or engage in other forms of "unconventional" monetary policy.

Will the economy in fact return to a technical recession, marked by declines in real GDP?  As explained recently, we think the odds are still against such an outcome (see Ed McKelvey, “Private-Sector Insurance against a Double Dip,” US Daily, August 12, 2010).  This is mainly because several components of economic activity that usually help drag the economy down during recessions have already suffered large hits and are unlikely to fall much further, if at all.

Despite this, we continue to believe that the risk of a renewed technical recession—defined as a return to quarter-on-quarter declines in real GDP—is an uncomfortably high 25%-30%.  In our view, this exceeds the likelihood of the trend/above-trend growth scenario envisaged in the consensus forecast.

Looking a bit further afield and toward mid-term elections, I liked the following summary from FRBC.  Bold is again my own emphasis.  (And it’s also worth wondering if last night’s Democratic primary win for Kendrick Meeks here in South Florida over billionaire Jeff Green foreshadows a coming theme…the victory of a “Main Street” Democrat over a guy many view as a “Wall Street” fatcat…)

            Election Preview: Seeds of a Revolution?
 
Summary

For the first time, President Obama’s job approval dipped into the “low 40s,” which we view as the threshold at which Republicans have a greater-than-50% likelihood of retaking control of the House of Representatives. Investors are increasingly beginning to consider the possibility that Republicans will net the 39 seats needed to have a majority in the House and to provide a check on President Obama and the Democrats’ agenda in Congress. However, Republicans face serious structural challenges to winning control, including strong Democratic fundraising, strong core Obama support, and candidate-quality concerns. The attached report examines the factors that will drive the 2010 House elections.
 
            Key Points

·                     Midterms are about the President. Midterm Congressional elections tend to serve as a referendum on the President. In the post-war era, Presidents with approval ratings below 50% have lost an average of 36 seats in the House. Obama’s approval rating has reached dangerous lows. Despite the President’s declining popularity on Wall Street, we note that his core support kept his job approval in the mid to high 40s through the early summer. According to the Gallup survey, President Obama’s approval rating dropped to a record-low 42% for the first time in the August 12–14 polls. Our review of the past dozen midterm elections shows that an approval rating of 42% or lower could lead to a net loss of 39 House seats for the President’s party. The President appears to have been hit hard by the so-called “Ground Zero Mosque” controversy. We will watch closely whether the latest Gallup results were a late-summer blip or the beginning of a more serious trend.

·                     Top-line numbers may hide more serious declines. Despite modest total job approval numbers, the President suffers much lower approval with groups more likely to be key midterm voters. The President faces much more significant approval gaps among older voters, white voters, and more affluent voters who are more likely to vote in midterm elections.

·                     Intensity is on the side of Republicans. Among voters who say that they have the most interest in the midterm elections, Republican Congressional candidates enjoy a double-digit lead. Nearly half of all Republicans say that they are “very enthusiastic” about the midterms, compared with about one-fourth of Democrats.

·                     Swing voters are leaving the President. The President’s approval rating with crucial independent voters also dropped to a record-low 39%. Republicans also enjoy a double-digit lead on the generic ballot, with 35% of independents saying they would vote for the Democrat and 46% for the Republican.

·                     Dollar signs of optimism for Democrats. Despite challenging trends, Democrats enjoy a number of advantages. Control of Congress has helped the Democrats maintain a significant fundraising advantage. Heading into the third quarter, the Democratic Congressional Campaign Committee (the campaign arm of House Democrats) holds more than $35 million, compared with just $22 million for the National Republican Congressional Committee.

·                     There are few swing seats for the taking. In order for Republicans to win the House, they would need to win a net of 39 seats, taking the six likely takeovers and 33 of the 37 too-close-to-call Democratic seats without losing any Republican seats. Among the bright spots for House Democrats are four seats currently held by Republicans that are likely to be won by Democrats this fall. These include historically Democratic seats in Hawaii and New Orleans, Louisiana, as well as open seats in Delaware and Illinois. Congressional Democrats like to point to these four seats as an additional firewall they have built to maintain their majority in the House.

