Wednesday, October 6, 2010

Morning Note...

Futures are currently up 10bps and off the earlier highs this morning, as the ADP Employment Change for September (a pre-cursor of Friday’s Official Nonfarm Payrolls release) disappoints:  it showed a loss of 39,000 jobs whereas a gain of 20,000 was expected.  [Note that the correlation between the ADP data and the Labor Department’s data is far from iron-clad, a topic that was taken up in this past weekend’s Wall Street Journal  “Numbers Guy” column.  However, the basic argument is that the ADP data is growing a following in terms of depicting a more accurate reading of the “true economy.”  The article is included in the quote section below and it’s worth a read.]  Europe is up roughly 75bps on aggregate on better-than-expected economic data – Germany’s Factory Orders in particular – and in spite of the Fitch downgrade of Ireland’s debt, which is no surprise.  Asia was mostly higher overnight.  Metals and commodities (like copper, gold, palladium, and silver) continue to make new highs.  Gold, in fact, is up over $100/oz. in the past month.  Oil flat.  The USD is slightly weaker, down 10bps.  In U.S. earnings news, COST beat by 2c and reported in-line revenues, but is trading slightly lower on weaker sales.  Monsanto missed by 3c, announces job cuts, and guides FY2011 lower, but is somehow trading higher.  Constellation Brands reported lower profits than expected. YUM Brands reported in-line earnings.  Looking ahead, September retail sales are due tomorrow.  Jobs data on Friday. 

Interesting commentary from Goldman Sachs this morning, calling the economy’s outlook “fairly bad:”

Goldman Sachs Says U.S. Economy May Be ‘Fairly Bad’ 2010-10-06 04:46:23.568 GMT

Oct. 6 (Bloomberg) -- Goldman Sachs Group Inc. said the U.S. economy is likely to be “fairly bad” or “very bad” over the next six to nine months. “We see two main scenarios,” analysts led by Jan Hatzius, the New York-based chief U.S. economist at the company, wrote in an e-mail to clients. “A fairly bad one in which the economy grows at a 1 1/2 percent to 2 percent rate through the middle of next year and the unemployment rate rises moderately to 10 percent, and a very bad one in which the economy returns to an outright recession.” The Federal Reserve will probably move to spur growth as soon as its next meeting on Nov. 2-3, Hatzius said. Expectations for central bank action have already led to lower interest rates, higher stock prices and a weaker dollar, according to Goldman, one of the 18 primary dealers that are required to bid at government debt sales. Fed Chairman Ben S. Bernanke and his fellow policy makers are debating whether to increase Treasury purchases to spur the U.S. economy by keeping borrowing costs low. U.S. five-year yields dropped to a record 1.1755 percent today amid signs the recovery is losing momentum. The “fairly bad” outlook for slow growth and rising unemployment without a recession will probably be the one that occurs, the e-mail said.

Regarding the oft-mentioned “currency wars,” I thought this article was also interesting:

‘Currency War’ Weekend Risks Revisiting 1930s: Chris Farrell 2010-10-05 22:00:00.0 GMT

Oct. 6 (Bloomberg) -- The stakes will be unusually high when the global finance mandarins of the World Bank and the International Monetary Fund gather for their annual meeting this weekend in Washington. Their task in back-room negotiations and high-level corridor discussions is to head off an incipient currency war that could degenerate into a round of beggar-thy- neighbor policies reminiscent of the 1930s. The Institute for International Finance, a global association that represents more than 420 of the world’s major financial institutions, is nervous enough to publicly call for the first global currency agreement since the Plaza Accord of 1985. “A core group of the world’s leading economies need to come together and hammer out an understanding,” said Charles Dallara, the managing director of the institute. He’s absolutely right. The current currency conundrum makes the risk of another tumble for the fragile global economy all too real. For a while, it was striking how governments refrained from pursuing protectionist policies during the Great Recession. It seemed that a major lesson of its predecessor, the Great Depression of the 1930s -- that nations’ embrace of tariffs and other barriers to trade in an effort to protect domestic industry was a disaster for everyone -- had been absorbed. That’s still the case, but the current recovery has been so anemic that governments everywhere are under enormous pressure to grab a bigger slice of a diminished economic pie for their companies and workers by cutting the value of their currency.

