Thursday, December 16, 2010

Morning Note...

Futures are flat-to-slightly lower (-5bps) despite better-than-expected economic data, which has been offset by selected U.S. corporate earnings.  November Housing Starts were the highest in recent months, at 555k vs. the 550k expectation.  Also, Initial Jobless Claims for the week ending December 11th were lower than expected (net positive) at 420k vs. the 425k expectation.   Continuing Claims for the week ending December 4th were 4.135M vs the 4.115M expectation.  However, FedEx (FDX; -1%) missed earnings estimates and – considering its status as a global commerce litmus test – has kept a lid on U.S. futures thus far.  Food giant General Mills (GIS; -50bps) also disappointed.  Note that December Philly Fed and LEI data is due at 10am today.  Overseas, European markets are slightly lower (-30bps) on average and Asian markets were mixed overnight.  Note that Euro leaders have kicked off a two-day summit on their current sovereign debt issues – watch for headlines out of this meeting.  Oil -55bps.  Gold -65bps.  USD -15bps.  Also note recent volumes have generally been lighter than average, and U.S. equity markets seem to be inversely correlated – for the most part – to the USD.

Here’s BTIG’s O”Rourke on that same topic:

Dollar Dance Meets QE Unwind.

It was an interesting trading session today.  The Dollar dance - in which U.S. assets move in the opposite direction of the U.S. Dollar - returned.  The Euro had been mildly weaker overnight as Moody's placed Spain on negative watch for a Downgrade.  Apparently, the new review was already priced into Spanish bonds and CDS, which displayed little reaction to the news.  Likewise, the Euro recovered nearly all of its losses before U.S. trading commenced.  The Euro then weakened versus the Dollar throughout the session.  As the Dollar strengthened versus the Euro, U.S. assets began to falter.  Equities, Treasuries and Commodities all began to move lower.  The trading action had the appearance of part Dollar Dance (risk assets moving lower on a stronger Dollar) and part QE unwind (rotation out of Treasuries and Commodities).  We have been bond bears for some time, but now we believe Treasuries are due for a healthy bounce in the near term.  They have reached the point of being so oversold that the reasoning becomes circular.  If the rise in rates continues at this pace, it will become a short term headwind for Equities, and if Equities exhibit weakness, Treasuries will start attracting a flight to quality bid.

In light of the Treasury market rout that has occurred over the past two months, now is a good time to revisit the Fed Model.  The Fed Model is intended to track the relative valuation gap between the S&P 500 and Treasuries.  From the 1960's through 2000, the S&P 500 Earnings Yield and the 10 Year Treasury Yield tended to trend together.  When the relationship was out of line, it was an opportunity.  In the past decade of low interest rates and multiple contraction, the relationship has broken down and Equities pervasively appeared cheap.  Although the relationship has broken down over time, it does not mean there is not value in making comparisons to the recent history during the crisis as well as the past decade when Equities "appeared" inexpensive relative to bonds.  The S&P 500's trailing earnings yield is 6.44%, making it still 83% higher than the 10 Year Treasury yield.  The higher the premium, the more attractive Equities are than Treasuries.  Today's level is still notably higher than the 20-30% premium the earnings yield had most of the decade when Equities appeared cheap.  It is also well above the 20% premium with which the earnings yield started 2010.  Simply stated, Treasury yields have been artificially low and S&P earnings had a historic recovery.  We also use a BTIG Fed Model that uses a VIX adjustment to create a higher threshold that Equities must surpass to be attractive.  By that measure as well, Equities remain very attractive relative to bonds. Although the S&P 500 is higher than it started the year, it remains notably more attractive than Treasuries.  This is the reason we view a continued run-up in interest rates as only a short-term headwind for now. 

Btw, here’s something from yesterday that I found interesting:

            Bullishness Reaches 3 Yr. High in Investors Intelligence Survey 2010-12-15 11:23:00.624 GMT

Dec. 15 (Bloomberg) -- The percentage of newsletter writers classified as bullish reached 56.8%, the highest since Dec.
2007, according to Investors Intelligence…High bullish percentage signals “a strong likelihood that the rally is nearing a top"…Bulls 56.8% vs 56.2% last week…Bears 20.5% vs 21.3%...Newsletter writers classified as correction 22.7% vs. 22.5%...Bull/bear spread rises to 36.3% from 34.9%, highest since

JPHQ ups WYNN.  BARD ups HOT.  DBAB cuts HTS.  FBRC cuts ASPG, ATK, AVAV, CMTL, LLL, RTN.  GSCO cuts RAX3.  MSCO cuts RIG.  OPCO cuts VRSN.  BARD cuts IRET.  UBSS cuts CPIX. 

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

Today’s Trivia:  You may not know that certain landmark U.S. sites have their own zip codes.  For example, the Empire State Building’s zip code is 10118.  What might you find at 20500 or 90090?
Yesterday’s Question: According to Wired Magazine, what percentage of photos on the internet are of naked women?

Yesterday's Answer:  Supposedly 80% (!!) of all internet photos are of naked women. 

Best Quotes:  Interesting BBERG piece on Basel II…

Basel Regulators Give Details of Bank Capital, Liquidity Rules
2010-12-16 10:00:00.24 GMT

By Jim Brunsden
     Dec. 16 (Bloomberg) -- Bank regulators published details of an overhaul of liquidity and capital rules for lenders, to allow markets to make more thorough assessments of how well financial companies will cope with the new requirements.
     Lenders would have needed 602 billion euros ($798 billion) to comply with the rules if they were in place at the end of last year, the Basel Committee on Banking Supervision said. The committee agreed in July to phase in the requirements up to Jan.
1, 2019, to mitigate their impact.
     Regulators are overhauling bank capital and liquidity requirements because existing rules, known as Basel II, failed to protect lenders from insolvency during the financial crisis.
The main elements of the overhaul were approved by leaders of the Group of 20 countries last month.
     “The transition period provides banks with ample time to move to the new standards in a manner consistent with a sound economic recovery,” Nout Wellink, the chairman of the Basel committee, said in a statement on the group’s website.
     The Basel committee said that the 602 billion euros would have been needed for banks to cope with a requirement to hold core capital equivalent to 7 percent of their assets, with these assets weighted according to their riskiness. The figure has been calculated by regulators based on data collected from 263 banks.
     Banks that do not meet the requirement will face restrictions on paying dividends, regulators said in September.
     Banks would also have failed at the end of 2009 to meet new rules on bank liquidity that have been drawn up by the Basel committee, the group said.

                      Bank Business Models

     Banks that fail the minimum liquidity requirements could meet them by “lengthening the term of their funding or restructuring business models,” the Basel committee said. The committee plans to introduce the liquidity rules between 2015 and 2018.
     The Basel committee published a text clarifying the details of the regulatory overhaul. As well as revised rules on capital and liquidity, the overhaul also includes a limit on banks’
     The new rules are a “landmark achievement that will help protect financial stability and promote sustainable economic growth,” Wellink said.
     The Basel committee brings together regulators from 27 countries including Brazil, China, India, Germany the U.K. and the U.S.