Thursday, October 28, 2010

Morning Note...


Futures had been flat all morning, but surged +60bps at 8:30am on the release of better-than-expected unemployment data.  Initial Jobless Claims for the week ending October 23rd were 434k vs. the 455k expectation and the 455k prior reading.  Continuing Claims were also lower than expected, at 4.356M vs. 4.430M.  The prior reading was 4.478M.  Of course, this begs an interesting question given the recent “bad news = good news since it prompts heavy Fed stimulus” tone of the market:  could better-than-expected economic data (including tomorrow’s first look at Q3 GDP) cause markets to pause since “less Fed action” would be inferred?  As of right now, with the futures popping off the jobs data, the answer is no…  In corporate news, Q3 earnings season continues in earnest:  Akamai (AKAM; +4%) reported in-line, Avon Products (AVP; -6%) missed by 6c, AstraZeneca (AZN; -3%) beat by 2c, Beckman Coulter (BEC; +4%) beat by 12c, Eastman Kodak (EK; +7.5%) beat by 29c, Flextronics (FLEX; +11%) beat by 3c, Flowserve (FLS; -8%) missed on revenues, Motorola (MOT; +5%) beat by 5c, Annaly Mortgage (NLY; -5%) missed by 7c, Norfolk Southern (NSC; -2%) beat by 10c, Sketchers (SKX; -11%) missed by 28c, Symantec (SYMC; +7%) beat by 6c, Teradyne (TER; -9%) beat by 3c, and United Therapeutics (UTHR; +7%) beat on revenues.  Overseas, Asia was mixed overnight and Europe is up ~1% as of writing.  Oil +70bps, Gold +1%, and USD -85bps. 

The big news yesterday was actually market commentary from both Bill Gross at PIMCO and Jeremy Grantham at GMO.  Gross was cautious on QE and decidedly negative on Washington – he even came across as slightly tea-party-esque.  (Text below in case you missed it.)  Grantham blamed the Fed for any and all ills of the past 15 years (since Greenspan, essentially) and he’s probably right.  A politicized bank like the Fed that openly manipulates “free and open” market pricing does indeed make one wonder if we live in a capitalistic free-market society at all… (PDF attached in case you missed that one too.) 

Good rant from Hedgeye this morning:

The #1 headline on Bloomberg this morning is "FED ASKS DEALERS TO ESTIMATE SIZE, IMPACT OF DEBT PURCHASES." So, after creating massive disconnects in global expectations and seeing both inflation and interest rates rise this week, look at what the New York Federal Reserve is doing this morning - giving conflicted and compromised bankers a "survey" on the size and impact of Quantitative Guessing. This isn't leadership - this is a joke.

Can you imagine if another Washington (Ron Washington, the Manager of the Texas Rangers) took a stinking survey days before game-time? What in God's good name would his players think? Ben Bernanke has stated this plainly, so take his word for it - he has no idea what QE's impact will be.

A better question to ask yourself is what aren't people talking about? What's the risk that the current market debate is about the bark on a QE tree as opposed to the burning forest of credibility in the US economic system? What if the Chinese or Japanese sell Treasuries and rates rip higher?

What people aren't talking about on Wall Street is the crisis of leadership in this country. We're hyper focused on what group-thinkers at the Fed will do next. At the same time, the politicized members of this conflicted institution are being held hostage to where the political wind blows. We've stopped thinking about re-thinking US monetary policy altogether.
                                                                                                                                                                                                                                                      I often get asked for my advice - what would I do? First, I say stop. That's it. Just stop what these people are doing to your hard earned savings. Put that in your survey Bill Dudley. Stop. Then start to un-learn bad policy and re-learn the lessons of the US Military's 2009 plebe class:

"We have a crisis of leadership in America because our overwhelming power and wealth earned under earlier generations of leaders, made us complacent, and for too long we have been training leaders who only know how to keep the routine going. Who can answer questions, but don't know how to ask them. Who can fulfill goals, but don't know how to set them. Who think about how to get things done, but not whether they're worth doing..."

Also thought this BTIG summary of Cramer’s Mad Money last night was interesting:

Jim Cramer's "Mad Money" Jim Cramer said, "Don't fight Wednesday's pullback, welcome it." He listed 10 reasons why investors should embrace a market selloff. 1. The market's gotten ahead of itself in preparation for next week's election -- assuming a Republican sweep. 2. The Federal Reserve is expected to stimulate the economy. 3. Earnings can't last forever. 4. There was no news Wednesday to drive the markets up. 5. There were visible losers - Whirlpool (WHR), Jones Apparel (JNY) and Sprint (S) earnings all disappointed - but no one noticed. 6. International companies need a weak dollar. 7. Unemployment numbers are coming. 8. There are too many bulls, and the markets are now overbought. 9. Too much short covering. 10. It's October - the end of the tax year for many mutual funds. Cramer told viewers that with all these sell indicators out there, investors should expect, and not fear, the next selloff when it comes.