                      Market Intervention

Japan, South Korea, Taiwan, Brazil, and Switzerland have all intervened in the currency markets to lower the value of their money to stay competitive. The Bank of England looks favorably on a weak pound. U.S. officials talk a good game about maintaining the value of the dollar even as they hope its decline will shore up the nation’s beleaguered manufacturing industries. But with so many countries trying to tamp down the value of their currencies, the tension has flared into the open. The European Union is worried that the continent’s recovery will falter with the euro appreciating some 15 percent since June against the U.S. dollar and its shadow currency, China’s yuan. (The yuan’s value is pegged to the greenback; it is trading around 6.69 per dollar.) The U.S. House of Representatives passed on Sept. 29 the Currency Reform for Fair Trade Act that would allow the government to slap countervailing duties on imports from countries deliberately undervaluing their currencies.

                         ‘Currency War’

“We’re in the midst of an international currency war, a general weakening of currency,” warned Brazil’s Finance Minister Guido Mantega on Sept. 28. World Bank President Robert Zoellick a week later said that he didn’t think “we’re moving into an era of currency wars but there’s clearly going to be tensions.” That’s hardly a reassuring comeback. The core of the global imbroglio is the contentious economic relationship between the world’s two leading economies, China and the U.S. The political and economic leaders of both countries need to act as global statesmen and not parochial politicians. It isn’t impossible that cooler heads will prevail. Yet there’s no gainsaying that this looks like the most critical juncture in policymaking since the collective embrace of John Maynard Keynes and Milton Friedman following the collapse of Lehman Brothers in 2008. The U.S. has long charged that the yuan is undervalued and China’s “manipulated” currency gives its industries a huge advantage in the global competition for markets and profits. To be sure, China’s government allowed the yuan to appreciate against the dollar by some 21 percent from 2005 to 2008, and it relaxed the peg again in June, 2010. But the yuan is only up some 2 percent since the change in currency policy.

                        China’s Advantage

Official “manipulator” tag or no, there’s no question that China manages its currency to its advantage. However, the charge of manipulation is a bit reminiscent of Captain Renault’s (Claude Rains) feigned surprise in the immortal film “Casablanca” that he was “shocked, shocked” to find gambling going on in the watering hole operated by Rick Blaine (Humphrey Bogart). When it comes to currencies, manipulation is the rule rather than the exception. The 20th century alone has provided some rich examples.
President Franklin Roosevelt abandoned the gold standard in 1933 (and the earlier countries dropped the gold standard, the quicker they recovered from the depression.). The legendary postwar Bretton Woods currency system was built on managing currencies (with “manage” a code word for manipulation). President Richard Nixon depreciated the value of the dollar in 1971 by ending its convertibility into gold. And a quarter century ago representatives from France, West Germany, Japan, the U.S. and Britain convened at New York’s Plaza Hotel and hammered out an agreement to slash the dollar value in an effort to defuse economic tensions with an emergent Japan. So much for free-floating exchange rates.

                       Bringing Back Jobs

It’s also doubtful that that a revaluation of the yuan would bring manufacturing jobs back to America, as its advocates hope. The wage gap between the two countries is simply too great for a shift in currency values to have much of an impact. No, the real issue is that the currency dispute highlights a major fault line in the global economy. The dollar peg has allowed China’s exporters to rack up huge trade surpluses while suppressing demand at home. The money earned abroad is converted mostly into U.S. dollar assets, such as Treasury securities. China’s consumers aren’t benefitting. At the same time the U.S. hasn’t saved enough -- and has consumed too much. It’s well known that China needs to consume more and the U.S. save more. Both countries need to show investors concrete actions rather than rhetoric toward those goals.