·                     Multi-way primaries will take their toll on Republicans. Despite the importance of national trends, we note that candidate quality is also crucially important. The opportunity to unseat Democrats has lead to large bruising multi-way Republican primaries. Republican nominees will emerge from this contentious process with damaged images and depleted war chests. Moreover, the swelling Tea Party movement is producing Republican primary winners who are not the preferred groomed candidates of the Republican establishment. These unpolished politicians increase the risk of gaffes that could cost the GOP seats that they should win. Even when the establishment candidate wins, the presence of a Tea Party candidate has forced a number of candidates to move further towards the right than they would have wanted to win their primaries. This will make it harder for these candidates to attract swing voters during the general election.

·                     Most likely outcome: a narrow majority for either party. At this early stage, the most likely outcome is a narrow majority for either House Democrats or Republicans. Either scenario would severely compromise the President’s agenda. Republicans have shown a much greater ability to hold ranks with narrow majorities and attract conservative Democrats in Congress. On the other hand, Congressional Democrats have a broader coalition and have demonstrated difficulties passing controversial measures without losing a number of their Members.

BERN lowers MDT target.  TOL earnings surprise to the upside.  BofAMLCO ups WIN.  BCAP ups TSP.  JMPS ups QSII.  OPCO ups ORCC, GLW.  JMPS cuts NLY.  MSCO cuts D, PEG.  WEFA cuts MDT.  PCX COO resigns.  PSUN lower on earnings.  VECO buyback. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 

Today’s Trivia:  Remember Ted Kaczynski?  Why was he known as “The Unabomber?”

Yesterday’s Question:  A little business trivia this morning…in 2009, the airline industry collected roughly $5.1 billion from what two fees in particular?
                                                                                                                                                             
Yesterday's Answer:  In 2009, the airline industry collected $2.7 billion on baggage fees and $2.4 billion on ticket change fees. 

Best Quotes: 

Morgan Stanley - Fixed Income Research  
Sovereign Risk Analysis 
Primary Analyst: Arnaud Marès 

August 25, 2010 

Sovereign Subjects: Ask Not Whether Governments Will Default, but How
 
This is the first issue of Sovereign Subjects, a new Morgan Stanley publication focusing on sovereign risk in advanced economies. In this first installment, we take a broad perspective on government balance sheets and raise several themes to which we will return in more depth in subsequent issues. We encourage clients to provide us with feedback on this new publication. 

Debt/GDP ratios are too backward-looking and considerably underestimate the fiscal challenge faced by advanced economies’ governments. On the basis of current policies, most governments are deep in negative equity.  

This means governments will impose a loss on some of their stakeholders, in our view. The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take. 

So far during the Great Recession, sovereign (and bank) senior unsecured bond holders have been the only constituency fully protected from partaking in this loss. 

It is overly optimistic to assume that this can continue forever. The conflict that opposes bond holders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well aligned with those of influential political constituencies. 

There exists an alternative to outright default.  ‘Financial oppression’ (imposing on creditors real rates of return that are either negative or artificially low) has been used repeatedly in history in similar circumstances. 

Investors should be prepared to face financial oppression, a credible threat against which current yields provide little protection. 

Tuesday, August 24, 2010

Morning Note...


Surprisingly a lot to say today… Futures are down ~120bps this morning as the bullish M&A spark of the past few days is extinguished and replaced with a bearish wall of worry and U.S. Treasury yields continue to drop to all-time low levels.  In earnings news, retailer Big Lots (BIG) is slightly lower after beating estimates and bookseller Barnes & Noble (BKS) reported a wider than expected loss.  However, fast food retailer Burger King (BKC) is higher after posting its earnings release.  In overseas earnings, European building materials company CRH is down 16%, weighing on the entire global homebuilding sector and also adding to concerns ahead of today’s 10am Existing Home Sales release.  Regarding Europe (down nearly 2% across the board and CDS widening), Amherst grad and Nobel Prize-winning economist Joseph Stiglitz warned of a double-dip recession:  "Cutting back willy-nilly on high-return investments just to make the picture of the deficit look better is really foolish,’’ Stiglitz told Dublin-based RTE Radio.  "Europe is at risk of going into a double-dip.”  Asia was mostly lower overnight.  Oil is down 2% and Gold is down 1% this morning. 

