Monday, December 20, 2010

Morning Note...

**Please note I will out the rest of the week and the next Morning Note will be December 27th**

Futures are 40bps higher this morning after a relatively quiet – as expected – weekend.  The biggest stories continue to fall into the “known known” category:  instability in the Korean Peninsula and concerns over European sovereign debt.  In fact, the closest thing I can find relative to this morning’s market strength is simply the lack of any negative news over the weekend.  Europe up ~1%, Asia lower overnight, USD flat, EUR/USD 1.3161, Oil +40bps, Gold +45bps.  Thus the path of least resistance continues to be higher, aka “The Santa Claus Rally.”  Don’t take my word for it –I chuckled at this Barclay’s Trader Note titled “Not much to talk about, Go Back to Bed:”

European equities are up over 1% while S&P 500 futures are up 30 bps.  The Euro is getting whacked again down 0.5% vs the USD.  Meanwhile, commodities are having another big move with cotton up another 2.43%.  The market is doing an admirable job of shaking off more noise coming out of N Korea, inflation from China, European sovereign cds widening, and the Euro back on the lows.  Expect holiday volumes to start this week in earnest this week. 

If you are looking for a sobering read amidst your holiday cheer, however, here’s something I stumbled across last week:

            10 reasons to shun stocks till banks crash
Commentary: Stocks a sucker bet in a rigged game; meltdown ahead
By Paul B. Farrell, MarketWatch

SAN LUIS OBISPO, Calif. (MarketWatch) — Do not buy stocks. Not for retirement. Not in the coming decade. Don’t. Huge risks.

Wall Street is a loser. Stocks are Wall Street’s ultimate sucker bet. And it’ll sucker you again. You’ll lose, worse than in the last decade. Wake up before Wall Street banks trigger the next meltdown, igniting mass bankruptcy.

Here are 10 more reasons not to bet at Wall Street’s casino … wait till after they implode:

1.      American stocks are a high-risk sucker bet

That’s the view of Peter Morici, the former chief economist at the International Trade Commission: that U.S. stocks are a sucker bet. Is Main Street waking up to Wall Street’s con? Maybe. “With corporate profits breaking records, Wall Street anxiously anticipates the return of the individual investors to the stock market. It may be a long wait, because the little guy may have concluded investing in stocks is a sucker bet.”

America’s divided into two stock markets: one for Wall Street’s rich insiders, another for Main Street’s suckers: “Investors, as opposed to traders, buy stocks in companies whose profits they expect to rise. The conventional wisdom says stock prices will follow profits up, but over the last two business cycles, that simply has not happened.”

From 1998 to 2010, profits rose 203%. But the S&P 500 was up just 7%. And still, naive investors buy into Wall Street’s sucker bet.

Who’s pocketing the huge profits? Rich insiders. “Because most of the increased value created by higher profits,” says Morici, “has been captured by hedge funds, electronic traders, private equity funds, and aggressive M&A shops, free standing and at major investment banks, which have multiplied over the last two decades.”

Warning: With the resurrection of the GOP and Reaganomics, Wall Street will skim more from Main Street, get even richer. And yes, you’ll lose more.

2.      New ‘big short’ dead ahead: Derivatives con game will crash again

In a Bloomberg story, “Big Short” author Michael Lewis asks: “Why are the same Wall Street banks that lobbied so hard to dilute the passages in the Dodd-Frank financial overhaul bill banning proprietary trading now jettisoning their proprietary-trading groups, without so much as a whimper?”

The answer’s simple: Wall Street’s sneaky and will do anything to keep the derivatives casino running hot. Insiders “have no intention of ceasing their prop trading,” according to Lewis. “They are merely disguising the activity, by giving it some other name.”

3.      Hedge funds shorting China: Warning — U.S. faces collateral damage

Get it? China may well crash first. Fortune’s Bill Powell interviewed hedge-fund kingpin Jim Chanos of Kynikos Associates, who’s “betting that China’s economy is about to implode in a spectacular real estate bust.” China is “an economy on steroids.” In a Charlie Rose interview, Chanos said “China’s on an economic treadmill to hell.” If so, then all of Wall Street’s highly promoted emerging markets are also sucker bets.

