Wednesday, September 15, 2010

Morning Note...

Futures ~40bps lower this morning as September’s Empire Manufacturing Survey results disappoint, Mortgage Applications were lower than the prior week, European markets are broadly weaker, and political news tilts slightly against the GOP and thus perhaps slightly damages the “stock market boost from midterm elections” sentiment.  The Empire State Manufacturing Survey of General Business Conditions for September fell to 4.14 from the prior 7.10 and the expected 8.00.  Mortgage Applications fell 8.9% week-over-week for the week ending September 10th.   Elsewhere, Import Prices rose more than expected both month-over-month (+0.6% vs. +0.3% exp) and year-over-year (+4.1% vs. +3.8% exp) in August.  In Asia, Japan last night intervened in an effort to halt the recent rise in the yen (JPY).  Overnight, the JPY fell to $85 against the USD and Japan’s stock market (highly tied to competitively priced exports, i.e. a lower yen) rose 2.25% as a result.  Note Gold remains near record highs at ~$1268/oz.  Oil is down ~2.5% this morning, and the USD is up 60bps.  Also note that Homebuilder BZH and steel giant NUE lowered Q3 forward guidance.  Industrial Production and Capacity Utilization for August were mostly in-line with expectations.  Initial Jobless Claims due tomorrow – worth noting that claims disappointed across the pond in the UK

Political news is at the forefront this morning, as many of yesterday’s primaries yielded interesting results.  Here’s a solid summary from Concept Capital:

Last night was a devastating – and embarrassing – night for Senate Republicans at the ballot box.  Winning the ten seats necessary to take the Senate majority became extraordinarily difficult when the Tea Party-backed candidate beat the shoe-in Senator, former Governor Mike Castle, in Delaware.  With 85% of votes in, former Attorney General Kelly Ayotte is hanging on to a thousand point lead over her Tea Party-backed challenger.  Ayotte needs to hold on for the GOP to have a shot at the majority.

            The Senate once looked to be very much in play – that changed with this Delaware election.

Delaware GOP Chair Tom Ross, who will probably resign today, has called O’Donnell “delusional,” and told AP’s Philip Elliott in a phone interview on Sept. 2: “She's not a viable candidate for any office in the state of Delaware. … She could not be elected dog catcher.”

Do not lose sight of the bigger picture here though – the Republicans are still going to pick-up A LOT of Senate seats in the midterms – likely around 7 or 8.  The Republicans have to win ten of twelve competitive races and hold the four they are defending to win control of the Senate.  The road to the Senate Republican majority ran through Delaware…that road is now closed.

            Takeaways from last night’s primaries:

            ·       Gridlock is the name of the game in the next Congress.  Obama’s regulatory agencies are going to be running the show in 2011 and 2012.

·       The Delaware Senate seat is one of the seats whose November 2nd winner will be seated for the Lame Duck, due to the appointment issue.  Republicans were counting on this seat.  The other seats that will see new Senators in the Lame Duck include Illinois and West Virginia and possibly Colorado (the election statutes are hazy).  The Lame Duck is not going to be as red as was once thought.

·       The Senate Republican Caucus next year was always expected to be quite conservative, though Castle was expected to play the role as a leading moderate.  That is obviously not on the table anymore.  Expect the Senate Republicans to be very aggressive on spending bills and block anything (other than taxes) that is not offset.

·       Wealthy Buffalo businessman Carl Paladino defeated former Congressman Rick Lazio for the GOP nomination for Governor.  This is almost irrelevant as Attorney General Andrew Cuomo is going to be the next Governor.

Regarding recent market action, BTIG’s Mike O’Rourke made mention of the Wall Street Journal’s recent speculation on the Fed’s current approach:

The WSJ again appears to have the inside track on an upcoming FOMC meeting.  Late in the day, the Journal reported that the “Fed wrestles over next steps.”  Apparently, the FOMC is split as to what conditions merit a second round of quantitative easing (QE2) and thus a further expansion of the balance sheet.  Although the methods and instruments of monetary policy are new, the question is an old one.  How much time is the appropriate amount of time to allow current policy to work before refilling the punch bowl and risking an overly stimulative policy?  The doves will argue that with Unemployment well above Fed targets, Inflation at the low end of Fed targets (and risking going lower), and growth below trend, the Central Bank should be doing more.  The hawks will argue that the FOMC only completed its asset purchase program 6 months ago and has already taken steps to prevent the natural wind down that commenced as a result of the refi boom.  Policy action is generally believed to work on a 6 to 12 month lag and hawks would prefer to give the policy time to work.  An indication that the debate is real materialized two hours later when non-voting hawk Richmond Fed President Jeff Lacker was quoted by the WSJ advocating a high threshold for additional Fed action.  

