Monday, August 2, 2010

Morning Note...


Futures ~1.25% higher this morning on the back of strong earnings in European financials and in-line economic data from China.  In Europe, HSBC (HSBA LN; +5%) and BNP Paribas (BNP FP; +5%) are leading market strength.  Additionally, the GBP is higher, perhaps on HSBC’s announcement that first-half net income doubled and bad debt provisions fell by 46%.  In China, PMI fell from 52.1 in June to 51.2 in July and achieved a 17-month low.  However, the data was largely in-line with expectations, stayed above the 50-level (the break-even for expansion vs. contraction), and indicated that the pace of decline of certain components of the economy are beginning to slow.  Thus “the declining rate of decline” = net positive.  Further, this release also supports the position that China’s recent policy moves have indeed “pricked the bubble” or cooled off a potentially overheated economy and frees them from additional suppressive moves.  M&A activity also seems to be heating up globally.  Nokia Siemens is in talks to sell a stake to private equity firms (WSJ).  Intel is close to a deal to buy Infineon’s wireless business (WSJ).  RBS is likely to announce ~$7 billion in asset sales (WSJ).  BP may sell its German gas station business for EU2 billion (Reuters).  Over the weekend Greenspan warned the U.S. may face a double-dip recession if housing prices decline further.  (Thanks…)  Barron’s was positive on Africa as the new emerging market in this weekend’s edition.  The WSJ weekend cover story was on equities being historically cheap relative to bond prices.  According to the article, the earnings yield on the S&P 500 is 6.6% as of Friday – the highest level since 1995.  Moreover, the gap between 10-year Treasuries and the earnings yield is the widest in 30 years.  Looking ahead this week, there are a series of market-impacting economic releases due in the U.S.  At 10am this morning we’ll get ISM manufacturing data.  Tuesday brings auto sales.  Wednesday we’ll see ISM non-manufacturing data.  Thursday brings retailers’ same-store-sales data.  Friday is the big Official Nonfarm Payrolls release for July.  (This is probably the most important release of the week – a Further, note that the Bank of England and the ECB meet and decide on interest rate policy on Thursday.  (The next FOMC meeting, btw, is set for August 10th.)  Comments from Bernanke and Geithner are expected today.  In earnings news, roughly 3/5ths of the S&P500 have reported, with 76% beating earnings estimates (Bloomberg).  This week, one-fifth of the S&P500, or 100 companies, are due to report.   In political news, Congress heads for recess next week so headline news should be quiet there as we head into the “dog days” of August.  (So named because of the prevalence of the Dog Star, or Canis Major, in the evening sky at this time of year.) 

In terms of themes… will strength in European financials continue to lead markets across the pond?  How will large cap U.S. media stocks react to this week’s slew (TWX, VIA, CBS, DISCA) of earnings?  How about consumer staples, given Kraft and Proctor & Gamble report this week?  How will the market react to tomorrow’s widely anticipated new product release from RIMM?  Given that July’s positive performance (~7% gain on the S&P) is the strongest since last July 2009, will August 2010 also follow August 2009 (+~3.5% on the S&P)? 

Last Friday’s commentary from Gluskin Sheff’s David Rosenberg (following the weak GDP number) may seem out of place (or “ancient history” at minimum) given this morning’s optimism, but it’s worth a read nonetheless:

SLOW MOTION RECOVERY

The economy underperformed expectations in the second quarter with the initial estimate of real GDP growth coming in at a 2.4% annual rate. The revisions to the back-data also showed the Great Recession to be even greater than initially thought with the economic loss now totaling 4.1% from 3.7% previously. And the revisions also reveal a policy- and inventory-induced recovery that is now losing steam at a faster rate than was thought before, especially with respect to consumer spending – the 2.4% GDP pace is down from 3.7% in the first quarter and 5% in the fourth quarter of last year.

There are legions of economists out there who claim that it is normal to see the economy take a breather at this stage of the cycle, but in truth, what is “normal” in the context of a post-WWII recovery is that four quarters into it, real GDP expands at over a 6% annual rate. That puts 2.4% into a certain perspective. And with the revisions now showing the downturn deeper, the level of economic activity in real terms is still 1% below the pre-recession peak. Again, when you look back at 55 years worth of post-war data, what is normal 2-1/2 years after a recession begins is that by now we are at a new peak already (breaking above the prior high in GDP by 8%, on average).

The big story in the second quarter as has been the case for much of the past year was the contribution from inventories – there was a “build” of $75.7 billion and this added over a percentage point to headline GDP growth. This follows a “build” of $44 billion in the first quarter so this is no longer the case that companies are merely reducing the pace of inventory withdrawal. Businesses actually added to their stockpiles at the fastest rate in five years. And with sales lagging behind, this inventory contribution is likely to fade fast in coming quarters. Real final sales – representing the rest of GDP (excluding inventories) – came in at a paltry 1.3% annual rate last quarter and has averaged 1.2% since the economy hit rock bottom a year ago in what is clearly the weakest revival in recorded history.

