Monday, October 4, 2010

Morning Note...

Futures are ~25bps lower this morning as markets pause ahead of Q3 earnings which kick-off tomorrow.  News is relatively light this morning, as Europe trades roughly 1% lower, Oil is up 30bps, Gold is down 10bps, and the USD is up ~35bps.  Markets are perhaps looking ahead to not only earnings this week (kicking off with YUM tomorrow, MAR Wednesday, PEP Thursday morning, and AA Thursday night), but to both midterm elections and the next FOMC meeting in only 29 days.  Note that September retail sales data will be released Thursday and the big September jobs report (Official Nonfarm Payrolls) is due Friday.  In Europe, a government-appointed panel is recommending tougher capital requirements for Swiss banks and Sanofi-Aventis launches a hostile bid for Genzyme.  Also, the ECB’s next meeting is scheduled for Thursday the 7th.  In Asia, the Bank of Japan’s latest meeting is tonight.  Asian markets were mixed overnight as China remains closed for holidays.  More chatter out there regarding state and municipal default.  California’s budget is in the news, and Harrisburg, PA is in danger of a complete default. 

Interesting Bloomberg story this morning about S&P estimates for 2011 being taken down:

S&P 500 Profits Cut for First Time in Year by Analysts 2010-10-04 07:35:35.735 GMT
Oct. 4 (Bloomberg) -- For the first time in more than a year analysts are cutting their forecasts for Standard & Poor’s 500 Index earnings, jeopardizing gains from the biggest September rally since World War II. Estimates for S&P 500 companies’ combined 2011 profit fell as low as $95.17 last month from an August high of $96.16 and posted the first quarterly reduction since the three months ended June 2009, according to more than 8,500 analyst forecasts tracked by Bloomberg. The revision came as the benchmark gauge for U.S. equities rose 8.8 percent last month, the largest September advance since 1939. Now, money managers at Stifel Nicolaus & Co. and USAA Investment Management Co. are preparing for weaker returns in October as Alcoa Inc.’s Oct. 7 report starts the third-quarter earnings season. Bulls say even with the decline in analyst estimates, equities remain cheaper based on forecast profits than at any time since 1988, excluding the six months after Lehman Brothers Holdings Inc.’s bankruptcy in 2008. “Earnings forecasts are going to be somewhat more muted in their expectations for future growth,” said Chad Morganlander, a Florham Park, New Jersey-based money manager at Stifel Nicolaus, which oversees $90 billion. “It’s not necessarily a bad thing, but it’s certainly not the fuel that will reignite animal spirits.” Analysts cut 2011 profit estimates for benchmark stock indexes in 20 of the world’s 24 developed markets last month as U.S. unemployment remains near the highest in 27 years and European lawmakers enact austerity measures to shrink budget deficits. Income forecasts for the FTSE 100 Index of U.K. companies have fallen 4.9 percent since the end of May, while those in Hong Kong’s Hang Seng Index are down 1.5 percent since February, data compiled by Bloomberg show.

In case you missed the Weekend WSJ Op-Ed from Charles Schwab against low-interest rates, it’s an interesting read against the backdrop of looming QE2 and “real negative fed funds rates” (and for a good summary of the Fed, also see the quote section below): 

Enough With the Low Interest Rates!
Fed policy punishes savers without making credit more readily available.

The Federal Reserve's experiment with near-zero interest rates, which began following the credit crisis of 2008, has now become counterproductive.

As a temporary fix it served its purpose. It was an emergency antibiotic appropriate for the illness. But continuing with the experiment is disfiguring the economy and fueling doubt. Healthy economies find their own equilibrium based on market forces of supply and demand. When people don't think market forces are driving the economy and believe instead that it is being driven by excessive government intervention, they don't take the risks an economy requires.

It's time to stop the experiment and return to monetary normalcy.

The negative impact of current policy is clear. The near-zero interest rate experiment is weighing on consumer and investor confidence, and the Fed signals its lack of confidence with each "extended period" proclamation. It is providing banks with low-interest financing that can be used to create modest returns through a carry-trade in U.S. Treasurys but is adding nothing to the velocity of money, which is what actually generates economic growth.

The Fed's super-loose policy has driven down the security and spending power of savers, particularly those in retirement who played by the rules during their working years and now depend on the earnings from their savings for a decent quality of life. As a result, savers and investors are being forced to take more risk with their money as they hunt for higher yields.

The extreme monetary policy is also having no positive impact on the availability of consumer or business credit, job growth or consumer and business spending.

Consumer spending accounts for two-thirds of the U.S. economy. Despite record low rates, consumer borrowing continues to retrench. As of August, we'd seen our fourth straight month of contraction to $9.1 billion. Revolving credit-card debt shrank to $7.4 billion, continuing a 20-month stretch of declines.

Small businesses that create jobs are unable to borrow in any meaningful amounts except via 100% collateralized loans. Banks continue to hold large capital bases, mostly because they have no definitive signal yet from the federal government or regulators about what their capital requirements will be. So they take the most conservative path available—they sit on their money. Today there is more than $7.5 trillion of deposits in FDIC-insured commercial banks and savings institutions, earning—and doing—essentially nothing.

It is time to let the inherent power of economic forces engage. The Fed can help by removing the "extended period of time" language at its next meeting. Elimination of this language would remove some of the glue that has lenders stuck.

The Fed should then move quickly to help rates float and find a more natural level. Lenders would be less afraid of getting slammed by a sudden shift in government monetary policy, knowing instead that their pricing of credit is based on market conditions, which have historical precedent and some measure of long-term predictability.

