Friday, June 25, 2010

Morning Note...

Happy Friday… Futures ~15bps higher as financial reform – finally, and for better or worse – appears to be behind us, as Congress delivered a reconciled bill set for a final vote next week and delivery to President Obama for enactment prior to the July 4th holiday.  See below for specifics on this FinReg Bill.  Overseas, the Financial Times reports that Basel III is backing down on its proposed stringent liquidity requirements, which is helping European financials.  However, Greek CDS continue to widen to record levels, and – for what it’s worth – Romania rejected austerity measures and France is on strike to protest the proposed increase in the retirement age.  Also, EU officials are meeting today in Brussels to discuss whether Spanish savings banks and German state banks should be included in the upcoming round of stress tests.  In economic news, the final GDP revision for Q1 came in at +2.7% vs. the +3% expectation and Personal Consumption was also lighter, at +3% vs. the +3.5% expectation.  In earnings news, ACN beat by 4c and is trading 2% higher premarket.  Activist Ronald Burkle disclosed a 6% stake in American Apparel (APP).  ORCL beat by 6c and is 5% higher premarket.  And Blackberry maker RIMM beat by 4c but misses revenue estimates and trades down 5% premarket.  In currency news, the yuan rose 50bps against the USD, marking its biggest weekly gain since December 2008. 

Looking ahead, UofMich consumer confidence is due at 10am.  Also note the Russell rebalance today – hopefully that will spark some volume.  Regarding the Russell, great advice from the Barclay’s desk:  Today is a great "liquidity" day with the annual Russell Rebalance taking place.  We always tell fundamental investors the same thing.  Don't try to "trade the trade".  We suggest picking your fundamental levels and being in scale mode irrespective of the time of day.  These trends have a tendancy to go the "wrong way".  For example, many times if there is supposed to be 2 million shares to buy on the bell from indexers the stock actually sells off for the last half hour of the day.  Don’t forget - G20 this weekend in Toronto.  Also, make sure you watch USA/Ghana at 2pm tomorrow or be labeled a communist.  It’s win or go home at this point…

Before getting to the meat of the quotable stuff, here’s another nice little tidbit from Barclay’s that made the rounds last night…good observation, but “cum grano salis” (look it up):  …down 4 days in a row now…since hitting the Mar09 lows, SPX hasn’t traded down 5 for consecutive days. It has been down 4 days in a row on 5 different occasions with an average return on the 5th day of +2.32%...

From the institutional perspective, here’s a summary of the landmark FinReg bill that was apparently hashed out at roughly 5am this morning after an all-night session:

House/Senate reconciliation process wraps up after compromise reached on Lincoln derivatives amendment; sets stage for vote to take place next week & for Obama to sign into law by Jul 4 weekend break.  Democratic members of the House and Senate committees agreed at ~5:30amET this morning on a Lincoln compromise; no Republicans voted in favor of the reform package.  The Lincoln language was softened slightly. 

Lincoln amendment compromise reached - banks can trade in-house foreign exchange and interest rate swaps, gold and silver swaps, and derivatives designed to hedge their own risk.  But banks will need to spin off dealing desks to affiliates to handle agricultural, energy and metals swaps, equity swaps, and uncleared credit default swaps.  Non-financial companies "using swaps to hedge or mitigate commercial risk" are exempt from clearing the trades, as long as they explain to regulators how they are meeting financial obligations.  The financing arms of manufacturers do not have to clear swaps when they assist in selling the parent company's products.  Clearinghouses will not be forced to accept credit risk from other clearinghouses.  Capital and margin requirements for uncleared swaps done by non-bank swap dealers and major players will be set at "appropriate" levels (somewhat softer language than prior).  Regulators will have at least a year after the time of passage to implement the legislation.  Reuters 

Volcker Rule compromise reached - would limit a bank’s investment in private-equity or hedge funds to 3 percent of a fund’s capital. Total investment in private-equity and hedge funds wouldn’t be able to exceed 3 percent of a company’s tangible common equity.  Dodd proposed adding language to curb conflicts of interest by preventing firms that underwrite an asset-backed security from placing bets against the security.  Bloomberg 

And from the consumer perspective, I will lean on friend and former Amherst Student sportswriter Ron Lieber’s excellent summary in the New York Times:

After months of haggling, the terms of financial reform are set, so long as both houses of Congress vote to accept them in the coming days. While elected officials spent much of their time working out the details of regulating complex derivatives and grappling with whether banks ought to make big bets with their own money, they also set a number of new rules that will directly affect consumers.

CONSUMER BUREAU The bill would create an independent Consumer Financial Protection Bureau, housed within the Federal Reserve. The bureau is to be headed by a single director appointed by the president and confirmed by the Senate.

The new bureau would write and enforce rules for most banks, mortgage lenders, credit-card and private student loan companies. Smaller banks and credit unions, or those with less than $10 billion in assets, would have to obey the consumer bureau’s rules — but the smaller institutions’ enforcement and supervision would remain with their current regulators, said Travis Plunkett, legislative director for the Consumer Federation of America.