Normally, real final sales are expanding at closer to a 4% annual rate in the year after a recession officially ends. Then again, we haven’t heard anything official just yet about the one that began in December 2007 – and so the fact that it is averaging at around one-third that typical pace in the face of unprecedented policy stimulus is rather telling. And frightening.

HUM beats by 33c.  IBN higher on earnings and upgrade at CSFB.  JPHQ cuts ARNA.  BYD upped at JEFF on news it discontinues effort to acquire Station casinos assets.  MNKD beats by 3c.  SNHY upped at BARD.  BCAP ups APL.  STFL ups GTIV.  Soleil ups GNTX, PAG, USTR.  BofAMLCO cuts LLTC.  JEFF cuts SJM.  OPCO cuts AEP.  BARD cuts FCS, MU, ONNN, STM, TXN.  STFL cuts BPO.  UBSS cuts EXC.  WEFA cuts VQ. 

Asia higher overnight.  Europe nearing 2% gains this morning.  Oil +185bps.  Gold -15bps.  EUR/USD 1.3102.  USD -35bps.

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
HUMANA INC                  49.21    +4.66% 3520
NEWELL RUBBERMAI       16.22    +4.65% 2500
MURPHY OIL CORP         56.54    +3.27% 1000
LSI CORP                       4.15      +2.98% 6913
SLM CORP                     12.35    +2.92% 500
FLUOR CORP                  49.68    +2.88% 400
SOUTHWESTRN ENGY     37.45    +2.74% 10272
US STEEL CORP             45.52    +2.68% 36204
FREEPORT-MCMORAN    73.35    +2.53% 25187
CITRIX SYSTEMS           56.40    +2.51% 1000

Today’s Trivia:  According to Malcolm Gladwell’s The Tipping Point, how many different advertising messages is the average American subject to in one day? 

Yesterday’s Question:  Name the first U.S. state that allowed women to vote. 
                                                                                                                                                                       
Yesterday's Answer:  Wyoming.   

Best Quotes:  Time to Buy Dollars as Euro Reaches Austerity Limits 2010-08-02 10:25:18.605 GMT

By Liz Capo McCormick and Anchalee Worrachate
     Aug. 2 (Bloomberg) -- FX Concepts LLC, the hedge fund that bought the euro in June just as it began a 9.7 percent surge against the dollar, now says it’s almost time to get out of the currency.
     The firm, which manages $8 billion in assets, expects the euro’s advance from a four-year low on June 7 to come undone by September, partly because European austerity programs will start to weigh on growth. Reports last week that showed Spanish consumer confidence falling to the lowest level this year and banks tightening credit standards in the region suggest the budget measures may already be undermining the recovery.
     The same fiscal measures that helped restore confidence in the euro may soon weaken the region’s economies and torpedo the rally. A July 30 survey of 21 money managers overseeing $1.29 trillion by Jersey City, New Jersey-based research firm Ried Thunberg ICAP Inc. found 75 percent don’t expect Europe’s common currency to strengthen over the next three months.
     “Austerity is really bad for growth,” said Jonathan Clark, vice chairman at New York-based FX Concepts, the world’s biggest currency hedge fund. “In the U.S., austerity is mainly on the state level, but in Europe they are whole-hog into cutting spending to reduce deficits. Under a pessimistic scenario, the European currencies are in a lot of trouble.”

                          Spending Cuts

     Spain, Portugal and Greece will reduce spending by an average 4.3 percent of gross domestic product from 2009 to 2011, said Gilles Moec, an economist in London at Deutsche Bank AG, Germany’s largest lender. The euro area will expand 1.5 percent this year, less than a previous estimate of 2 percent, UBS AG, the biggest Swiss bank by assets, said in a July 16 report.
     The cuts contrast with the U.S., where President Barack Obama signed into law a $34 billion extension of unemployment benefits last month. The Congressional Budget Office projects a record $1.47 trillion deficit this fiscal year ending Sept. 30, and $1.42 trillion in 2011.
     While U.S. growth is slowing, it beats the European Union, where a 750 billion-euro ($981 billion) backstop for the region’s most indebted nations stabilized the currency after it slid from $1.5144 on Nov. 25 to the June 7 low.
     U.S. GDP grew at a 2.4 percent pace in the second quarter, compared with 3.7 percent in the prior period, the Commerce Department in Washington said July 30. Corporate spending on equipment and software jumped at a 22 percent annual rate, the biggest increase since 1997.
     The median second-quarter estimate for the euro region is 1.30 percent, and 1.10 percent for the year, based on a survey of 20 economists by Bloomberg.

