Tuesday, August 3, 2010

Morning Note...

Futures ~25bps lower as markets pause following yesterday’s surge higher.  In general, yesterday’s commentary from both Ben Bernanke and Tim Geithner offered dovish signals as to the next FOMC move, be it August 10th or later but it’s unclear as to whether or not anyone believes them.  Bernanke did concede that a double-dip was possible, but was relatively upbeat on the economy (consumer spending is “likely to pick up” amid a “moderate” expansion).  For his part, Geithner said “a review of recent data on the American economy shows that we are on a path back to growth” in a New York Times op-ed.  This morning’s Wall Street Journal, however, takes the position that the Fed will re-new its past efforts at quantitative easing (which is perhaps also the reason the USD has been weak of late…in short, it seems the “USD down, equities up” trade may be back on after a brief hiatus):

Federal Reserve officials will consider a modest but symbolically important change in the management of their massive securities portfolio when they meet next week to ponder an economy that seems to be losing momentum.

The issue: Whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually, as it is expected to do in the months ahead. Any change—only four months after the Fed ended its massive bond-buying program—would signal deepening concern about the economic outlook. If the Fed's forecast deteriorates significantly, it could also be a precursor to bigger efforts to pump money into the economy.

Moving to stop the Fed's portfolio from shrinking would prevent monetary policy from slightly tightening in the face of a weakening recovery.

The London Telegraph made a similar argument overnight:

Federal Reserve to start the deflation fight next week, expert claims

The Federal Reserve is set to kick-start a new phase of monetary easing, a leading Wall Street economist claims.

Paul Sheard, Nomura's chief global economist, argues that the current conditions are ripe for the American central bank to take affirmative action to put the US recovery back on track.

In the first call of its kind from a Wall Street economist, Mr Sheard says that given subdued growth and concern about inflation, the Federal Open Markets Committee will act when it meets a week today.

His comments follow those of James Bullard, president of the St Louis Fed, who last week said the central bank needs to equip itself with a plan for further quantitative easing should it be required, and after the latest US growth figures showed the American economy deteriorated somewhat in the second quarter.

The Fed is thought unlikely to make any change to its base Federal funds interest at the meeting, which has been held at a range of 0-0.25pc since December 2008.

"We now believe that current conditions have moved policymakers into action and that the FOMC will adopt a more accommodative stance at its 10 August meeting," Mr Sheard wrote in a research note. "We expect the Fed to at least stop the passive contraction of its balance sheet."

In earnings news, oil service giant Baker Highes (BHI; -5%) is lower after missing estimates by 2c.  Dow Chemical (DOW; -5%) also missed by 2c.  Emerson Electric (EMR; +2.25%) beat by 10c and raised guidance.  Consumer staples bellwether Procter & Gamble (PG; -3.5%) misses by 2c but guides slightly lower.  Pharma giant Pfizer (PFE; +3%) beats on earnings and revenues, and guides in-line with expectations.  Mastercard (MA; -1.75%) also beat earnings estimates this morning.  Internet security firm Verisign (VRSN; +2%) reported an in-line quarter and guided forward margins slightly lower.  In M&A news, Kinross Gold (KGC) and Red Back Mining (RBI CN) agree to a $7 billion merger.  In economic news, Personal Income and Personal Spending for June were in-line with expectations and thus a relative non-event.  Keep a close eye on today’s Auto Sales data, however, for its potential to move the markets a bit.  In geopolitical news there are a few things worth watching.  First, there are wildfires & drought across Russia, which are causing deaths and will certainly affect Russia’s wheat harvest.  Second, there was overnight unrest – leading to 36 reported deaths – in Karachi, Pakistan overnight.  Finally, it was reported this morning that Lebanon and Israel exchanged border fire leading to deaths on both sides. 

I must admit that there is an interesting tone to this morning’s reading.  In the past, a +2% day might be followed up with commentary like “momentum is to the upside,” “buy ‘em,” or “we broke up through the 200-day – and volume was decent – let’s keep it going”… But instead, all of today’s commentary seems downright cautious.  I’m not sure what that means exactly, but it is worth noting.  My guess would be that last Friday’s GDP spooked people, and that there are concerns ahead of this Friday’s jobs data.  As a result, perhaps people don’t quite believe in yesterday’s strength.  But by all means don’t take that as the gospel truth…the only thing I know for sure is that I don’t know anything.  The more I read, however, the more market pundits keep coming back to Friday’s unemployment release.  We shall see. 