                      Lessons From France

That’s certainly a lesson from the experience of pre-Great Depression France. In a sense, France was the China of the 1920s. The industrial world went off the 19th-century gold standard during World War I. The belligerents went back on the gold standard when the guns went silent, but at different times and with different values. For example, Britain embraced its prewar stance on the gold standard, leading John Maynard Keynes to famously argue that the value of sterling had been fixed at an unsustainably high rate.  Britain ended up running large trade deficits while the French picked a lower value that encouraged trade surpluses, says Eugene White, economic historian at Rutgers University. France also absorbed huge amounts of the world’s gold reserves, increasing its share from 7 percent to 27 percent between 1927 and 1932. Its gold hoarding created an artificial shortage of reserves and put other countries under enormous deflationary pressure, according to Douglas Irwin, an economist at Dartmouth University.

                         Trade Tensions

Trade tensions rose between Britain and France. Central bankers from the two cross-channel rivals, Germany and the U.S. met at a private home of Ogden Mills, the wealthy U.S. Treasury under-secretary, on the north shore of Long Island in July 1927 to address the situation, but no deal was reached between the two. “The French forced everyone to have deflation,” says White. “It was a major contributor to the Great Depression.” Instead, the Federal Reserve under Benjamin Strong decided to support Britain by cutting U.S. interest rates in August. It was a major blunder that fueled America’s speculative frenzy and the stock market was up 20 percent by yearend. The boom went bust in 1929. “Some historians,” writes Liaquat Ahamed, author of “Lords of Finance,” “see the meeting on Long Island as the pivotal moment, the turning point that set in train the fateful sequence of events that would eventually lead the world into depression. The Fed’s move was the spark that lit the forest fire.”

                      Peace and Prosperity

This time around world leaders can’t afford a similar disagreements and policy mistakes. It won’t be easy. China’s mercantilism is deeply ingrained. Indeed, the Guanzi, an ancient collection of essays named for minister of state Guan Zhong (he died in 645 B.C.) not only offered up perhaps the world’s first articulation of the quantitative theory of money, but it also suggested how important mercantilism was to providing peace and prosperity to the empire. But in the 21st century, the world economy needs China’s consumers to boost their demand for all kinds of goods, including imported ones. Yet with domestic savers earning a negative interest-rate, inflation stirring at an understated 3.5 percent rate, and demand suppressed, money is pouring into real estate instead. “It’s like a pressure cooker,” worries White. Unless the Chinese government revalues its currency “they’re setting up their banking system for collapse,” he says. At the same time, America’s political class needs to shift from indulging in deficit-hating rhetoric and embrace deficit- reducing specifics. In the meantime, it remains up to central bankers to strike the kind of deal that buys the global economy time by boosting growth. For starters, let’s hope their emissaries in Washington can do better this weekend than their peers did on Long Island in 1927.

            (Chris Farrell is a columnist. A version of this column also is posted on The opinions expressed are his own.)

AIB confirms proposed sale of its 22.4% MTB holding.  CSFB ups MXIM.  CSFB cuts ONNN.  JPHQ positive LAMR.  BMOC raises AAPL estimates. 

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

Today’s Trivia:  According to Meredith Whitney on CNBC yesterday, what percentage of Americans do not have a checking account?

Yesterday’s Question: Male students at BYU need a doctor’s note to do…what?

Yesterday's Answer:  Male students at BYU apparently need a doctor’s note to grow a beard.