In other news, a key Wall Street Journal article this morning is also adding to market caution.  The article points out that the recent August 10th FOMC meeting was the most fractious since Bernanke took over as Chairman, as 7 of 17 Fed Presidents either outright opposed or expressed reservations at the Fed’s plan to maintain $2.06 trillion of stock, mortgage debt, and Treasury holdings.  This represents a measure of discord and uncertainty among key policy makers, and if there’s anything the market hates, it’s uncertainty.  Elsewhere, a New York Times article speculates that the recent M&A activity is nothing to get too excited about.  Here’s another scary news item:  California will delay $2.9 billion/month of payments to school districts and counties in order to preserve cash and may return to issuing IOU’s.

The USD/JPY (Dollar/Yen) relationship is making headlines today, as the Yen has strengthened against both the USD and the EUR.  This is somewhat counter-intuitive considering the Japanese market has just entered official “-20% off the high level” bear territory, but the Yen – because of long-standing zero-interest-rate-policy (ZIRP) in Japan – does not necessarily trade on fundamentals.  As a result, the Yen is susceptible to “artificial” currents, such as selling of the USD and buying of the JPY by the investment community (representing a “risk off” move, since – according to recent chatter, people have been long the USD and short the Yen).  Of course, the Japanese government – especially entering an official “bear market” – does not want a strong Yen, which would suppress the pricing power of its exports, and may act to intervene, i.e. start selling JPY in the open market, at any time.  (And with that, by the way, I have reached the limit of what I know about USD/JPY currency trading, so if anyone wants to call out any errors, please let me know – my skin is thick enough…)

For the technicians out there, here’s a concerning reminder from Jefferies as it relates to the broad market:

The Russell 2000 will open this morning below the 600 support level. The next stop on the downside looks to be the 585 level. That was the low that was tested in Feb as well as July of this year. Current levels represent a 20% correction from 2010 highs (745). A test of the lows will mean another 2.8% decline. The Russell 2000 is down 3.6% YTD. Keep in mind small caps should underperform on down days as liquidity is the issue.

The market these days reminds me a bit of my favorite John Wooden quote:  Never mistake activity for achievement.  In other words, there are some important economic releases on the horizon and the market will surely react…but given the dearth of decision-makers in front of the screens this time of year, I’m not sure how much exactly to read into any upcoming market moves.  Volumes, as always, are key. 

This may or may not have made the rounds Monday morning (I was on a plane), but in a continued effort to delve into the depths of the internet in order to find value-added market commentary, I stumbled across this piece on famed investor and billionaire Dallas Maverick’s owner Mark Cuban’s (yeah…I know…but don’t shoot the messenger – it’s a good read) blog:

The Stock Market is still for Suckers and why you should put your money in the bank  Aug 20th 2010 11:24PM

I wrote a whole series of articles warning people about the stock market over the years. You can see them here. It’s gotten worse. So I thought i would write some more about why you should probably avoid putting any new money into the stock market…

If you haven’t noticed, individuals are avoiding the stock market in droves.  There has been an enormous exodus from equity based mutual funds. Why? Because people buy stocks for only one reason, they want them to go up in price. If you don’t believe the market is going to go up. If you don’t believe you can find a greater fool to buy your stock, or the stock your funds own, why would you buy either? You wouldn’t and people aren’t.

The amazing thing is that doing nothing in the market is the smartest approach to the market. It is pretty  much impossible for some man or woman or child who devotes a couple of hours per week to the market to outperform the professionals who spend 24×7 doing this for a living and when they are asleep, they have a workforce full of people doing more of the same.  In this day and age, none of us are smarter than the market.

I didn’t always think this way.  I didn’t ever think there was a truly efficient market until just recently.  What changed? The availability of capital changed.  While we can argue about whether or not the market is efficient because everyone has access to the same information, I would always argue that they didn’t efficiently use that information and even if they did, capital was not always allocated correctly  to every market segment.

Capital found its way to where people/funds thought they were smarter than the rest. Some people thought they understood the tech markets better than others. Some thought they understood retail better, etc.  The belief that an individual/fund had an advantage drove where capital was allocated.  People posted good performance or identified macro opportunities and put their own and others money to work.  Others saw the success and followed.  Like the saying goes “first there were the innovators, then the imitators, then the idiots”.    Fortunately for market participants over much of the history of the stock market, if you were the innovator that was  smarter and faster than the other guys, you could make money on the long and / or short side of the market before the imitators and then the idiots flooded the market.