Regarding good reads, the guys at Hedgeye are not pulling any punches this morning:


"There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt."
-John Adams, US President

Yesterday was another great day for our short position in the US Dollar. It was a terrible day for our short position in the SP500. As perverse as this may sound, both the US stock and bond markets all of a sudden love the idea of America losing its status as the world's reserve currency as we enslave our citizenry with debt.

The sad news is that despite both America and Japanresorting to "quantitative easing" in the recent past, some professional politicians in this country have learned nothing from these mistakes. So if you have any American friends who get all amped up and cheer the stock market on when they hear "rumors of QE2", please take a step back, take a deep breath, and tell them to be careful of what they hope for.

Hope, of course, is not an investment process. Hope is not going to make America's debt and deficit problems go away. Neither will the Paul Krugman type fear-mongering that got both the US and Japan in this mess to begin with. Before the internet, dinosaurs, and YouTube, Krugman's fear-based model provided the false premise that no one would hold him accountable to his recommendations. No matter where the Krugmanites go, here it is:

"So never mind those long lists of reasons for Japan's slump. The answer to the country's immediate problems is simple: PRINT LOTS OF MONEY."
-Paul Krugman (1997)

For a slightly more esoteric read ahead of Friday’s jobs data, here is a sampling from the recent John Mauldin note, as penned by George Magnus of UBS: 

Moreover, population aging is weakening our labour markets in unexpected ways. No self-respecting economist or investor can ignore the monthly labour market reports, especially in the U.S. A lot of people now know that the so-called U6 rate, which comprises headline unemployment, people loosely associated with the labour force, and those forcibly working partstudies done by the Federal Reserve Bank of St. Louis and the Centre of Economic and Policy Research have tried to adjust the unemployment rate to allow for the fact that the labour force age structure has risen over the past 20-30 years. In other words, there are proportionately fewer young people, and more older people in the work force.

The significance of the age shift is that older unemployed and underemployed are more likely to remain that way. In addition, modern labour surveys are smaller than they used to be and so they are more likely to miss people who have been unemployed and given up looking for work for good. Both studies reckon that the U.S. unemployment rate, properly measured and comparable with earlier times, is now about 1.5% higher than the official rate. This is bad news when we want to get people back to work in the private sector as quickly as possible, while public cutbacks are announced and before another economic downturn commences.

The loss of growth drivers arising from labour supply and labour market developments doesn’t mean that equity values are going to decline absolutely and persistently, but it does suggest that the rate of return on equity will drop compared with the last decades. Simply, capitalism rewards scarcity, and as labour supply fades relative to the availability of capital, returns will shift towards the former. For skilled and highly educated workers, this is good news. Not so for those that aren’t, as production technologies demand ever more skilled human capital.

We actually have no template about what to expect because 21st century population aging is unique. But it seems reasonable to expect lower rates of return in those countries where labour supply tightens significantly, while conceding that the directional change in equity markets will continue to reside in macroeconomic management, profits, innovation, governance, financial stability and so on.

LEAP investor day today.  RIMM expected to release new products today.  ACOR beats by 28c.  AGAM beats by 1c but misses on revenues.  ARMH initiated MP at BLAIR.  CGNX beats by 16c.  CTSH beats by 4c.  ESLR reports in-line and beats on revenues.  HK announces tender offer for 9 1/8th% notes due 2013.  HLF beats by 39c.  HOLX beats by 1c.  MTW upped at MSCO.  OPLK beats by 7c.  RDN lower on earnings.  PWAV beats by 1c.  SHPGY upped at CITI.  SUNH announces 19.3M share offering.  VSH beats by 11c.  WTI beats by 10c. 

Asia weaker overnight.  Europe mixed to slightly lower.  EUR/USD 1.3221.  USD -35bps.  Oil +85bps.  Gold +13bps. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
COGNIZANT TECH-A       62.50    +12.78%           563636
BAKER HUGHES INC        45.68    -9.06%  571830
DOW CHEMICAL             26.33    -7.06%  250962
MGIC INVT CORP            8.32      -6.09%  9850
QLOGIC CORP                15.38    -5.59%  500
FIRSTENERGY CORP       36.39    -5.33%  26200
VULCAN MATERIALS       44.50    -5.02%  2000
PROCTER & GAMBLE       59.71    -3.79%  1065778
PFIZER INC                    16.01    +3.42% 6382304
DEAN FOODS CO            11.39    -2.98%  4570

Today’s Trivia:  According to an article in this past weekend’s New Yorker magazine on the demise of the bluefin tuna, where does the word tuna come from?

Yesterday’s Question:  According to Malcolm Gladwell’s The Tipping Point, how many different advertising messages is the average American subject to in one day? 
Yesterday's Answer:  254.