Another hedge-fund player warned: Chanos “is shorting the entire country,” including a company “Goldman Sachs recommended as a buy … the listing for the Hong Kong Stock Exchange … China’s Merchants Bank, one of Beijing’s largest.”

Back in the 1980s, Japan “grew largely on the back of capital investment” and then turned into “a capital-destruction machine, and that’s what China is now. You have an economy that’s 60% fixed-asset investment, and not even in the developing world is that sustainable.”

Chanos won’t pinpoint the timing or the trigger: “He just believes it’s coming,” and he is betting on it. Reminds us of Henry Paulson shorting Goldman Sachs’ crooked deals before the 2008 crash.

4.      New insider-trading indictments killing Main Street confidence

Investor distrust of Wall Street’s casino will skyrocket in 2011. Before the elections in November, an AP-CNBC poll found 61% of investors had already lost confidence in the market, thanks to extreme volatility; 55% believe the market’s rigged to favor insiders.

It’ll get much worse as the FBI/DOJ investigations of insider trading add indictments and perp walks. As more facts surface, this could get bigger than Enron and the SEC mutual-fund fraud suits combined: more proof of Wall Street’s rigged game.

5.      Banksters’ perfect gambling record proves stocks a rigged game

Last year we reported that Goldman Sachs made more than $100 million in profit a day for 23 days in one month. This year the con game has gotten bolder.

Morici says “J.P. Morgan and Bank of America went through the entire third quarter without a negative trading day, no losing days on proprietary trades. Unless you believe in perfection, something stinks about the information they are using. If someone is winning all the time, then someone else is losing. That’s the ordinary investor. Stocks have become a rigged game.”

Yes, America’s 95 million average investors are suckers in a rigged game.

6.      Wall Street is socially worthless, existing only to make insiders rich

In the New Yorker, John Cassidy writes: “Much of what investment bankers do is socially worthless.” Wall Street exists solely “to make itself very, very rich.”

Yes “worthless,” but “for a long time, economists and policy makers have accepted the financial industry’s appraisal of its own worth, ignoring the market failures and other pathologies that plague it.”

Worse, continues Cassidy, “even after all that has happened, there is a tendency in Congress and the White House to defer to Wall Street.” Why? Wall Street’s huge lobbying war chest. Soon all this will come to a disastrous climax, Wall Street will implode on blind greed.

7.      The Fed is America’s worst nightmare, a $3.3 trillion moral hazard

Moral hazard simply means no consequences for Wall Street’s complicity in triggering the 2008 catastrophe. As a result, Wall Street insiders came away believing they can take bigger and riskier bets in the future because they will get away with it next time, too.

Why? Because America’s suckers will be dumb enough to bail them out the next time, too, with no consequences when they fail miserably again.

Last week the Fed made the moral-hazard risks more obvious by releasing 21,000 documents showing how an arrogant Ben Bernanke approved $3.3 trillion in cheap-money taxpayer bailouts to incompetent Wall Street banks, blue chips and even banks in Switzerland, France, etc. Bernanke’s making fiscal policy, and he’s a tragic disaster. When President Obama reappointed him last year, we echoed author Nassim Nicholas Taleb, calling it Obama’s worst domestic-policy blunder.

But it can get worse: Caving in to the GOP on Bush tax cuts to the rich will funnel billions more of our tax dollars into the rigged game. Final proof Obama is Wall Street’s co-conspirator in the class war against 300 million average Americans.

8.      Wake up to a new normal: no growth, deflation

In his latest newsletter, economist Gary Shilling, a longtime Forbes columnist, warns: “Real economic growth rates of 2% or less are likely through 2011.” But we need 3.3% just to keep up with population growth.

So “high unemployment remains a political problem … with weak economic growth, looming deflation, and the dollar and Treasurys remaining the safe havens in a sea of global trouble.”

Warning: America’s new era, featuring no growth, deflation and a jobless recovery, will continue for years, resembling Japan over the past two decades. Worse, brutal deficit cuts will trigger riots, as in England, France.

9.      Privatize Social Security: New GOP Congress loves dumb ideas

Here’s political Reaganomics at its numbest. Alan Sloan writes in Fortune: “Privatizing Social Security: Still a Dumb Idea.” The idea was “slaughtered when George W. Bush proposed it.” Yet many GOP millionaires in the new Congress campaigned on privatization.