BCAP ups WDC.  RCII ups buyback.  BBNT cuts DOLE, CQB.  BMOC ups IPI.  Canaccord cuts CML.  CITI cuts KLAC, reits buy on EBAY.  COWN ups SVNT.  CSFB cuts SSW.  DBAB ups STM, DDR.  GSCO cuts MT, ups NOC.  Janney cuts CAVM.  JPHQ ups NVO, cuts AVBY.  MOKE cuts AIQ.  MACQ ups LM.  OPCO cuts RIMM.  RAJA cuts SCHW.  RBCM cuts S.  STFL ups A, cuts STX, CHRW.  WEFA ups PLD, cuts DDR. 

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

Today’s Trivia:  746 watts is equivalent to what commonly-used measure of power?
                                                                                                                                                           
Yesterday’s Question:  What popular casino game was invented by mathematician Blaise Pascal?

Yesterday's Answer:  Pascal invented Roulette.   

Best Quotes:  PIMCO note…

Run Turkey, Run
·      The Fed’s announcement of a renewed commitment to Quantitative Easing has been well telegraphed and the market’s reaction is likely to be subdued.
·      We are in a “liquidity trap,” where interest rates or trillions in asset purchases may not stimulate borrowing or lending because consumer demand is just not there.
·      The Fed’s announcement will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment.
They say a country gets the politicians it deserves or perhaps it deserves the politicians it gets. Whatever the order, America is next in line, and as we go to the polls in a few short days it’s incumbent upon a sleepy and befuddled electorate to at least ask ourselves, “What’s going on here?” Democrat or Republican, Elephant or Donkey, nothing much ever seems to change. Each party has shown it can add hundreds of billions of dollars to the national debt with little to show for it or move our military from one country to the next chasing phantoms instead of focusing on more serious problems back home. This isn’t a choice between chocolate and vanilla folks, it’s all rocky road: a few marshmallows to get you excited before the election, but with a lot of nuts to ruin the aftermath.
Each party’s campaign tactics remind me of airport terminals pre-9/11 when solicitors only yards apart would compete for the attention and dollars of travelers. “Save the Whales,” one would demand, while the other would pose as its evil twin – “Eat Whale Blubber,” the makeshift sign would read. It didn’t matter which slogan grabbed you, the end of the day’s results always produced a pot of money for them and the whales were neither saved nor eaten. American politics resemble an airline terminal with a huckster’s bowl waiting to be filled every two years.
And the paramount problem is not that we contribute so willingly or even so cluelessly, but that there are only two bowls to choose from. Thomas Friedman, the respected author of The World Is Flat, and a weekly New York Times Op-Ed author, recently suggested “ripping open this two-party duopoly and having it challenged by a serious third party” unencumbered by special interest megabucks. “We basically have two bankrupt parties, bankrupting the country,” was the explicit sentiment of his article, and I couldn’t agree more – whales or no whales. Was it relevant in 2004 that John Kerry was or was not an admirable “swift boat” commander? Will the absence of a mosque within several hundred yards of Ground Zero solve our deficit crisis? Is Christine O’Donnell really a witch? Did Meg Whitman employ an illegal maid? Who cares! We are being conned, folks; Democrats and Republicans alike. What have you really heard from either party that addresses America’s future instead of its prurient overnight fascination with scandal? Shame on them and of course, shame on us. We’re getting what we deserve. Vote NO in November – no to both parties. Vote NO to a two-party system that trades promises for dollars and hope for power, and leaves the American people high and dry.
There’s another important day next week and it rather coincidentally occurs on Wednesday – the day after Election Day – when either the Donkeys or the Elephants will be celebrating a return to power and the continuation of partisan bickering no matter who is in charge. Wednesday is the day when the Fed will announce a renewed commitment to Quantitative Easing – a polite form disguise for “writing checks.” The market will be interested in the amount (perhaps as much as an initial $500 billion) as well as the targeted objective (perhaps a muddied version of “2% inflation or bust!”). The announcement, however, has been well telegraphed and the market’s reaction is likely to be subdued. More important will be the answer to the long-term question of “will it work?” and perhaps its associated twin “will it create a bond market bubble?”
Whatever the conclusion, not only investors, but the American people should recognize that Wednesday, even more than Tuesday, represents a critical inflection point in determining our future prosperity. Of course we’ve tried it before, most recently in the aftermath of the Lehman crisis, during which the Fed wrote $1.5 trillion or so in “checks” to purchase Agency mortgages and a smattering of Treasuries. It might seem a tad dramatic then, to label QEII as “critical,” sort of like those airport hucksters, I suppose, that sold whale blubber for a living. But two years ago, there was the implicit assumption that the U.S. and its associated G-7 economies needed just an espresso or perhaps an Adderall or two to get back to normal. Normal just hasn’t happened yet, and economic historians such as Kenneth Rogoff and Carmen Reinhart have since alerted us that countries in the throes of delevering can take many, not several, years to return to a steady state.
The Fed’s second round of QE, therefore, more closely resembles an attempted hypodermic straight to the economy’s heart than its mood elevator counterpart of 2009. If QEII cannot reflate capital markets, if it can’t produce 2% inflation and an assumed reduction of unemployment rates back towards historical levels, then it will be a long, painful slog back to prosperity. Perhaps, as a vocal contingent suggests, our paper-based foundation of wealth deserves to be buried, making a fresh start from admittedly lower levels. The Fed, on Wednesday, however, will decide that it is better to keep the patient on life support with an adrenaline injection and a following morphine drip than to risk its demise and ultimate rebirth in another form.