The door was open to opportunity in the past simply because capital was relatively expensive. It was expensive to raise, it was expensive to borrow.  High cost of capital creates scarcity of capital.  The more expensive the scarcer. The scarcer the capital, the more untapped opportunities just waiting for innovators to exploit and the longer it took the imitators and idiots to chase the same opportunities and close them. Which is why you found funds and smart people posting great returns over a long period of time.

But a not so funny thing happened on the way to and through the Great Recession. Capital became progressively cheaper.  It became the opposite of scarce. It became readily available. To anyone.

The innovators had put together unique mortgage programs. The imitators made it a little easier to partake.  Then the idiots took over. Capital was so easy and suckers and idiots so prevalent, everyone believed that there was always going to be a greater fool to buy their house and /or give them refinancing money. Until the idiots couldn’t collect on the mortgages they lent or pay the mortgages they took out.  That de-levered the system and we know what happened next to the banking, mortgage and housing industries and the entire economy.

In response to that great de-levering, the government stepped in and I truly believe they saved us.  Sure, they watched as the idiots dragged us into the mire. Sure they allowed all those mortgages to be guaranteed and that was a key culprit in the Great Recession.  Our government has never been very good at being proactive at anything. Reactive… that’s another matter. That gets the votes.

So the government reacted and poured money into the system. They allowed just about any bank with a pulse to borrow money. To this very minute it is incredibly cheap to borrow short term capital. Particularly if you are in the business of trading/hacking the stock market.  If you are a big fund or investor, money is cheap.  Unfortunately for the stock market, it is cheap for everyone. In other words, capital is not longer expensive and it is no longer scarce.

When capital is so cheap that everyone with a pulse thinks they can make money once they borrow it, the stock market is in trouble.

Remember the rule about first there are the innovators, then the imitators, then the idiots?  It is why the stock market is truly in trouble.

There is SO MUCH CAPITAL available at so little cost to so many that the timeline from innovator to idiot is measured in days, hours and probably even milliseconds.  The guys who are actually smart and uncover new opportunities can’t even get in a position large enough to make it worth their while before the imitators and then idiots pile in right behind them.

Remember the Flash Crash and the discussion about how trades are made in milliseconds, what I called hacking the system? I don’t know for certain, but I’m willing to bet that those innovators that made money by trading in milliseconds, now have so many imitators and idiots that have piled in behind them , putting servers right next to theirs and hiring their algorithm  coders away from them,  that there is no longer any advantage, or not enough of one for any of the players to make any real money.

There is so much capital chasing so little return that big time players are getting out of the business.

So what does this mean for you?

It means that I don’t know if the market will go up or down, or by how much.  My guess is that it stays in a trading range for a while. There isn’t much money coming in, but enough of that easy to come by capital has so  much ego attached to it, that the same people will get in and out of the market over and over again and trade amongst themselves.

Until something happens.  What that will be, I have no idea.

But I do know that I have continued to add to my cash balance or sovereign debt from around the world (that I have owned for a while now and has been profitable and is very, very liquid.) The stocks I still own for the most part pay me a nice cash on cash return, or I have owned them for a long, long time and have more in gains than I want to pay taxes on.  But in total, I have been a net seller of stocks for more than a year. The only investments I am making are small buys into private companies.  I want as much “powder dry” as possible for when something happens.

I’m not saying you should get out of the stock market. What I am saying is that it is not a bad thing to accumulate cash right now.  Retention of capital is a good thing. Don’t go chasing stocks.  Something is going to give in this market. Like I said, I don’t know what it is, but I want to have as much capital available as possible for when it happens.

Baron Rothschild said “the time to buy is when there is blood in the streets”, Warren Buffet said it differently when he said ” you pay a very high price in the stock market  for a cheery consensus”

This is the time to start saving for a “bloody day”.   There will be a time when capital regains its scarcity. When it becomes more expensive. When it does, what do you want to have in as great an amount as possible ? Capital.