One key aspect of the story is commentary from very recently retired Federal Reserve Board Vice Chairman Don Kohn.  The two key quotes from Kohn were that “A lack of progress toward lower levels of unemployment would be a reason to give serious consideration to additional action,” and "I don't think you need the shock and awe."  These quotes substantiate the key takeaway of today’s article that at next week’s meeting, the FOMC may indicate a willingness to commence small scale asset purchases (beyond replacement purchases) in the future.  If it happens, such a move will take the Fed one step closer to the policy that St. Louis Fed President Jim Dullard has been advocating - using asset purchases and sales in the same manner the FOMC has traditionally used interest rates.  Over the summer, Bullard added a new twist stating that a  zero interest rate policy increases the likelihood of a Japan-like deflationary environment.  A true adoption of his stance would include a sooner than expected increase in interest rates.  Right now that seems very unlikely because despite being innovative, it brings a high degree of uncertainty.  As such, it potentially risks making a policy mistake on the tightening side, which is the type of mistake the Fed cannot afford to make in a fragile recovery.

Since the Journal had the right policy action coming out of the last meeting, we suspect they will be right again.  Therefore, we will watch for indications that the FOMC will allude to small scale asset purchases.  We think it goes a step further than what we were advocating prior to the August meeting, re-opening the asset purchase program but only using it if necessary.  In this case, they will likely use it on a small scale in order to reinforce the point that they are here and ready to support the recovery.  The timing is remarkable, considering it is an election year.  As confidence in corporate America slowly rebounds, we suspect this will likely be intended to send the message to those on the fence about hiring or increasing capex that the Fed is willing to do some handholding to get them off the fence.

Regarding real estate, here’s a less-than-thrilling story from Bloomberg news:

U.S. Home Prices Face Three-Year Drop as Inventory Surge Looms 2010-09-15 04:01:01.4 GMT By John Gittelsohn and Kathleen M. Howley

Sept. 15 (Bloomberg) -- The slide in U.S. home prices may have another three years to go as sellers add as many as 12 million more properties to the market. Shadow inventory -- the supply of homes in default or foreclosure that may be offered for sale -- is preventing prices from bottoming after a 28 percent plunge from 2006, according to analysts from Moody’s Analytics Inc., Fannie Mae, Morgan Stanley and Barclays Plc. Those properties are in addition to houses that are vacant or that may soon be put on the market by owners. “Whether it’s the sidelined, shadow or current inventory, the issue is there’s more supply than demand,” said Oliver Chang, a U.S. housing strategist with Morgan Stanley in San Francisco. “Once you reach a bottom, it will take three or four years for prices to begin to rise 1 or 2 percent a year.” Rising supply threatens to undermine government efforts to boost the housing market as homebuyers wait for better deals. Further price declines are necessary for a sustainable rebound as a stimulus-driven recovery falters, said Joshua Shapiro, chief U.S. economist of Maria Fiorini Ramirez Inc., a New York economic forecasting firm. Sales of new and existing homes fell to the lowest levels on record in July as a federal tax credit for buyers expired and U.S. unemployment remained near a 26-year high. The median price of a previously owned home in the month was $182,600, about the level it was in 2003, the National Association of Realtors said.

BERN cuts TYC.  GSCO ups BTM.  UBSS ups RDC, NETL.  GSCO cuts MU, MXIM.  ARI to offer 6M shares.  AU offers 15.8M shares.  EPB offers 10M shares.  LVLT offers $175M in convertible notes.  MPWR to be added to S&P500.  NOVL may be putting itself up for sale.  Homebuilder BZH and steel giant NUE lowered guidance.  PLL beats by 8c.  SONC cut at KEYB. 

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

Today’s Trivia:  In 1943 the Philip Morris company ran an ad that actually acknowledged smokers cough.  But what did they claim caused the cough?

Yesterday’s Question:  Any guess at to the connection between Willy Wonka & The Chocolate Factory and William Wallace of Braveheart fame?

Yesterday's Answer:  Willy Wonka & The Chocolate Factory was written by Roald Dahl, who also penned James and the Giant Peach and Fantastic Mr. Fox, among others.  According to a recent New Yorker article, he is also a direct descendent of William Wallace, the basis for the film Braveheart

Best Quotes:  Trader Talk… This week has seen rising stocks and a sharply weaker dollar while Treasuries and gold have rallied (the latter to a new record of $1,269/oz). Rather than a new paradigm these decouplings appear the result of different moving parts. Stocks are reacting to the combination of more clarity around Basel 3 and stronger than expected economic data (Retail Sales), while speculation in the market about a new round of quantitative easing supports Treasuries and gold while weakening the dollar. Credit spreads have been largely unchanged this week but supply volumes are heavy. For example issuance in high grade has totaled $54bn since Labor Day and was well received.   Retail Sales report showed that consumers increased spending for the back-to-school season. Total retail sales increased 0.4%, only slightly above our and consensus expectations for a 0.3% gain. However, "core control" sales, which nets out autos, gasoline and building materials, jumped 0.6% compared to our forecast of a 0.3% increase. This suggests upside risk to our forecast for Q3 GDP to increase 1.8%. Although today's report is better-than-expected, it still shows that consumers are spending conservatively and allocating funds toward necessary purchases.  Seems like a good idea,    The market seems stuck in s trap, stuck in this range 1000 – 1130.   I am calling for a break to the upside. Is there worse sentiment than we’ve had over the past year.   Buy the dips.  (BofAMLCO)