Friday, August 6, 2010

Morning Note...


Happy Friday…Futures are ~90bps lower this morning as the Official Nonfarm Payrolls report for July came in weaker than expected and, frankly, in both a “big picture” sense and in the “slow summer Friday” sense, not much else matters.  The Official Change was -131k vs. the expected -65k, and the prior reading for June was revised down to -221k from -125k.  The component “Change in Private Payrolls” also disappointed for July, coming in at +71k versus the +90k expectation.  The Unemployment Rate ticked down slightly to 9.5% from 9.6%, but at this point, most market-watchers pay more attention to the U6 number, which incorporates the under-employed and those who have give up looking, as a true measure of the economy.  For those interested, here’s the run-down as per Wikipedia:

·         U1: Percentage of labor force unemployed 15 weeks or longer.
·         U2: Percentage of labor force who lost jobs or completed temporary work.
·         U3: Official unemployment rate per ILO definition.
·         U4: U3 + "discouraged workers", or those who have stopped looking for work because current economic conditions make them believe that no work is available for them.
·         U5: U4 + other "marginally attached workers", or "loosely attached workers", or those who "would like" and are able to work, but have not looked for work recently.
·         U6: U5 + Part time workers who want to work full time, but cannot due to economic reasons (underemployment).

Among the more interesting commentary this morning, PIMCO’s Bill Gross is on the tape saying the Fed is “unlikely to raise interest rates for two to three years.”  (Hello, Japan…)  Further, Amherst College alum – and Nobel Prize winning economist – Joseph Stiglitz said that the U.S. economy faces an “anemic” recovery and the government will need to enact another round of “better designed” stimulus measures.  According to a Bloomberg TV interview from yesterday, he also said “the recovery is so weak that it is not strong enough to generate new jobs for the new entrants in the labor force, let alone to find jobs for the 15 million Americans who would like a job and can’t get one.”  In other interesting commentary, I am loathe to follow-up Bill Gross and Joseph Stiglitz with Yale’s answer to the “Hanson Brothers,” Daryl Jones of Hedgeye, but this is a good read:

Earlier this week, Keith and I presented to our clients on the topic of U.S. Sovereign Debt.  Debt and deficit issues in the United States are not exactly non-consensus as they are widely discussed and contemplated.  In fact, in the spirit of "watch what they do and not what they say", we had the second Obama administration economic official resign today in Christina Romer, the chair of the Council of Economic Advisors.  This of course comes on the back of the July departure of Peter "The Paparazzi" Orzag, who ran the Office of Management and Budget.  Watch what they do and not what they say…

Undoubtedly, both Orzag and Romer have come to the same realization as us, which is that U.S. economic growth is poised to slow in coming years.  In our presentation on Tuesday, we narrowed this projection down to one key variable in our multi factor, chaos theory based model.  This factor is sovereign debt.  So if you are staffed with managing the budget or the economy in a slow growth environment, you better either wave the white flag and go back to teaching at Berkeley (Romer), or prepare your stomach for the new reality of Bad To Worse.

While many of you have read Reinhart and Rogoff's book, "This Time is Different", which studies the long term implications of large sovereign debt balances,  the professors also wrote a fascinating paper earlier this year, "Growth in a Time of Debt."  This paper looks at over 210 years of data relating to sovereign debt balances and future economic growth.  The key conclusion is that as debt-as-percentage-of-GDP crosses the Rubicon of 90%, future growth slows.  And in dramatic fashion.

According to their paper, from 1790 to 2009, for 20 of the most modern economies, as debt exceeded 90% of GDP, average annual economic growth was 1.7%.  This was compared to economic growth of 3.7% at less than 30% of debt to GDP, economic growth of 3.0% with debt to GDP from 30% to 60%, and economic growth of 3.4% with debt to GDP of 60% to 90%.  In effect, as debt as a percentage of GDP passes the Rubicon of 90%, growth falls below the average by more than three standard deviations.  As the quants will tell you, that is statistically significant!

