Wells Fargo reported record profits, nearly doubling analyst estimates despite the worst recession in the post-war era. The Fed designed its aggressive policy to slash interest rates over the past year to yield the maximum benefit for banks just as the economy fell of a cliff. The major banks are sitting on a pile of free cash as depositors earn less than 1% on their savings. This steepening of the yield curve has made it impossible for even bankers to lose money. So the Fed's actions have punished savers yet again and transferred a significant amount of wealth from the saving public to the banks. These actions continue to discourage saving while simultaneously encouraging excessive risk taking by lenders and debtors. However, an economy needs a solid savings base in order to encourage sustainable capital investment that is not based purely on debt. This begs the question; why do oil companies reporting record profits infuriate the general public while banks are applauded for producing record quarters? After all, don't both these industries generate their profits at the expense of the general public?
This upcoming week will see financial heavyweights Goldman Sachs, JP Morgan Chase, Bank of America and Citibank all report first quarter results. These companies are all expected to post solid numbers as they will benefit from the same operating environment that Wells Fargo exploited during the quarter. However, the market has priced in a solid earnings season for these banks following the Wells Fargo pre-announcement on Thursday and significant run-up in bank shares over the past four weeks. Do not expect the banks reporting this week to "blow out" the numbers because Wells Fargo achieved its results by under-reserving for future losses. I advised investors to avoid shorting financial stocks ahead of the mark-to-market rule change several weeks ago, and they have rallied sharply since that point.
Let me be as clear as possible. Although the financial sector will produce positive operating cash flow aided by free money, it remains insolvent, sitting atop a pile of bad assets. While bank share prices no longer reflect this reality, it is only a matter of time before the market prices these bank stocks accordingly. With additional capital raises looming and loan defaults accelerating, some excellent long term shorting opportunities are emerging within the sector following this earnings season. No other industry employs the amount of leverage that financials utilize. Even at a 10:1 leverage ratio, banks use $1 in equity to fund $10 in lending. So a small change in the value of the underlying assets can wipe out a large amount of equity. This is exactly what has plagued the sector for the past 18 months. The banks' tangible equity pales in comparison to the size of their actual balance sheets. After all, what is a couple billion dollars in quarterly profit when banks maintain balance sheets in the hundreds of billions? Further, these balance sheets will continue to deteriorate as the economy contracts.
Saturday, April 11, 2009
Friday, April 3, 2009
The Service Based Economic Model Has Failed
The once popular rhetoric of the past decade has turned to a whisper as cracks in our service based economy continue to widen. The dinner bill is due and everyone is trying to pass the check off to the next person as they scramble for the exits. Unfortunately, the years of binging are much more expensive than anyone could have imagined as the sticker shock sets in.
The official March U-3 unemployment rate rose to 8.5% as the U.S. shed another 663,000 jobs in March, roughly in line with estimates. Even more concerning was the large January adjustment, pushing total job losses to 740,000 for the month. It's odd how the current month figures came in so close to estimates while there was such a significant adjustment to the January report. Originally, the BLS estimated that the U.S. "only" lost 598K jobs in its original January release. That's nearly a 24% margin of error from the most recent revision. Would the BLS ever consider transferring job losses to prior months in order to cushion the impact on the markets? I will let you decide for yourself, but I fail to see the point behind releasing a draft report that could include a 24% margin of error. The U-6 unemployment rate, which is far more reflective of reality, soared to 15.6%. As I previously stated, this figure factors in underemployed and marginally attached workers.
http://www.bls.gov/news.release/empsit.t12.htm
Treasury prices fell last week and yields rose to 2.9% on the 10-year note as the market anticipated the U.S. will sell an anticipated $59B in notes this week. Interest rates have climbed back to the levels prior to the Fed's announcement of its treasury purchase program in March. Yields would have risen to well over 3% had it not been for these note purchases. The Treasury has several auctions scheduled for next week, and investors will keep a close eye on the auction results, although the Fed will no doubt provide support in the face of waning foreign demand. Note that the CDS spreads on government issued debt has risen steadily over the past six months as risk is transferred from the private sector to the government with all the bailouts.
I want to take a step back and discuss where I think the general economy is headed over the next several years. Putting the recent equity market rally aside, I have long-term concerns on the U.S. economy. This stance is a matter of common sense and based on the following factors:
1) Slightly less than 70% of the U.S. economy is based on consumer spending. This debt-fueled spending has also supported 25% of the world economy, buoying export countries like China, Japan, and Taiwan. As American consumption increased, productive capacity declined, forcing the government and households to take on more debt to maintain their standard of living. There are more than $5T in outstanding credit lines and $500B was pulled in Q4. Prominent banking analyst, Meredith Whitney, believes that banks could pull more than $2.7T by the end of 2010. With rising unemployment and lower credit availability, it does not take a genius to see where consumer spending is headed over the next year....down.