                        Budgetary ‘Zeal’

     Federal Reserve Chairman Ben S. Bernanke said July 22 more fiscal stimulus is needed to support the U.S. recovery. European Central Bank President Jean-Claude Trichet is taking the opposite tack, writing in the Financial Times that industrial countries should begin addressing deficits now. The ECB meets Aug. 5, and will likely keep its key interest rate at 1 percent, according to all 51 economists surveyed by Bloomberg.
     “We continue to question the sustainability of the euro’s recent rebound given the zeal with which European officials have embraced fiscal consolidation,” said Mansoor Mohi-uddin, global head of currency strategy in Singapore at UBS. The world’s second-biggest currency trader, after Deutsche Bank, predicts the euro will end this year at $1.15. “We expect the euro to face renewed downward pressure.”

                        Raising Estimates

     The euro strengthened 1.1 percent to $1.3052 last week, capping the biggest monthly gain since May 2009. While it rallied against the greenback in the five trading days ended July 30, it was little changed based on Bloomberg Correlation- Weighted Currency Indexes, rising 0.1 percent. It gained 0.2 percent to $1.3080 today.
     Rising confidence in Europe’s economy and a slowdown in the U.S. helped quell speculation the 16-nation currency union would splinter. Goldman Sachs Group Inc., Wells Fargo & Co. and at least 12 other firms raised their estimates for the euro in June or July, Bloomberg data show. The 15 percent slide in the first half also proved a boon for German exports.
     The number of unemployed Germans fell in July to the lowest level since November 2008, the Federal Labor Agency in Nuremberg said July 29. The same day, an index of executive and consumer confidence in the region compiled by the European Commission in Brussels rose to the highest level since March 2008 in July.

                          ‘Great Deal’

     “Governments have done a great deal bringing stability back to the region, and that will manifest itself in a stronger euro in the longer term,” said Fabrizio Fiorini, head of fixed income at Aletti Gestielle SGR SpA in Milan.
     The bears say Germany will be unable to prop up the euro much longer as the Frankfurt-based ECB’s quarterly Bank Lending Survey released July 28 showed banks tightening credit. Consumer confidence in Spain fell to minus 26 last month from minus 25 in June, while sentiment in Portugal and France matched their lows for the year, the commission said July 29.
     The euro may reach $1.33 before falling along with stocks, according to Clark at FX Concepts. The median estimate of 39 strategists surveyed by Bloomberg is for it to weaken to $1.21 by year-end.
     The euro “will correlate strongly with equities,” Clark said. “We are expecting equities to turn around and go down into the second quarter of next year or longer.”
     The MSCI World Index advanced 8.9 percent since the euro rally began eight weeks ago.

                          Bond Signals

     Record gains this year by longer-maturity German bonds show investors are concerned growth across Europe may wane.
Securities due in 2020 and later returned 13.8 percent, the most since the euro’s introduction in 1999 and compared with 13.1 percent for similar-dated Treasuries, indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies show.
     “There’s still a lot of stress in the euro-zone economy,”
said Shahid Ikram, deputy chief investment officer at Aviva Investors. The market is “probably viewing the debt burden as being deflationary. Any reduction in debt is likely to impinge on the potential rate of growth,” he said.
     The fund management division of Britain’s second-largest insurer, which oversees $403 billion in assets, is looking for opportunities to bet the euro will weaken against the dollar, Ikram said.

                        Currency Options

     Demand for options granting investors the right to sell the euro versus those giving the right to buy suggests eight weeks of appreciation may peter out.
     The euro’s three-month option risk-reversal rate was minus
2.14 percent on July 26, approaching the most since June 29.
When negative, the measure means demand for options giving the right to sell the currency is greater than demand for those that allow purchases. The rate was minus 1.71 percent today.
     “The fiscal challenges facing the euro zone remain immense,” said Shaun Osborne, chief currency strategist at TD Securities Inc. in Toronto and the most accurate foreign- exchange forecaster from the end of 2008 through the first half of this year based on data compiled by Bloomberg. Osborne forecasts the currency will depreciate to $1.08 by year-end.
     “The euro needs to go lower to try and help some of the fiscal bite that is going to start to have an impact on some of the more peripheral economies,” he said.
     A weaker euro may help companies in the region as it boosts competitiveness and makes revenue earned overseas worth more when it’s brought home. Eni SpA, Italy’s largest oil and gas company, said July 28 second-quarter profit jumped 81 percent as crude prices climbed and the euro declined.
     Gary Shilling, president of the economic research firm A.
Gary Shilling & Co. in Springfield, New Jersey, has predicted the euro may drop to parity with the dollar since January. He was correct in all 13 of his investment guidelines for 2008.
     “This has really just been a lull between storms in Europe,” Shilling said. “We still have a situation where the likelihood of defaults and restructuring in Greece, and probably Portugal and Spain, are still very high. That doesn’t mean they won’t be bailed out, but the turmoil that is likely to result should drive the euro lower.”

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