We at PIMCO join with Ben Bernanke in this diagnosis, but we will tell you, as perhaps he cannot, that the outcome is by no means certain. We are, as even some Fed Governors now publically admit, in a “liquidity trap,” where interest rates or trillions in QEII asset purchases may not stimulate borrowing or lending because consumer demand is just not there. Escaping from a liquidity trap may be impossible, much like light trapped in a black hole. Just ask Japan. Ben Bernanke, however, will try – it is, to be honest, all he can do. He can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it is all he can do, and as he proceeds, the dual questions of “will it work” and “will it create a bond market bubble” will be answered. We at PIMCO are not sure.
Still, while next Wednesday’s announcement will carry our qualified endorsement, I must admit it may be similar to a Turkey looking forward to a Thanksgiving Day celebration. Bondholders, while immediate beneficiaries, will likely eventually be delivered on a platter to more fortunate celebrants, be they financial asset classes more adaptable to inflation such as stocks or commodities, or perhaps the average American on Main Street who might benefit from a hoped-for rise in job growth or simply a boost in nominal wages, however deceptive the illusion. Check writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. Public debt, actually, has always had a Ponzi-like characteristic. Granted, the U.S. has, at times, paid down its national debt, but there was always the assumption that as long as creditors could be found to roll over existing loans – and buy new ones – the game could keep going forever. Sovereign countries have always implicitly acknowledged that the existing debt would never be paid off because they would “grow” their way out of the apparent predicament, allowing future’s prosperity to continually pay for today’s finance.
Now, however, with growth in doubt, it seems that the Fed has taken Charles Ponzi one step further. Instead of simply paying for maturing debt with receipts from financial sector creditors – banks, insurance companies, surplus reserve nations and investment managers, to name the most significant – the Fed has joined the party itself. Rather than orchestrating the game from on high, it has jumped into the pond with the other swimmers. One and one-half trillion in checks were written in 2009, and trillions more lie ahead. The Fed, in effect, is telling the markets not to worry about our fiscal deficits, it will be the buyer of first and perhaps last resort. There is no need – as with Charles Ponzi – to find an increasing amount of future gullibles, they will just write the check themselves. I ask you: Has there ever been a Ponzi scheme so brazen? There has not. This one is so unique that it requires a new name. I call it a Sammy scheme, in honor of Uncle Sam and the politicians (as well as its citizens) who have brought us to this critical moment in time. It is not a Bernanke scheme, because this is his only alternative and he shares no responsibility for its origin. It is a Sammy scheme – you and I, and the politicians that we elect every two years – deserve all the blame.
Still, as I’ve indicated, a Sammy scheme is temporarily, but not ultimately, a bondholder’s friend. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead-end where those prices can no longer go up. Having arrived at its destination, the market then offers near 0% returns and a picking of the creditor’s pocket via inflation and negative real interest rates. A similar fate, by the way, awaits stockholders, although their ability to adjust somewhat to rising inflation prevents such a startling conclusion. Last month I outlined the case for low asset returns in almost all categories, in part due to the end of the 30-year bull market in interest rates, a trend accentuated by QEII in which 2- and 3-year Treasury yields approach the 0% bound. Anyone for 1.10% 5-year Treasuries? Well, the Fed will buy them, but then what, and how will PIMCO tell the 500 billion investor dollars in the Total Return strategy and our equally valued 750 billion dollars of other assets that the Thanksgiving Day axe has finally arrived?
We will tell them this. Certain Turkeys receive a Thanksgiving pardon or they just run faster than others! We intend PIMCO to be one of the chosen gobblers. We haven’t been around for 35+ years and not figured out a way to avoid the November axe. We are a survivor and our clients are not going to be Turkeys on a platter. You may not be strutting around the barnyard as briskly as you used to – those near 10% annualized yields in stocks and bonds are a thing of the past – but you’re gonna be around next year, and then the next, and the next. Interest rates may be rock bottom, but there are other ways – what we call “safe spread” ways –to beat the axe without taking a lot of risk: developing/emerging market debt with higher yields and non-dollar denominations is one way; high quality global corporate bonds are another. Even U.S. Agency mortgages yielding 200 basis points more than those 1% Treasuries, qualify as “safe spreads.” While our “safe spread” terminology offers no guarantees, it is designed to let you sleep at night with less interest rate volatility. The Fed wants to buy, so come on, Ben Bernanke, show us your best and perhaps last moves on Wednesday next. You are doing what you have to do, and it may or may not work. But either way it will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment.
If a country gets the politicians it deserves, then the same can be said of an investor – you’re gonna get what you deserve. Vote No to Republican and Democratic turkeys on Tuesday and Yes to PIMCO on Wednesday. We hope to be your global investment authority for a new era of “SAFE spread” with lower interest rate duration and price risk, and still reasonably high potential returns. For us, and hopefully you, Turkey Day may have to be postponed indefinitely.
William H. Gross
Managing Director