2) The American standard of living has steadily declined over the past several decades. There are currently 32M people on food stamps in this country, representing over 10% of the population. This is an astonishing number for the largest economy in the world and indicative of a failed system. It was possible in the 1950’s and 1960’s for a factory worker to comfortably support his family on one income alone. Today, that quality manufacturing job has disappeared, while it often takes dual incomes to maintain a similar standard of living. In short, families have to work longer and harder for lower wages as the cost of living skyrockets. This often goes unreported in most media outlets because these fundamental shifts are easy to overlook.
3) Neither the government nor the private sector has come up with a long-term structural solution to resolve the growing trade deficit. The approach has been to throw more debt at the problem just as the economy tries to deleverage. There is a significant difference between this downturn and those in prior cycles. America had a stronger savings rate and manufacturing base to fall back on during the prior postwar recessions. Unfortunately, the spending programs outlined in the stimulus consists of too many one time handouts that add little long-term value to kick start the economy. In other words, this country must make a fundamental shift from over consumption to production, but no administration over the past 20 years has been willing to tackle these serious issues.
4) Putting the credit crisis aside for a moment, the economy was due for a significant correction based on the demographics of the U.S. population. The baby boomers have just surpassed their peak spending years at roughly 48 years of age. This will result in a severe spending slowdown that will dramatically reduce GDP growth for the better part of the next decade. It will not be until the echo boomers reach their peak spending years that you will see a meaningful rebound within the domestic economy.
The questions that bullish money managers and analysts cannot answer should also be the simplest. What will bring the quality jobs back? What catalyst will provide the foundation for a sustained economic recovery as consumers reign in their spending to reduce their debt levels? These are the fundamental questions that bullish analysts continue to dodge. Until these issues are resolved, the economic contraction will not see the bottom.
The official March U-3 unemployment rate rose to 8.5% as the U.S. shed another 663,000 jobs in March, roughly in line with estimates. Even more concerning was the large January adjustment, pushing total job losses to 740,000 for the month. It's odd how the current month figures came in so close to estimates while there was such a significant adjustment to the January report. Originally, the BLS estimated that the U.S. "only" lost 598K jobs in its original January release. That's nearly a 24% margin of error from the most recent revision. Would the BLS ever consider transferring job losses to prior months in order to cushion the impact on the markets? I will let you decide for yourself, but I fail to see the point behind releasing a draft report that could include a 24% margin of error. The U-6 unemployment rate, which is far more reflective of reality, soared to 15.6%. As I previously stated, this figure factors in underemployed and marginally attached workers.
http://www.bls.gov/news.release/empsit.t12.htm
Treasury prices fell last week and yields rose to 2.9% on the 10-year note as the market anticipated the U.S. will sell an anticipated $59B in notes this week. Interest rates have climbed back to the levels prior to the Fed's announcement of its treasury purchase program in March. Yields would have risen to well over 3% had it not been for these note purchases. The Treasury has several auctions scheduled for next week, and investors will keep a close eye on the auction results, although the Fed will no doubt provide support in the face of waning foreign demand. Note that the CDS spreads on government issued debt has risen steadily over the past six months as risk is transferred from the private sector to the government with all the bailouts.
I want to take a step back and discuss where I think the general economy is headed over the next several years. Putting the recent equity market rally aside, I have long-term concerns on the U.S. economy. This stance is a matter of common sense and based on the following factors:
1) Slightly less than 70% of the U.S. economy is based on consumer spending. This debt-fueled spending has also supported 25% of the world economy, buoying export countries like China, Japan, and Taiwan. As American consumption increased, productive capacity declined, forcing the government and households to take on more debt to maintain their standard of living. There are more than $5T in outstanding credit lines and $500B was pulled in Q4. Prominent banking analyst, Meredith Whitney, believes that banks could pull more than $2.7T by the end of 2010. With rising unemployment and lower credit availability, it does not take a genius to see where consumer spending is headed over the next year....down.
2) The American standard of living has steadily declined over the past several decades. There are currently 32M people on food stamps in this country, representing over 10% of the population. This is an astonishing number for the largest economy in the world and indicative of a failed system. It was possible in the 1950’s and 1960’s for a factory worker to comfortably support his family on one income alone. Today, that quality manufacturing job has disappeared, while it often takes dual incomes to maintain a similar standard of living. In short, families have to work longer and harder for lower wages as the cost of living skyrockets. This often goes unreported in most media outlets because these fundamental shifts are easy to overlook.
3) Neither the government nor the private sector has come up with a long-term structural solution to resolve the growing trade deficit. The approach has been to throw more debt at the problem just as the economy tries to deleverage. There is a significant difference between this downturn and those in prior cycles. America had a stronger savings rate and manufacturing base to fall back on during the prior postwar recessions. Unfortunately, the spending programs outlined in the stimulus consists of too many one time handouts that add little long-term value to kick start the economy. In other words, this country must make a fundamental shift from over consumption to production, but no administration over the past 20 years has been willing to tackle these serious issues.