Best Quotes:  Fed Likely to Pass On More Stimulus Amid Signs Economy Weak (2010-08-03 04:00:01.6 GMT) By Craig Torres and Scott Lanman

     Aug. 3 (Bloomberg) -- Federal Reserve policy makers signaled they will probably pass on providing more stimulus at their Aug. 10 meeting and wait to see if signs of weaker economic growth persist.
     Chairman Ben S. Bernanke told lawmakers in South Carolina yesterday that consumer spending is “likely to pick up” amid a “moderate” expansion. St. Louis Fed President James Bullard said on July 29 that he expects the “recovery will continue through the fall.” Three days earlier, Philadelphia Fed President Charles Plosser said in a Bloomberg News interview that calls for more Fed stimulus “are premature.”
     Officials indicated they may ease more should the economy falter after reports of a flagging housing industry and persistently high jobless rate. Options include strengthening the pledge to keep interest rates around zero, cutting the rate the Fed pays on excess bank reserves, or buying more Treasuries or mortgage bonds. No consensus has emerged among policy makers for any of those actions, remarks by officials show, and Bernanke didn’t mention them in a speech yesterday.
     “You have to get a significant downward revision to their forecast that spills over into next year” to get the Federal Open Market Committee to vote for more easing, says Laurence Meyer, a former Fed governor and vice chairman of forecasting firm Macroeconomic Advisors LLC in Washington.
     “The only thing that could push the committee to ease, or a signal that tightening is even further off, might be a worse- than-expected employment report,” he said.

                         Downside Risks

     Still, one FOMC option would be to change part of its statement to stress it is attentive to downside risks. Economic reports after the August meeting confirming a significant slowdown would prime investor expectations for some Fed action in September.
     Companies added 90,000 jobs last month, according to the median estimate in a Bloomberg News survey of economists. The unemployment rate is forecast to rise to 9.6 percent.
     “They would need to see a couple of months of bad labor market data and bad spending data” before easing further, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. and a former member of the forecasting team for the Fed Board of Governors.
     Fed officials and economists are trying to determine the economy’s trend from a stream of uneven data that may signal a pullback following investor concerns about a possible European default in May.

                      Household Sentiment

     Manufacturing slowed last month, according to the Institute for Supply Management’s manufacturing gauge which fell to 55.5 last month from 56.2 in June. High unemployment is weighing on household consumption and sentiment. The Conference Board’s consumer sentiment index fell to 50.4 last month, the lowest level in five months, figures from the New York-based private research group showed.
     Weaker consumer spending helped slow gross domestic product to a 2.4 percent annual pace in the second quarter, less than forecast, after a 3.7 percent first-quarter gain that was larger than previously estimated.
     Financial market conditions have improved, which should help channel the Fed’s low-rate policy to consumers and business.
     U.S. corporate bond sales set a record last month and yields on the debt fell to the lowest in more than four years.
Investors are snapping up the debt as 77 percent of companies in the Standard & Poor’s 500 Index that have reported second- quarter earnings beat analysts’ estimates.
     The S&P 500 rose 2.2 percent yesterday, extending July’s
6.9 percent rally which was the best monthly gain in a year.

                        Another Recession

      If the economy was approaching another recession, “you presumably would not see stock markets like the ones we’ve been seeing,” said Neal Soss, chief economist at Credit Suisse in New York and a former aide to former Fed Chairman Paul Volcker.
     “Against that sort of backdrop, it strikes me that the urgency from the Fed’s point of view is reduced rather than increased,” he said. “That doesn’t mean they shouldn’t have contingency planning under way.”
     The Fed signaled in June that Europe’s debt crisis may harm U.S. growth and repeated a pledge to keep interest rates near zero “for an extended period.” The central bank cut the benchmark interest rate almost to zero in December 2008 and turned to purchases of Treasury, housing-agency and mortgage- backed securities as the main tool of monetary policy.
     Fed officials will leave the rate unchanged again at the August meeting, according to economists surveyed by Bloomberg News last month.

                          Fast Enough

     Policy makers in June expected the economy to expand at rates fast enough to bring down the unemployment rate. Growth in
2011 should be in a range of 3.5 percent to 4.2 percent, according to their central tendency forecasts, and 3.5 percent to 4.5 percent in 2012. The central tendency removes the three highest and three lowest forecasts from committee members.
     Unemployment should average 8.3 to 8.7 percent in the final three months of next year, and fall about another percentage point to 7.1 percent to 7.5 percent by 2012.
     “The Fed has had a bit more optimistic view for some time” compared to Wall Street forecasters, said Michael Hanson, senior economist at Bank of America Merrill Lynch in New York.