Best Quotes:

Mind the Gap: Employment Figures Tell Different Stories


The sluggish economic recovery prompts an urgent question: When will employers start hiring for real? And will we know when they do?
There are many estimates of employment, from both government agencies and private companies, that are sometimes contradictory. Economists who analyze these numbers generally say that while the government's statistical methodology is more rigorous, this might be a moment where its approach is falling short.
The Labor Department's monthly estimate of nonfarm payroll jobs is the most closely followed employment report. The numbers can move stock and bond markets world-wide.
But several private entities also produce employment estimates. Temporary-help firm Manpower Inc. has been surveying employers quarterly about their hiring plans since 1962. The Conference Board, a research group that compiles the index of leading economic indicators, publishes an employment trends index. And Automatic Data Processing Inc. in 2006 launched a monthly job estimate, based on the roughly 20 million paychecks it handles for clients.
Many economists remain skeptical of the methodology used by the private companies. But the ADP report in particular has fans on Wall Street, where some analysts view the company's lower job estimates in recent months as a warning sign about the economy.
Both the Labor Department and ADP estimates are based on surveys of roughly 400,000 workplaces, but the employers are chosen in different ways. The Labor Department selects employers to mirror as precisely as possible the U.S. economy; it says the survey covers roughly one-third of the nation's private employees.
The government data have several handicaps. For one, not all employers complete the survey each month. Also, in a complex economy, it can be difficult for the government to count jobs at businesses that are opening and closing.
Government statisticians acknowledge these issues, and include a margin of error in the monthly report: The Labor Department says there is a 90% chance that its monthly estimates are within 100,000 of the actual number of U.S. jobs. When jobs are growing slowly, as now, that's a significant number. The department estimates that private employers have added jobs every month this year, but in five of the eight months so far, the gains were less than 100,000.
A booming or shrinking economy poses a different problem for government statisticians, by disrupting their projections for new and dying firms. To adjust, officials once a year match their estimates to the total number of jobs employers report on payroll taxes.
ADP faces different statistical issues. It knows exactly how many people are working at the companies it samples, because it cuts their paychecks. But the sample is skewed by the firms that choose to use ADP's service. It has too many construction firms, and not enough of the nation's biggest employers, for example. So Macroeconomic Advisers LLC, a consulting firm hired by ADP, attempts to adjust the numbers to more closely match the economy.
Some economists question whether those adjustments are adequate. ADP's early record was spotty. In just its second report, covering June 2006, ADP estimated that private employers added 368,000 jobs, a number that later was shown to be vastly overstated by annual tax data.
Joel Prakken of Macroeconomic Advisers says the problems arose because ADP knows more about workers who are hired than those who are fired. For various reasons, employers sometimes wait months to formally purge workers from their rolls, even if they are no longer being paid.
Since then, ADP has tweaked its methodology several times. In 2008, it began adjusting its estimates to reflect the number of new unemployment claims filed each week.
Ray Stone, of Stone & McCarthy Research Associates, an economic and market-forecasting firm, says he already knows the unemployment-claims figures. He would prefer that ADP stick to a purer measure of its clients' payrolls. Like most economists, Mr. Stone considers the Labor Department numbers more reliable, despite their flaws, because of the way survey participants are selected. "It's the best series available to us, as imperfect as it is," he says.
Mr. Prakken sees the issue differently. "I don't think about it as one being right and one being wrong," he says. Prices on U.S. government bonds often swing up or down in the few minutes after ADP releases its monthly report, typically two days before the Labor Department number. If the markets are reacting so quickly, "that means there's value in the data," he says.
Determining which report delivered a more accurate picture of employment could be a polite debate among economists. But with nearly 15 million Americans out of work, the differences take on more significance. And lately, those differences have become stark.
Since December, the Labor Department estimates that private employers have added 763,000 jobs. ADP pegs the number at 127,000.
The discrepancy could reflect gaps in ADP's data because of its client base.
On the other hand, the Labor Department could again be mis-estimating the number of new and dying companies, as it did last year. That would presage another big adjustment to its numbers, and suggest the economy is growing more slowly than thought. A Labor Department spokeswoman declined to comment.
Some Wall Street economists view the second scenario as more likely. Joshua Shapiro, chief U.S. economist for consulting firm MFR Inc., says several indicators, including the ADP numbers, unemployment claims and business-confidence surveys, imply fewer jobs are being created than the official statistics suggest. "You put a lot of this together and it just sort of waves yellow flags about taking the government numbers at face value," Mr. Shapiro says.
—Carl Bialik returns next week.