CREDIT SCORES While you still can’t get a free credit score each year with your three free credit reports, you will soon be able to see the score if it has hurt you in some way.

MORTGAGES The bill offers a number of new protections, many of which are a bit like closing the barn door after all of the animals escaped. Lenders, for instance, will have to check borrowers’ income and assets. Most lenders have learned that lesson by now or have ceased to exist.

Other rules include a ban on prepayment penalties for people with adjustable rate and other more complex types of mortgages. Mortgage brokers and bank employees will no longer be able to earn bonuses based on the type of loan they put you in. That will presumably eliminate any incentive to push high-interest loans on borrowers (who might otherwise qualify for a better deal) to inflate bank profits.

CREDIT AND DEBIT CARDS Hate those merchants that won’t let you use your credit card unless you spend more than a certain amount? Well, now they have Congress’s blessing, as long as the minimum is not higher than $10. The Federal Reserve can increase the minimum if it chooses. As for maximums, only the federal government and colleges and universities can limit what people spend. So if you are paying tuition on a credit card and earning a couple of free plane tickets each year, that fun may soon end.

Merchants are also free to offer discounts to people who pay cash instead of using cards, or use debit instead of credit cards. They will not, however, be able to charge one price for people using American Express cards and a lower price for people using Visa and MasterCard credit cards. …It is not clear what the Fed will do or how the big banks and Visa and MasterCard will react. This could take a few years to play out, or many years if lawsuits start flying.

FIDUCIARY DUTY The Securities and Exchange Commission was given the authority to create a new rule for brokers that would require them to put their clients’ interests first. But that won’t happen right away. Consumer advocates wanted the so-called fiduciary standard in the new law, and it appeared in the House’s original proposal.

EQUITY INDEXED ANNUITIES These annuities are complex financial products that promise a minimum return on your investment. But they often require you to tie up your money for long periods of time and charge hefty surrender fees if you need to pull out your money early. Unscrupulous salesmen, who collect lucrative commissions, have used deceptive marketing techniques to sell these products to senior citizens, which is why sales of these annuities have been the subject of many lawsuits.

But a provision in the legislation will prevent the S.E.C. from regulating them, a step backward, consumer advocates and the commission have argued, from what is now the case. The S.E.C. had adopted a rule to regulate these annuities as securities, but it had not yet been enacted. Now, the annuities would be treated as insurance products, which means they would be overseen by state insurance regulators.

Regarding yesterday’s concerns over FNM & FRE liability falling to banks, BTIG’s Mike O’Rourke spelled out the Congressional comedy of errors (remember the great line from Will Rogers, oft used here…the opposite of Progress is Con-gress…) in last night’s note:

…Then news of a  proposal by House Republicans to make the banking sector liable for the losses at the GSEs in the liquidation fund portion of the FinReg bill was another indication of how lost the legislative body is.  First Congress creates the GSEs.  The GSEs crowd the banks out of their vanilla home mortgage business, forcing them to embrace riskier businesses like derivatives and securitizations.  Now the GSEs have hundreds of Billions of Dollars in losses, and the House Republicans want to lay it off on the banks who are dealing with their own losses.  Barney Frank must have been chuckling to see the Republican members of the House do his heavy lifting for him.  Senate negotiators rejected the measure.  Needless to say, today’s round of negative headlines was enough to move Bulls to the sidelines. 

Mike also discussed yesterday’s jobs data, and sets the context ahead of the big June unemployment report, due on Friday July 2nd (catalyst alert!): 

One of the data points lacking inspiration was the Initial Jobless Claims report.  The bottom line is that 457,000 beating a 463,000 claims estimate is not enough to make a difference.  Small expectations beats at these levels do not provide any additional help to the economy.  Without resumption of the downward trajectory, Non-Farm Payrolls and the Unemployment Rate will not improve.  Considering it has become a key focal point, it is only appropriate to provide the proper context.  Going back over 40 years, the current levels of 450,000-475,000 on a 4 week moving average are consistent with adding nothing in Non-Farm Payrolls per month, and still losing approximately 30,000 Private Sector Payrolls.  Even the 425,000-450,000 range indicates flat Non-Farm Payrolls.  The key threshold that needs to be broken is 425,000.  At that point, approximately 100,000 Non-Farm Payrolls are being added, most of which are Private Sector.  That rate is still not enough to bring the Unemployment Rate down, but it is a very healthy start.  The true sweet spot arrives when initial Claims drop below 375,000, then the economy is adding 200,000 Non-Farm Payrolls, 170,000 of which are Private Sector.  That is the point where Unemployment starts declining and the recovery gains real momentum.

AZZ reports in-line.  FCEL announces stock offering.  MXIM, POWI, VLTR upgrade at NEED.  TIBX beats by 2c and beats on revs. TUP upgrade at JPHQ.  ZOLL upgrade at RBCM. 