In other news, the Russian heat wave and wheat crisis I mentioned a few days ago is getting real traction now.  Here’s a full summary from Cantor Fitzgerald’s desk:

o        Multiple industries affected
o        Trigger in the group may be 10 am earnings conf call by CF, which reported last night and trade dn 3%..
o        Wheat was up as much as 6% overnight..went negative, but now moves positive again after 7am et
§         panic buying in wheat mkts – BBG: U.S. wheat futures jumped  fluctuated this am….up earlier as much as 6 percent  on Friday, taking weekly gains to more than 25 percent as  Russia's move to temporarily halt grain shipments sparked a buying frenzy.
o        Shares in European brewers and food producers were hit hard on Friday, with traders citing worries about soaring grain prices after Russia's move to temporarily halt grain shipments.
§         The food and beverage producers sector was the worst performer in Europe, down 2 percent, while the benchmark STOXX Europe 600 was up
o        declines at brewing companies in EU today
·         Heineken NV lost 3.5 percent to 33.92 euros and Carlsberg AS slumped 4.5 percent to 491.7 euros
·         Diageo and Anheuser-Busch InBev  falling on higher wheat prices..per BBG
o        Also watch food companies: 
§         KFT reported mixed last night….trades up after hrs tho
·         KFT also talked about wheat on EPS call last night..sd its well hedged ..BBG
·         Food producers Nestle, Danone and Associated British Foods were down 0.9 to 2.5 percent, while Unilever fell 2.5 percent, a day after it warned of a tougher second half due to higher commodity cost and stiff competition after reporting higher second quarter sales
o        Watch agricultural linked names: CF, AGU,  ADM, Monsanto, Potash Corp….all Rise as Wheat Climbs – rally may continue Friday
§         Syngenta, the world’s biggest maker of agricultural chemicals, climbed 3 percent Friday  as the price of wheat rallied.
o        CF reported last night: 
§         2Q2010 miss on weaker pricing despite strong volumes (per Goldman)
§         Call….10am ET. Dial in: 866-713-8562.
o        Traders in Asia consider force majeure on Russia wheat
§         Reuters) - Trading companies that have sold Russian wheat to millers in Asia are considering declaring force majeure on supply contracts after Moscow slapped on grain export curbs, traders said on Friday.
§         http://in.reuters.com/article/idINIndia-50672320100806

AIG higher on earnings.  Cramer positive on Agriculture sector (BG, IPI).  FBRC ups H, TFSL.  CITI cuts KRC.  JPHQ cuts RIG.  BARD cuts HEW, ROCK.  UBSS cuts TS.  AGO beats by 21c.  ATPG misses on earnings and revenues.  ATVI misses by 1c.  CEC misses by 3c.  EOG misses by 7c.  CROX beats by 15c.  HANS beats by 3c.  HAR misses by 2c.  KOG misses by 1c.  NILE misses by 4c.  UL cut at UBSS.  RST beats by 4c.  POWR beats by 2c. 

Asia mixed overnight.  Europe lower.  EUR/USD 1.3257.  USD -47bps.  Oil -140bps.  Gold +80bps. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume):  N/A…new BBERG launchpad functionality stinks – can no longer “cut and paste.”

Today’s Trivia: What interesting immunity do sharks possess that has scientists buzzing over shark cartilage studies?

Yesterday’s Question:  It’s well documented that the Bull Shark has the highest testosterone levels of any animal…how many times greater is it than the average human male?
                                                                                                                                                                  
Yesterday's Answer:  According to Shark Week, an average male has a testosterone level of 40mg/l, whereas a Bull Shark has 900mg/l. 

