Friday, October 8, 2010

Morning Note...

Futures are ~30bps lower as the Official Nonfarm Payrolls release for September disappoints, coming in at -95k vs. the -5k expectation.  The Change in Private Payrolls also disappointed, at +64k vs. the +75k expectation.  The Unemployment Rate ticked slightly lower, but remains at 9.6%.  Given the logic chain (A=B and B=C, thus A=C) that poor jobs data equals a higher chance of quantitative easing (QE2) and quantitative easing dilutes the USD because of the obvious money printing, the immediate result of this morning’s jobs data was a weaker dollar.  This should, in turn, reflate equities…we shall see.  [But, in fact, while I have been typing, futures sold off on the jobs number, rallied to unchanged and even positive, and now have tumbled back as the USD rallies to +25bps on the day…]  Note that the USD/JPY (Dollar/Japanese Yen) sunk to 82 Yen/Dollar for the first time since 1995!  (See Quote Section below for another good “Currency Wars” article)  In earnings news, Alcoa (AA; +2%) beat by 4c and beat on revenues.  In other corporate news, Barclay’s cuts Credit Suisse (CS) to Sell this morning.  Overseas, China re-opened +3% after a seven-day holiday.  The rest of Asia was mixed overnight.  Europe is roughly 50bps lower at the moment.  Oil is down ~1% and Gold is flat.  Looking ahead, this weekend’s IMF meeting will certainly generate some headlines, and expect a slew of important earnings releases next week, including Intel, JP Morgan, Google, and General Electric.  The 2-day Wal-Mart analyst event also takes place next week. 

Given this morning’s unemployment release, it’s worth highlighting a solid op-ed from the Wall Street Journal that is cautious of QE (summary borrowed from JPHQ):

WSJ oped skeptical of more QE – “We hope this experiment in re-inflating the economy works better this time, but mark us down as skeptical. There is no such thing as free money, and a second round of QE carries enormous risks for what looks to us like far too little benefit”    Says the WSJ – “we're told the Fed's own internal models suggest that a purchase of $500 billion in Treasurys would only reduce the 10-year bond by something like 15 basis points. (The 10-year yield is now 2.38%.) This in turn would increase GDP by 0.2% a year and cut the jobless rate by 0.2%. That's not much bang for a lot of bucks”  

Good summary from SUSQ on this morning’s WSJ article on the foreclosure bill:

President Obama plans to veto a bill, named the Interstate Recognition of Notarizations Act of 2009, in which the veto could make it more difficult for banks to complete a speedy foreclosure process, giving the homeowners more time to renegotiate their loans with lenders. Obama is expected to send the bill back to Congress through a pocket-veto. Thus far, the administration has struggled to formulate a coordinated response to the recent “robo-signer” issue and allegations. According to some people familiar with the matter, regulators have not been more forceful with the issue because some federal officials believe those people who lost their homes would have done so anyway. Related stocks: JPM, BAC, C, WFC, PNC, USB, FRCC, FNMA, PMI, MTG, RDN, PHH, OCN, LPS, DHI, PHM, LEN, KBH, MTH, RYL, TOL, SPF, MDC, HOV, BZH.

Given yesterday’s better-than-expected retail sales data, it’s worth noting that the guys at Hedgeye are calling for a Q4 downturn in consumer spending:


Consumption Cannonball, The Hedgeye Macro Team's call for a sharp sequential decline in consumer spending beginning in 4Q (i.e. today).

The Retail Aftermath: The Hedgeye Retail Team's take on who wins and loses in a Consumption Cannonball scenario.

The CEO Hail Mary. Believe your own process...not management teams you see flashing their pearly whites in a 'double secret one-on-one' at a broker's conference. The ones who are best prepared are likely those that know how little they know about how next year will pan out. We'll outline the real questions to be asking management teams as this coming earnings season approaches.

The Third Derivative. Sure, there are plenty of great companies out there. They're the ones that have the proactive plans to tackle a negative spending climate. They can handle a shift in the rate of change in outside forces. But are they anticipating irrational moves by their competitors and supply chain partners during that time period? That's what separates the winners from the losers.

Raw Margins. We're convinced that so few people understand the process by which raw materials are procured. This includes a) who buys them, b) when they're bought, c) when they shift from the balance sheet to the P&L and are associated with revenue, d) the cumulative change in margin dollars in the supply chain, and most importantly e) who will win and who will lose.