So save your money. Pay off your credit cards.  Put your money in the bank where it is insured.   Be patient.  Get a good nights sleep knowing that your money is not going any where  and just wait till your capital is in demand and you get paid for it. When everyone is complaining about the money they lost, you will be ready to step in and buy.

That is how fortunes are made. Having money when no one else does.  And you can take that to the bank!

CITI cuts DUK.  SUSQ cuts COS.  WEFA cuts POM.  BGP CFO resigns.  BP weaker as the Coast Guard’s Deepwater Horizon investigation continues.  DELL may raise PAR offer.  FMCN higher on earnings. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 


Today’s Trivia:  A little business trivia this morning…in 2009, the airline industry collected roughly $5.1 billion from what two fees in particular?

Yesterday’s Question:  What do the letters in “M&M’s” stand for?
                                                                                                                                                             
Yesterday's Answer:  “M&M” stands for the two founders of the company: Mars & Murrie. 

Best Quotes:  From BCAP research…CNN reporting "The Situation" Mike Sorrentino will make $5 mil this year”

Friday, August 20, 2010

Morning Note...

**Please note that I am out Monday morning and thus there will be no Morning Note...**

Happy summer Friday.  As you might imagine, things are quiet…  Futures are down ~50bps on U.S. earnings releases, possible risk-trimming ahead of the weekend, and chatter from the ECB that markets are too fragile to begin to exit from its stimulus policies.  In earnings news, DELL (-2% premkt) beat by 2c and reaffirmed 2011 guidance.  Hewlett-Packard (HPQ; -1%) is trading lower despite posting in-line numbers.  Retailer Ann Taylor (ANN) is lower on earnings and news of a buyback.  Gap Stores (GPS; -2%) also announced a buy-back but big inventory build issues remain.  In other single-stock news, MSCO downgraded Blackberry-maker RIMM and Tyco (TYC) is trading higher on news it will replace SII in the S&P 500 index.  Note that Asia was weaker overnight, led by -2% in Japan and -1.7% in ShanghaiEurope is tracking down ~1% thus far.  Oil is down 1% and Gold is up 50bps.  The USD is higher (+85bps) against a basket of currencies.  The euro is lower, at 1.2694 vs. the USD.  Bond prices are once again higher as yields continue to drop.  The ten-year currently yields 2.56% and the two-year yields .48%.  As many market experts have wondered of late, what is the bond market trying to tell us?  Whatever it is, for the moment, it ain’t pretty…

Here’s more on retail from BCAP:

1)  ARO earnings in-line, 3Q guidance looks light, lack of blow up good enough
2)  GPS eps in line, big buyback positive, bear case still in tact (inventories)
3)  FL earnings better but comps worse, watch for guidance on 9AM call
4)  HST enters into new $400M financing agreement
5)  JWN announcing new $500M buyback (~7.3% of mkt cap)
6)  BarCap #1 II Andrew Lazar upping RAH estimates on AIPC acquisition
7)  Barron's positive on PEP citing emerging mkt growth and cost saves
8)  UA believe it or not sentiment trying to get a little better, competitor +
9)  HIBB missed eps on SG&A spend.  DKS could be weak on promotional env. 

Regarding yesterday’s jobs disappointment, BTIG’s Mike O’Rourke had this to offer:

Claims Games.

A week ago we warned that “Investors need to be aware that the next 8 weeks through the first week of October are the toughest stretch of seasonal adjustments for this data for the year.  On average, the adjustment will add 24% per week.”  So although we are disappointed to see a 500,000 print on Initial Jobless claims, we are not surprised.  On one level, we are actually modestly encouraged that today’s Non Seasonally Adjusted (NSA) reading edged out the reading of two weeks ago to be the new 3rd lowest print since September 2008.  As we did last week, we reiterate that printing new lows in the NSA is inconsistent with a reversal of trend.  In addition, with the exception of the Labor Day week, this week has the highest seasonal multiplier of the 8 week period.  The next two weeks will also be tough, so we expect prints in the vicinity of 500,000 but improvements should begin in September when the seasonal multipliers start getting smaller.  Last year, the week reported today (2nd week of August) was the peak week for the Seasonally Adjusted  number for this period where the seasonal multiplier weighs heavily.  The next two weeks made small improvements and additional improvements materialized in September.  Thus far, we appear to be following a similar pattern.  Additionally, back in 1983 during that recovery, there was a similar spike in the August Seasonally adjusted data and the 2nd week was the peak.  We have to admit we don’t expect the rapid improvements that occurred in Q4 1983, but today’s market is not currently on track for a 17% gain as it was in 1983.  The Philly Fed data is not as easily explained and will keep the focus upon the other regional manufacturing surveys as they come in to see if they offer confirmation. 