What bank today wants to offer and then hold 30-year fixed loans at these artificial and temporary rates? Right now most of that lending ends up with Fannie Mae and Freddie Mac—a government-subsidized pool of loans bearing no relation to a natural market for credit. Savers, who today see no end in sight to the Fed's zero-interest policy, would be more careful to avoid the temptation of chasing riskier longer-term yields, knowing that rates could move up at any time.

Our economy is ready to heal. It just lacks broad-based confidence among consumers and business people. It would be a giant boost to confidence if the Fed stood aside and returned to its traditional role as defender of monetary stability.

F initiated OW at MSCO.  SLE turns down $12 billion offer from KKR.  Barron’s positive UTX, cautious WWE, and cautious on the broader market in October.  CSFB cuts XL.  GSCO ups PVH.  JPHQ ups ALL.  UBSS ups DDR.  BCAP cuts LXK.  GSCO cuts JCP, M, MSFT.  JEFF cuts INFN.  MSCO cuts AVP, BMY.  UBSS cuts K, OCR, STR. 

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

Today’s Trivia: Name the only river that flows both north and south of the equator (i.e. it crosses the equator twice)?

Yesterday’s Question:  According to research from, which entertainment tabloid is most accurate, and what is the winning accuracy rate?

Yesterday's Answer:  According to (how did they measure this?), at 60% accuracy, Us Weekly is the most reliable tabloid.   

Best Quotes:  Splitting Fed-ache.
Friday was a busy day, but as is commonplace these days, you couldn’t tell from the action in the Equity markets.  The day started with NY Fed President and FOMC Vice Chairman Bill Dudley giving a very dovish speech balancing out the recent hawkish (and by “hawkish” we mean not supportive of QE2) commentary from the other Regional Bank Presidents earlier last week.  Dudley’s view can be summed up with one of his closing comments, “Currently, my assessment is that both the current levels of unemployment and inflation and the timeframe over which they are likely to return to levels consistent with our mandate are unacceptable.”  

The great thing about Dudley speeches is that he often gives concrete guidance to what the Fed is thinking.  In the beginning of the year, he was the one who indicated that as long as the  “exceptionally and extended” language was present, interest rates would remain low for another 6 months.  The irony is that the FOMC then began to dissuade investors from that notion in the spring just as we entered the soft patch, and it is now prepping for a second round of QE.  The insight Dudley proffered on Friday was an explanation of the influence the Fed believes QE has.  “With respect to the first question, some simple calculations based on recent experience suggest that $500 billion of purchases would provide about as much stimulus as a reduction in the federal funds rate of between half a point and three quarters of a point.”  Considering the Fed has purchased $1.7 Trillion of long term assets, it would indicate that the Fed Funds is around the theoretical approximate level of -2%.  That matches the predictions many economists have made that under the Taylor rule, the Fed Funds rate would be in the approximate range of negative territory.  An interesting side note is that as recently as July, in Congressional testimony, John Taylor himself stated that he did not believe the Fed Funds rate should be negative.  “There's not inflationary pressure, so the low interest rate that is there now seems to me about right.  I don't think that if you use a Taylor rule, at least as I originally defined it, you'd see negative rates.”

Charles Plosser of the Philly Fed and Richard Fisher of the Dallas Fed haves clearly come out against QE2 right now.  Similarly Narayana Kocherlakota of the Minneapolis Fed said he did expect much benefit from another round of quantitative easing.  All three gentleman are non-voters this year, but they become voters next year.  The final non-voter this year who also will vote next year is Chicago President Charles Evans who indicated he would support QE2.  This is getting interesting.  When the rotation occurs at the start of 2011 the FOMC will lose 3 moderate/dovish voters (Rosengren, Pianalto and Bullard) and one hawk (Hoenig).  They will be replaced with what looks like 3 hawks (Plosser, Fisher and Kocherlakota) and one dove (Evans).  The Governors and Dudley would all side with Bernanke on a dovish stance.  New Federal Reserve Board Vice-Chair Janet Yellen is also dove.  There is no question the dovish view will prevail on the FOMC,  but it will be hard to appear unified with so much potential opposition.  Now there are only two meetings left in 2010, and one of them starts on election day.  So if the FOMC wants to start QE2 and be limited to one dissent, they need to do it quickly. 

The most striking aspect of Dudley’s commentary was his explanation of why QE2 is imminently necessary right now.  Dudley stated he does not expect a “double-dip” and that he believes the economy is growing at 2%.  Dudley is focused upon returning the U.S. economy to the path of potential growth sooner rather than later.  He makes the accurate case that another round of weakness in a high unemployment environment can be devastating to  the recovery process.  We believe Dudley’s’ downside assessment is accurate, but considering he does not expect contraction or a double dip, it is mildly disconcerting that more asset purchases are being called for so quickly.  Central Bankers often explain the lag that occurs before the results of policy shifts materialize in the system.  The level of asset purchases during QE1 never hit intended targets of maximum holdings as securities matured and were pre-paid.  The QE-Lite program of holding the asset portfolios steady was only introduced in August.  Current policy has not been given ample time to work and now the pressure is on to do more.  Maybe it’s the election, or maybe it’s the composure of the 2011 Fed that has sped up the time frame.  Surprisingly, we have a high degree of confidence in the Fed executing its exit strategy as it has explained it.  That being said, it certainly feels like the Fed of old when it is willing to stimulate simply because growth is not where they would like it to be.