“You’d think,” Sloan posits, “that the stock market’s stomach-churning gyrations — two 50%-plus drops in just over a decade — would have shown conclusively the folly of retirees having to bet their eating money on the market. But you’d be wrong.” They’re about to resurrect it. Why? Simple. Because the GOP is the party of the rich.

Yes, it’s that simple: Wall Street’s casino would love to get their hands on another $20 trillion of your retirement money, to gamble in their derivatives casino.

“Why is privatizing Social Security such a turkey?” asks Sloan. “Because retirees shouldn’t have to depend on the market’s vagaries for survival money. More than half of married couples over 65 and 72% of singles get more than half their income from Social Security.” And “for 20% of 65-and-up couples and 41% of singles, Social Security is 90% or more of their income.”

Imagine if our Social Security had been privatized in the 2008 meltdown: It would have done more damage than nuclear warheads, totally wiping out the American economy.

10.  Warning: Wall Street will lose another 20% of your money by 2020

We have been making these same arguments for a long time: Wall Street has lost trillions in the stock market since 2000, a year in which the Dow Jones Industrial Average peaked at 11,722. It’s barely at 11,000 today. Adjusted for inflation, Wall Street has lost 20% of your money in the past decade.

CCL initiated OW at HSBC.  RBCM ups HOLX to “Top Pick.”  Cramer positive IDCC.  APSG to be acquired by RTN for $38/share. BARD ups ITMN.  Brean Murray cuts MPR.  RBCM ups PCS.  FBRC ups PCX.  BofAMLCO ups CME, HBAN.  BCAP ups PPS.  FBRC ups CNX.  BofAMLCO cuts MNKD.  BCAP cuts BMO.  BARD cuts SHO, FISV. 

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

Today’s Trivia:  Of the Oscar, the Heisman Trophy, and the Emmy, which is the taller award?
Yesterday’s Question: 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 Answer: The White House is found at zip code 20500, and 90090 is Dodger Stadium. 

Best Quotes:  BTIG forward look…

BTIG 2011 Compass.

"I can be reasonably certain of only one point: My economic forecast is highly likely to be wrong - but I don't know how."                   Federal Reserve Vice Chairman Don Kohn, April 8, 2010

This is the time of year for forecasts and predictions.  We genuinely believe retired Fed Vice Chair Kohn's may be the wisest words ever spoken by a Central Banker.  Accordingly, we don't think our own ability to make such prognostications is any better.  The investment journey is often discussed in terms of a roadmap, but we have always found a compass to be a much more fitting description.  A roadmap has far too much detail.  It tells you what is around every corner and in the uncertain world of financial markets, that is unrealistic.  On the other hand, a compass simply confirms that you are heading in the right direction.  With just a compass, you don't know if a tree has fallen in your path a few miles out, or if it is a downhill walk on a smooth surface.  For investors, dealing with this uncertainty is good because it requires that you be prepared no matter what the outlook.  Like others, we don't view the passing of a date on the calendar as providing any revelation that one's outlook should dramatically change.  Therefore, most of the themes on which we are focused are ones that we have been watching for some time, but this is an opportunity to string them together.   Our current view has three key themes: Investor Positioning, Valuation and Global Growth.

Investor Positioning.  

We view investor positioning almost equally as important to valuation as determining market direction.  Most market participants have experienced either top down or bottom up equity market moves in which stocks or an index with awful valuation went up and continued to go, and go, and go.  Likewise, value traps have been common, where the earnings are there now but will not be in the future.  In the first case, those who need to own the stocks do not and in the second, just about everyone owns them because they are so cheap.  We have been Bullish throughout the majority of the past two years.  The exception was when we went to Neutral from the start of May to mid-July.  Although the S&P 500 is on the cusp of re-claiming pre-Lehman levels, we believe there is a large numbers of assets that need to increase their levels of equity exposure and that transition will begin now.  