AA beats by 4c.  ADBE & MSFT partnership is rumored.  DRWI beats by 1c.  EXPE cut at GSCO.  FFIV cut at GSCO.  OPCO cuts JKS.  KLIC lower on guidance.  OSK upped at GSCO.  SCSC guides to the upside for Q1 2011.  BofAMLCO ups CNS.  OPCO ups VSAT.  BARD ups IBI.  CITI cuts MOT.  DBAB cuts VSEA, LRCX, NVLS, KLAC.  UBSS cuts VALE. 

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

Today’s Trivia:  Stolen from Jeopardy! last night…What company originated with the 1980 merger of SaferWay and Clarksville Natural Grocery?

Yesterday’s Question: The oldest airline in the world still operating under its original name was founded on this date in 1919.  What is it?

Yesterday's Answer:  KLM was founded on October 7th, 1919 and is the oldest airline still operating under its original name.

Best Quotes: 

Currency Wars: The Phantom Menace
By Kieran Osborne | Posted: 10-07-10 | 10:21 AM | E-mail Article
The last thing the global economy needs right now is anything that would hamper or derail economic growth. Unfortunately, there appears a growing specter of this occurring. Brazil and Japan’s recent decisions to intervene in the currency markets follow a disturbing trend. If policy makers are not careful, present dynamics may precipitate a worldwide economic slowdown, brought about by protectionist pressures and exacerbated by political motivations globally.
Competitive currency devaluation appears to be the name of the game for many Treasury departments and central banks alike. It may also be a key driver of the recent strength in gold; in such an environment, investors increasingly seek an asset that retains its intrinsic value. Vietnam instigated a devaluation of the dong earlier this year, Switzerland, a country renowned for stability and neutrality, attempted to devalue the Swiss franc relative to the euro, rhetoric out of Washington has intensified surrounding China’s decision to continue to peg its currency closely to the U.S. dollar, and now Japan and Brazil have both decided to take unilateral action, intervening to weaken their respective currencies.
For many countries, the motivation to devalue the currency is to spur export growth. Devaluing a countries’ currency is akin to providing a subsidy to the export sector, as it makes that country’s exports relatively cheaper. The flip side, is that it intensifies inflationary pressures, as a devalued currency means that imported goods become relatively more expensive; for a high-growth developing economy, the combination of an undervalued currency and increased production and labor costs can cause substantial domestic inflationary pressures, as evidenced in China.
Moreover, devaluing a currency may lead to escalating international political strains, global criticism, and intensification of protectionist pressures. Maybe the most prevalent example being the U.S. criticism leveled at China, culminating in the passing of legislation aimed at pushing up the value of the yuan. When one currency is artificially weak, other countries may be put at a disadvantage, as other countries’ goods and services may be less competitive in the global market. Such a situation can and has encouraged retaliation, whether through competitive currency devaluations or outright trade wars, in the form of additional import taxes and duties levied, or sanctions placed, on specific exporting countries deemed to be manipulating their currencies. Trade wars are good for no one: They create inefficiencies and slow down global growth. In a period of lackluster global growth, this is the last thing we need. Recent references of a “race to the bottom” and worldwide “currency wars” should not be taken lightly--given that the global economic recovery remains on unsteady ground, the implications of another slowdown in growth could be disastrous.
We have discussed at length the very questionable currency policies pursued by the Swiss National Bank--see our analysis here--and have been heartened to see that the SNB appears to have come to its senses and discontinued this approach.
We have long argued that China should allow its currency, the yuan, to appreciate, as it may help alleviate much of China’s domestic inflationary pressures. China has continued to rely on rather rudimentary banking regulation to curb lending and growth in monetary aggregates to rein in inflation and recently announced a plan to allow the currency to trade within a wider trading band. It turns out that “wider band” is a relative term; the yuan has appreciated by a little more than 2% since the announcement in June. The Chinese are unlikely to allow the currency to float freely overnight, as even small moves to the currency affect many businesses throughout the Chinese economy; the process is likely to play out over many years. This hasn’t stopped U.S. politicians from taking a swipe.
While treasury secretary Tim Geithner’s recent testimony to congress fell short of labeling China a currency manipulator (and was much less aggressive than many politicians had hoped for), the message out of Washington is clear: the U.S. is increasingly unhappy with China’s exchange-rate policies. In our opinion, however, China is unlikely to allow the currency to appreciate simply because of threats from Washington; rather, the nation will act in the best interests of China. Moreover, the debate over China’s currency policies is to some extent misguided: many politicians argue that a stronger yuan will generate jobs in the U.S. To a degree, this may be true: U.S.-based companies may think twice before making the decision on additional hires should the yuan appreciate. But it is unlikely that much of the jobs that already left as part of the outsourcing bubble that occurred throughout the last decade will return to the U.S.; the U.S. simply cannot compete on cost; these jobs are likely to migrate to lower-value producing countries, like the Philippines, Vietnam, or Thailand.
These countries produce goods at the low-end of the value chain, have limited pricing power, and are therefore forced to compete predominantly on price. As such, and in our opinion, these countries are more likely to instigate competitive devaluations of their currencies. With an ever-deteriorating consumer outlook in the U.S., the incentive for these countries to instigate competitive devaluations of their currencies grows significantly. Indeed, Vietnam has already intervened in the currency market, actively weakening the value of the dong. With a continued weak consumer outlook in many Western nations, it is quite likely that further competitive currency devaluations occur in the lower-value producing Asian nations.

