Monday, September 27, 2010

Morning Note...

Futures slightly higher this morning (+25bps) as “Merger Monday” comes back in vogue:  Southwest Airlines (LUV) is buying Air Tran (AAI; +56%) for $1.4 billion and Unilever (UNA NA or UL) is buying Alberto Culver (ACV; +18%) for $3.7 billion.  Asia was higher overnight as markets play “catch up” with our action Friday.  Also, Japan announced roughly $50 billion of new stimulus.  Looking ahead, China’s PMI data is due Thursday night for Friday morning, and note that China closes October 1st to 7th for the “Golden Week” holiday.  Europe flat to slightly lower this morning, as the ECB apparently considered unlocking rescue funds for Ireland but has yet to act, and Anglo Irish Bank is set to release restructuring details on Thursday and Moody’s cut the bank’s senior debt rating three notches.  A pan-European strike is set for Wednesday, September 29th, and will surely generate some major media headlines.  In other corporate news, the WSJ reports that takeover talks between Santander (STD) and M&T Bank (MTB) have broken down.  Economic data is a bit back-end loaded this week, as revised U.S. GDP is also due for Thursday morning and the ISM manufacturing index will be release Friday along with U.S. auto sales.  Barron’s was cautious on Technology & Semiconductor stocks. 

Worth noting two interesting stories from the New York Times and the Wall Street Journal.  According to the WSJ, the bulk of Q3 earnings pre-announcements have been negative, with a count of 77 downside warnings vs. 34 upside revisions.  The 2.3 ratio of “negative-to-positive preannouncements for Q3 is up sharply from 1.1 in Q2.”  According to the NYT, “The conventional wisdom is that gridlock is good for the stock market, but there’s no evidence that that’s been true over the last 84 years.”  The article goes on to point out that from 1926 through last year, an index of large-capitalization stocks returned about 7 percent, annualized, when there was gridlock, compared with about 12 percent when there was not.

Also, there was an insightful survey conducted by CNBC in light of David Tepper’s commentary Friday morning.  The survey results indicated that investors anticipate $500 billion of new stimulus from the Fed to be lasting roughly one year.  As a result, one wonders how “baked in” Tepper’s “Don’t fight the Fed” commentary actually is (bold emphasis mine):

Fed Will Boost Balance Sheet by $500 Billion: Survey
Published: Monday, 27 Sep 2010 | 7:00 AM ET
By: Steve Liesman, Senior Economics Reporter

The Federal Reserve will boost its balance sheet by about half a trillion dollars over a six-month period beginning in November and keep it inflated for up to a year, according to a survey of leading markets participants by CNBC.

About 70 percent of the 67 respondents, which include economists, strategists and fund managers, believe the Fed will begin quantitative easing again.

Of those, 80 percent believe the Fed will start before the end of this year. November is seen as the most likely month for the Fed to restart asset purchases by 38 percent of those who took the survey, but December was a close second with 32 percent.

“The trigger for the resumption of quantitative easing late this year will be an increase in unemployment back into double-digits,” wrote Mark Zandi, of Moody’s Economy.Com. He thinks the Fed will act in December and ultimately purchase an additional $1 trillion in assets.

The survey is among the first efforts to quantify market expectations for when and by how much the Fed will restart quantitative easing, or asset purchases, as is widely expected. Before the Fed Funds rate was lowered to zero, the Fed futures markets served as a proxy for market expectations for actions by the central bank.

The Fed has made clear that the size of the balance sheet is now a major tool for aiding the economy yet there is no obvious proxy for gauging market sentiment. CNBC will conduct the survey periodically to gauge how market expectations for the Fed change with incoming economic data and statements by Fed officials.

There is a wide range of answers surrounding the key unknown of how much the Fed will buy in assets. The average for the survey put the portfolio at $2.35 trillion by Feb. 1, growing to $2.5 trillion by August 2011. The Fed is expected to remain around that level through November, 2011. The Fed’s portfolio is currently targeted at $2.054 trillion, meaning market participants expect the portfolio to grow an average by about $500 billion by August.

At their September meeting, Fed officials hinted strongly that they would restart asset purchases, saying the Federal Open Market Committee “is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

But Fed officials have not so far offered any guidance for how much they would add to the portfolio. The Fed kept its balance sheet at about $800 billion before the financial crisis but raised it by nearly $1.5 trillion through the purchase of treasuries and mortgage-backed securities along with toxic assets it took on its balance sheet through the rescues of AIG and Bear Stearns.