From our vantage point, 2010 has been a speculator driven market.  The vanilla investment community has been in a defensive, deleveraging and re-liquefying mindset for 3 ½ years.  A historic shift has occurred from Equities to bonds, despite the low interest rate environment (Charts 1-4).  As such, Hedge Funds have become the predominant incremental investor.  In addition to the tremendous growth of Hedge Fund Assets relative to Mutual Fund Assets over the past decade (Chart 5), the turnover levels of the Hedge Fund community are multiples of that of the vanilla community.  In turn, fast money has aggressively rotated in and out of trades and assets classes.  The result has been rapid moves in succession, increased bouts of short term volatility but all in all, a much healthier market place.  For decades, vanilla investors, both institutional and retail, dominated the flows.  These investors generally fueled the rising tide that not only lifted all boats and easily blunted and absorbed the volatility of fast money making quick trades.  When the 17% correction occurred in the spring, the fast money community exhibited its penchant for risk management cutting exposures quickly and moving on to the next trade.  As the QE trade dominated over the past 6 months, Equities, although they received flows, were the third asset class in a 3 asset class race.  It is our view that this has left a number of investors with Equity weightings below levels at which they want to be as the economy recovers.


Although we believe Investor Positioning to be almost as important as Valuation, Valuation is the key to sustainability of moves.  We have all seen some stocks and indices trade with extremely lofty P/Es for extended periods.  Some instances have even lasted in excess of a year(s), but usually, reality sets in.  According to Standard & Poor's, 2011 estimates for S&P 500 earnings are $94.65 (Table 1).  As of Friday's close, the S&P 500 is trading 13.1x estimates.  Using a more conservative $90 estimate, the S&P 500 is trading 13.8x estimates.  In either case, both provide ample room for multiple expansion to begin moving the P/E back to the historic average multiple of 15.9x earnings before investors get concerned about Equities moving into "expensive" territory.  The S&P 500 has endured a decade of multiple contraction after a period of excess.  Now that a cleansing has occurred and healing has begun, the process of multiple expansion will likely begin.  What we believe to be the most important aspect of the earnings and valuation story is that it only takes 5% earnings growth in 2011 for the S&P 500 to post a record year of earnings.  The current 2010 estimate is $83.61.  Five percent growth next year will put earnings slightly above the record earnings of $87.72 in 2006.  As the world slowly returns to a sense of investment normalcy, being able to purchase an index posting record earnings that is at the same levels it was 12 years earlier is a very attractive proposition.  Even more importantly, the pressure will rise on the investment community to be there participating as that realization goes mainstream.  Hindsight risk, will be placed upon those who are not participating.  We expect that the prospect of record earnings, together with low bond yields, will prompt vanilla investors to return to Equities in 2011.

Global Growth.

Global Growth is the last key theme of our view.  We believe the Global Growth story is alive and intact.  The Great Recession created a reset for U.S. multinationals which were provided with the opportunity to downsize where growth was slowing and reinvest where it is picking up.   Large corporations are now flush with cash and have the opportunity and resources to invest in markets offering the best potential.  Below is a table of global growth forecast and S&P 500 Earnings.  Next year, global growth is expected to increase 4.22% down from 4.8% in 2010 (Table 2).   We also highlight that in the decade prior to 2008, the global growth average was just shy of 4%, suggesting that a 4+% growth world still provides ample opportunity for earnings to grow and that the 5% earnings growth necessary for record S&P 500 earnings is a likely scenario.

Risk Factors.

Finally, there are the risk factors.  In the uncertain world in which we live and invest, they are always there.  Their importance escalates with their probability and investor positioning.  There are many well known risks of which investors are aware in the market: Sovereign Debt, U.S. Federal Debt, U.S. Municipal Debt, U.S. Pension Liabilities, China Economic Slowing, Trade War fears, Inflation, Geopolitical Risk (Korea, Terrorism, etc), and the list goes on.  We believe each is a legitimate threat in its own right.  The risk we fear the most is China's economic slowing.  We don't expect it, but we would not rule it out either.  As always, the key is timing.  When investors are defensively positioned as they currently are, and the shocks are known, they are easier to digest.  When that risk exposure ramps, those risk factors are harder to shake off, but we have been in a net selling environment for 3 ½ years, and we expect it will be a multiyear process of re-allocating to Equities.  That does not mean there can't or won't be problems, it just means that at this point, we don't see them derailing our Bullish views.