Brazil’s economic expansion and the substantial appreciation of the Brazilian Real share similarities to the Australian experience. Rich in commodities and natural resources, both countries have benefited from insatiable demand out of Asia, particularly from China. Both economies have rebounded strongly and in both nations, the unemployment rate has declined steadily and remains well below the levels seen throughout much of the Western world. Both central banks have led the world in interest-rate increases, with the Reserve Bank of Australia raising the target rate by 1.5% since the latter half of 2009 and Brazil’s central bank raising rates by 2%. Increased investment demand has flowed into both nations and as such, both nations’ currencies have appreciated substantially: relative to the U.S. dollar, the Australian dollar has appreciated 39.9% for the period March 31, 2009, to Sept. 30, 2010; during the same period, the real appreciated 37.7%.
When it comes to exchange rate policies, the similarities stop there. Brazilian finance minister Guido Mantega has been particularly vocal about the government’s concerns surrounding the strength of the real, describing the present situation as an “international currency war.” Brazil previously imposed a 2% tax on foreign purchases of fixed-income securities and stocks in October 2009, in an attempt to curb gains in the currency. Brazilian policy makers have now stepped up their offensive, increasing the tax on inflows to 4% and buying billions of dollars in the market in an attempt to stave off further currency appreciation. Speculation is rife that further steps will be taken, or that direct capital controls may be implemented. The government is certainly not taking this issue lightly, sending the ominous message that they are “not going to lose this game.”
Conversely, Australia has been a leading proponent of the virtues of a free-floating currency, namely protection against inflationary pressures and boom-bust cycles. The Reserve Bank of Australia has lauded the flexible exchange rate as one of the great success stories of Australian economic policy making. In their opinion, Australia’s free floating currency has helped mitigate exaggerated economic booms and busts and has protected against high, and volatile, inflation. Currency price movements helped the economy adjust more smoothly to the current boom in the resource sector, helped protect the economy in 2008 when global risk aversion was at its peak, and during the Asian financial crisis and the bursting of the U.S. tech bubble (1).
Brazilian policy makers may do well to heed their Australian counterparts: The appreciation of the real has undoubtedly helped alleviate inflationary pressures in Brazil, helping bring inflation back toward the target rate of 4.5% from over 6% previously, and could help bring the rate to a more price-stable level. While Brazilian policy makers may or may not succeed in destroying the currency, one thing is for sure: they run the very real risk of alienating Brazil from global markets. In our opinion, Brazilian politicians’ motivations are flawed: on the one hand they believe the strong appreciation of the BRL will stifle economic growth; on the other hand the talk of imposing rather draconian measures to stem demand for the currency will likely drive investment away. These are the same investment flows required to drive economic growth in Brazil.
Potentially more damaging globally is if these actions prompt other nations to follow a similar path. Already we have seen South African, Peruvian, and Mexican politicians (among others) uttering misgivings about the strength of their respective currencies. Should we enter a period of competitive currency devaluations globally, the risks of trade wars may increase substantially, which could come with serious consequences for global markets.
Countries that run current account deficits, including the U.S., may be at the greatest risk should a global trade war scenario play out, as these countries are reliant on foreign investors to finance their deficits. Should additional tariffs, capital controls, or sanctions take effect (a very real threat given recent legislation surrounding currency manipulation), the U.S. may lose the trust of international investors, who may in turn pull funds out of its markets, putting pressure on the U.S. dollar.