In other intelligent commentary, this was posted earlier in the week by Hedgeye, but is worth a read for its consideration of inflation in a world where everyone is consumed by deflation:

Yesterday (August 16th) the S&P 500 closed flat on the day on anemic volume; it feels like everyone is on summer vacation.  We learned yesterday that the Chinese are selling their holding of US Treasuries in favor of Europe and Japan.  We are financially dependent on foreign lenders and our biggest creditor is saying "no mas" - on this news the S&P 500 traded flat on the day.   

The dollar sent the right message yesterday, declining 0.50% and it is headed lower.   The actions of the Chinese are telling the rest of the world to flee dollar-denominated paper assets.  This is a problem for the dollar as the Federal Reserve appears to be a lender of last resort for the U.S. Treasury.  While the selling of foreign-held dollar-denominated debt has been orderly so far, the inflow of foreign-held dollars into the U.S. will debase the dollar and lead to higher inflation.  Despite what the FED sees (it's focused on the "core" figure), the signs of inflation abound in the economy. 

(1)    Gold traded higher yesterday (looking to gain for a fourth day in a row) and has rallied 3.1% in the past month.
(2)    Copper traded up 0.8% yesterday and is up 13.3% over the past month.
(3)    Last Friday, the US CPI number crept higher and will again in August.
(4)    Today's UK inflation reading is above the BOE target rate
(5)    The US PPI number will also post an upside surprise

Since the US does not have the balance sheet to execute on any creditable plan and the world has little faith in our political leaders, it's hard to see a way out.  The "Fiat Fools" in Washington have already done everything in their power to spend or to create whatever money was needed to prevent systemic collapse in 2008. 

Yet, today we seem to find ourselves in a precarious position.  While the situation is not overly similar to 2008 (yet); Lehman Brothers' collapse is one important difference that shocked markets. Many facets of the economy are on a knife edge: housing is once more coming to the center of people's attention as a concern and unemployment remains at elevated levels. 

Should inflation meaningfully take hold, it would be a death knell for the margin story embedded in the current estimates for the S&P 500.  The only action that will expeditiously calm the markets is more spending or creating of U.S. cash (which creates inflation).  Daryl Jones has written extensively on this; our economy is addicted to foreign financing just as acutely as it is addicted to foreign oil. 

JPHQ cuts China growth estimates.  COCO -5% on earnings.  CRM +7.5% on earnings.  HRL beats by 4c.  INTU beats by 5c.  MRVL reports in-line and announces $500M buy-back.  RIMM downgraded at MSCO.  BCAP ups TX.  DBAB ups MWV.  GSCO ups RSG.  UBSS ups SYMC.  FBRC cuts MFE.  GSCO cuts SRCL.  JEFF cuts GLW. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 


Today’s Trivia:  What do the letters in “M&M’s” stand for?

Yesterday’s Question:  What is the origin of the word “Jaywalker?”
                                                                                                                                                             
Yesterday's Answer:  “Jay” was once slag for “foolish person.”  Thus, when a pedestrian ignored street signs, he/she was referred to as a “jaywalker.”   

Best Quotes:  BofAMLCO trader note… Good Morning - Markets lower to kick off the day.  AMG data shows that equities continue to be the black plague of investing.   Equities suffered their largest weekly outflows since July 7th and gave back all of the inflows for the prior month.  There has been a lot of talk about the low yields on the bond market, but it appears there is zero confidence that the economy is improving at all.   Therefore it seems like the asset allocation trade is a long way off.   M&A has been a big topic.  In a healthy environment I'd say it is a good thing.  Companies have historically high levels of cash and they are starting to spend, although it seems like it wont be to the benefit of a dividend or buyback.   Also the negative side of M&A is unemployment.   I watched it first hand, mergers lead to job loss.