Best Quotes:  Great commentary from BTIG’s Mike O’Rourke on the Obama Administration’s anti-business stance…

Not Anti-Business?
As a general rule in this note, we try to discuss politics in the context of what it means for the market, investors and the economy.  We are on record numerous times stating that we believe the Administration’s response to the financial crisis and the Great Recession was the appropriate one.  We also try to point out when the Administration or Congress pushes too far.  The President has succeeded in passing his two landmark pieces of legislation, Health Care Reform and “Wall Street Reform.”  There is the potential that he will also be credited for a third piece of important legislation, the stimulus bill, but for it to be considered landmark, it has to be proven to have worked and the jury will still be out on that for some time.  As we all know, the Democratic supermajorities in Congress will likely disappear after the November election.  It is a fair estimate to say that even if the President wins a second term, his legislative activity will be minimal going forward and microscopic relative to what has been passed.  With no stomach for additional stimulus in this country, we estimate it is in the President’s best interest to become the biggest cheerleader the economy and business has ever seen.  Two years into his Administration and having passed important legislation, the ownership of the problems becomes his.  Blaming the prior Administration will lose its impact on the American populace.

Over the past 1-2 months, the President has become acutely aware that he is perceived to be anti-business.  This is primarily the result of several high profile CEOs publicly expressing their view that they believe him to be.  The view we have often expressed is not that the President is “not anti-business” but rather simply “not business friendly.”  From an investment perspective, this should set up a positive dynamic.  A President who needs recovery and stands to benefit greatly from it, but also needs to repair his image and do some damage control.  Add into the mix the legislative agenda is clear going forward.  Then you see something like White House’s video “What Wall Street Reform Means For You.”    The video explains mortgages as IOUs you give to the big bank when you buy a house.  Here is how the White House explains what went wrong in this country, “Now you might think that your bank would just put that IOU in a safe place while you went about making your monthly payments.  But instead that IOU took a little detour (the video literally shows a casino).  And, as often happens when gamblers play with other people’s money or money they don’t have, the big bank bet big and lost big.  And since the bank was so big, the entire economy was affected. As a result, millions went unemployed, small businesses could not get credit and the middle class got squeezed.”  There you have it, right on the White House website, the banks and Wall Street ruined the U.S. economy, cost you your job and your home (that is later in the video).  We have advocated for reform since at least pre-Lehman in 2008.  We can deal with the reform that has been passed and move forward.  Yes, certain parts of  Wall Street and the banking system acted irresponsibly, but so did the American populace as a whole. 

The list of  bad actors goes on and on, many of whom were in the executive and legislative branches of government.  President Bush wanted to be the “Homeownership President.”  The GSE’s bought more influence in Washington than any other businesses.  They used the influence to expand their portfolios and garner capital requirements a fraction of the size of a bank, essentially crowding banks out of the mortgage business. Any attempts to reform the GSE’s were halted.  Homebuilding CEO’s, the National Association of Realtors and the Mortgage Bankers Association swore there was no housing bubble.  The American public is just as responsible for partaking in the charade for greedily buying assets with “other people’s money.”  

Beyond the blatant simplification and misrepresentation that it was all Wall Street’s fault, the biggest travesty of this video is the solution offered.  The White House noted that the new Consumer Financial Protection Agency will have the “sole job of reigning in the big banks,” to protect the consumer.  The false sense of security this video implies only illustrates the ignorance of whoever created and signed off on this video.  Any economy that is robust and healthy is going to be subject to the business cycle and if you seek to eradicate that, you either create the unhealthy environment we were in or you have no economy to speak of.  The new Consumer Financial Protection Agency will also be at the Federal Reserve.  The oversight of mortgage documents during the time in question was the purview of the Federal Reserve.  As much as we respect the Federal Reserve, they did nothing.  Even worse, they witnessed the problems and conducted studies but essentially did nothing.  This will not prevent another crisis.  We are not in the business of making guarantees, but we guarantee there will be future financial crises.  It is the price one pays for a vibrant economy.  The Government wonders why they American people don’t trust them.  It is because they make promises they cannot keep.  The false sense of security provided is what really does damage to the American people.   Regrettably, the White House is still content with an anti-business image.