The lack of guidance, along with differences over the economic outlook, results in a wide range of estimates from respondents for the size of the balance sheet through November 2011. In fact, 22 percent believe the balance sheet will be smaller by then than it is now, with the low coming in at $1 trillion, meaning a reduction in the portfolio by $1 trillion from the current level of $2 trillion.

Nearly 30 percent think the portfolio will be more than $1 trillion dollars larger, with the high at $4.1 trillion.

“If the Fed pulls the trigger, they will go big,” wrote Stephen Stanley of Pierpont Securities. He sees the balance sheet hitting $3 trillion by August.

Market participants believe the move will help lower interest rates, with 57 percent saying it would be totally or somewhat effective. About 38 percent think it will be ineffective and 6 percent unsure.

David Resler of Nomura Securities said lowering interest is not the principal goal of additional QE. Rather, he said will purchase assets to ward off deflation and boost inflation expectations.

Mark Vitner of Wells Fargo said: “There will only be a modest impact on interest rates… because the move is more widely expected and interest rates are already so low.”

Others were skeptical of the impact. Mark Elenowitz of TriPoint Global Equities wrote that he sees little impact because rates are already low. “My fear is that instead of prompting economic activity through sustained low interest rates, the Fed may provoke a debilitating bout of inflation,’’ he said. Others thought the Fed will have some impact, but at a cost of a very painful exit strategy.

Purchasing assets is just one of the actions the Fed could take. It has also said it could lower the interest rate paid on excess reserves, now at 25 basis points, and can make an even firmer commitment to keep rates low for longer. 

BEN upgrade at FBRC.  MSCO ups DRYS.  HNR to explore strategic alternatives.  GSCO cuts INFN.  Barron’s positive JBLU.  UBSS ups NUAN.  YRCW announces tentative agreement with Teamsters.  GSCO ups BDX.  WEFA ups ARI.  GSCO cuts ESRX, ZMH.  OPCO cuts RDWR.  Barron’s positive BBY. 

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

Today’s Trivia:  You may know that Al Capone was born in Brooklyn and spent most of his “career” in Chicago…but where did he die?

Yesterday’s Question:  Who am I?  Born on this date in 1936 in Greenville, Mississippi…winner of 18 Emmys, 17 Grammys, and 4 Peabody Awards…died in 1993…every kid surely knows his work without knowing who he actually is…

Yesterday's Answer:  Jim Henson, of Sesame Street and Muppet Show fame.   

Best Quotes:  From BofA/MLCO desk... “Good Morning - Fourth straight week of gains for the markets.  The market is up 10% in less than a month on light volume.  Three out of every four stocks are now trading above the 50 day mva.   S&P 500 companies have bought back 77.6 billion of stock in the second quarter.  Heavy week of economic data for the week ahead.  Case Shiller tomrrow. GDP on Thursday, and PPI on Friday.   Auto sales also due out on Friday.    M&A still alive and well.   LUV for Airtran, and Unileverr for Alberto Culver on the tape this morning.     1147.50 is the eighteen week high, 1132 was Fridays low.   I saw Wall Street II, it is horrible.   Have a great day”

From BTIG’s O’Rourke… “Friday’s rally was more equine than bovine.  In a rare media appearance, hedge fund manager David Tepper of Appaloosa provided a bullish outlook for Equities.  After the summer of popular pessimism as highlighted by the NY Times last month, and themes like deflation going mainstream, such comments from someone with a track record suddenly makes optimism acceptable once again.  The market received an added boost from a better than expected Durable Goods report with healthy upward revisions to the July report.  The way we like to define bull and bear tapes is as follows.  A bull tape is one where during selloffs, stocks don’t stay down long enough to afford the opportunity to buy and a bear tape is one in which stocks don’t stay up long enough in the rallies to afford the opportunity to sell.  As we all know, the equity market has been consolidating, not only in the trading range of the past 4 months, but actually for an entire year.  It has been positive that throughout September, down days have been scarce, but the quick and easy manner in which this week’s 3 day selloff was erased is a good indication that we are likely in the early stages of a bull tape.”