Asia lower overnight.  Europe ~50bps lower this morning.  EUR/USD $1.2296.  Oil +40bps.  Gold +43bps. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
JDS UNIPHASE               11.38    +4.12% 2625
KEYCORP                       8.375    +4.04% 22371
ORACLE CORP                23.07    +3.83% 636214
KB HOME                       11.79    -3.52%  17400
FIDELITY NATIONA         28.09    +3.5 %  8100
AETNA INC                    27.82    -2.93%  11640
FIFTH THIRD BANC         13.55    +2.65% 34678
HUNTINGTON BANC        5.89      +2.61% 77606
BB&T CORP                   28.83    +2.34% 4136
SCHWAB (CHARLES)       14.9500 +2.26% 200
US BANCORP                 23.10    +2.17% 15677
JPMORGAN CHASE          38.80    +2.02% 392162
ZIONS BANCORP            23.41    +2.0 %  1391

Today’s Trivia:  What is the fastest World Cup goal ever scored?
Yesterday's Answer:  Gonzales or Gonzalez is the most popular World Cup surname.   

Best Quotes:  For the geopolitically-inclined, here’s today’s STRATFOR piece on the McChrystal/Afghanistan scenario:


The commander of U.S. Forces-Afghanistan and the NATO-led International Security Assistance Force, Gen. Stanley McChrystal has resigned his command. His resignation is a direct result of his controversial remarks in a Rolling Stone interview broken late June 21, and not a reflection or indictment of the campaign he has led in Afghanistan. But that campaign and the strategy behind it are having significant issues of their own.

U.S. President Barack Obama on June 23 accepted the resignation of command from U.S. Gen. Stanley McChrystal, commander of U.S. Forces-Afghanistan and the NATO-led International Security Assistance Force, following a controversial interview with Rolling Stone Magazine. McChrystal's resignation is a direct result of this interview and is not itself an indictment of the status of the war he commanded or the strategy behind it. But ultimately, the U.S. strategy is showing some potentially serious issues of its own.

The U.S.-led campaign was never expected to be an easy fight, and Helmand and Kandahar provinces are the Taliban's stronghold, so progress there is perhaps the most difficult in the entire country. But the heart of the strategy ultimately comes down to "Vietnamization." Though raw growth numbers officially remain on track for both the Afghan National Army and Afghan National Police, according to testimony which U.S. Central Command chief Gen. David Petraeus and Undersecretary of Defense for Policy Michelle Flournoy gave before the U.S. Congress last week, there are serious questions about the quality and effectiveness of those forces and their ability to begin taking on increasing responsibility in the country.

Meanwhile, a U.S. program to farm out more than 70 percent of logistics to Afghan trucking companies appears to be funding both warlord militias independent of the Afghan security forces and the Taliban itself. As STRATFOR has discussed, this may be a valuable expedient allowing U.S. combat forces to be massed for other purposes, but it also risks undermining the very attempts at establishing good governance and civil authority that are central to the ultimate success of the U.S. exit strategy — not to mention running counter to the effort to starve the Taliban of at least some of its resources and bases of support.

Intelligence is at the heart of the American challenge in Afghanistan, a fact that was clear from the beginning of the strategy. Special operations forces surged into the country (now roughly triple their number a year ago) and are reportedly having trouble identifying and tracking down the Taliban. Similarly, slower-than-expected progress in Marjah and the consequent delay of the Kandahar offensive have raised serious questions about whether the intelligence assumptions — particularly about the local populace — underlying the main effort of the American campaign were accurate. Security is proving elusive and the population does not appear to be as interested or as willing to break with the Taliban and join the side of the Afghan government as had been anticipated.

So while there have absolutely been tactical gains against the Taliban, and in some areas local commanders are feeling the pinch, the Taliban perceive themselves as winning the war and are very aware of the tight U.S. timetable. Though the Taliban is a diffuse and multifaceted phenomenon, it also appears to be maintaining a significant degree of internal discipline in terms of preventing the hiving off of "reconcilable" elements, as the Americans had originally hoped. Senior Pentagon officials including Petraeus and Secretary of Defense Robert Gates have admitted as much: It is simply too soon for meaningful negotiation with the Taliban. There has been some recent movement, but nothing decisive or irreversible — and certainly nothing that yet shows strong promise.

And with the frustrations and elusive progress in the Afghan south, it is increasingly clear that the political settlement that has always been a part of the long-term strategy is becoming an increasingly central component of the exit strategy. This is the U.S. State Department's main focus, and there appears to be considerable U.S. support behind Afghan President Hamid Karzai's reconciliation efforts. The Taliban appear to be holding together, so negotiation with the Taliban as an entity (rather than hiving it apart) may be necessary. And given the Taliban's position, this could come at a higher price than once anticipated — and then only if the Taliban can be compelled to enter into meaningful negotiations on some sort of co-dominion over Afghanistan.

The U.S. Army and Marine Corps certainly have no shortage of competent generals to replace McChrystal. And the surge of forces to Afghanistan is not likely to be reversed — U.S. and ISAF forces are spread quite thin, despite the already-significant increase in troop levels. But whoever replaces McChrystal will continue to struggle with a war that remains deeply intractable with limited prospects for success.