4) Putting the credit crisis aside for a moment, the economy was due for a significant correction based on the demographics of the U.S. population. The baby boomers have just surpassed their peak spending years at roughly 48 years of age. This will result in a severe spending slowdown that will dramatically reduce GDP growth for the better part of the next decade. It will not be until the echo boomers reach their peak spending years that you will see a meaningful rebound within the domestic economy.
The questions that bullish money managers and analysts cannot answer should also be the simplest. What will bring the quality jobs back? What catalyst will provide the foundation for a sustained economic recovery as consumers reign in their spending to reduce their debt levels? These are the fundamental questions that bullish analysts continue to dodge. Until these issues are resolved, the economic contraction will not see the bottom.
Thursday, April 2, 2009
Market Wrap (4/2) & What's on Tap for Friday
The verdict is in. I said Wednesday that equities would see limited up side ahead of the Friday jobs report with the mark-to-market rule change providing the only possible exception as an upward catalyst. Once the FASB caved in and approved the measure, markets extended their gains with financials rising over 3%. The S&P closed up 23 points or 2.9%, well off the session highs as stocks pulled back late in the day ahead of tomorrow's employment report. The financial sector underperformed cyclicals, basic materials, and transportation today. The G20 are also increasing the International Monetary Fund's lending power to $750B. The dollar index slipped nearly 1.4% as the European Central Bank cut interest rates by 25 basis points to 1.25%, less than the 50 expected by most observers. Rhetoric coming from the G20 leaders did contribute to the positive sentiment in the market.
The consumer cyclical and transportation sectors drove the market's gains today rising 7% and 6% respectively. The G20's actions coupled with the possible easing of credit conditions fueled investor optimism that the economy will improve sooner than originally anticipated. This also prompted oil to rise 8% to over $52 a barrel. I am particularly confused by the strength exhibited in the retail sector as many of these stocks have soared over the past several weeks in the face of increasing unemployment and rising gas prices. Many of these stocks are no longer pricing in the severe strains that consumers will begin to endure over the next year.
Treasuries declined as investors fled from the safety of government bonds to equities in search of better returns. The yield on the 10-year increased to 2.76% and would have risen further had it not been for the Fed purchasing over $7B of notes in today's session. The Fed will most likely increase its treasury purchase program from $300B to over $600B in the next six months. Given the Fed's current treasury purchase pace, it will most likely surpass its original $300B limit within four months.
I want to hit on a brief point regarding the US dollar fluctuations and impact on equity markets. Investors can attribute about 1% of today's equity market gain to the weaker dollar. If the S&P rises 1% while the dollar falls 1%, then the U.S. market value has not risen from a real dollar perspective. Take today as an example. If you are money manager based out of the Euro-Zone and own a broad based S&P ETF, you are excited that it closed up 3.5%. However, since you will have to convert those gains back into your currency eventually, your real gains from a Euro perspective are only 1.4% (2.9% market gain minus 1.5% daily Euro gain). I just wanted to point this fact out since most people do not consider how currency fluctuations can impact their real returns. So if the S&P doubles from here, but the dollar index loses 50% of its value, then you have a 0% real rate of return.
The DOW is currently hovering near 8,000 after it closed at 11,500 on 12/31/99, meaning that it has lost 3,500 points or 30% this decade. However, once we review the DOW’s performance in terms of gold, which factors in the dollar's declining value, the market’s drop has been even more precipitous. Gold traded at roughly $300/oz when we ushered in this decade, but today, it has soared to over $900/oz, more than tripling its value over the past eight years. Once you apply the DOW/Gold ratio, the market’s drop is stunning. The ratio dropped from 38 (11,500/$300oz) in 2000 to 9 (8,000/$900oz) in 2009. So when you price the index in gold and compare the prices over the same time period, it has dropped by 76% (38-9/38)! This drop follows significant cuts in the capital gain tax rates to 15% and a favorable interest rate environment for the better part of the last decade. These are the types of measurements that main stream commentators and financial networks rarely discuss.
The BLS releases the March employment report tomorrow with economists forecasting 650,000 in job losses for the month. Traders have decided that poor employment numbers no longer matter since it is already baked in to the market. I am not a market timer nor do I aim to become one, but people continue to underestimate the true state of the job market and the longer term impact on the economy.
Company Spotlight
Sears Holdings (SHLD)completely defies all logic closing up over 8% to $52.13 today. Operating cash flows continue to deteriorate as it loses market share to competitors. Consensus analyst estimates for the current and next fiscal year is $.16 and $.58 respectively. Sears real estate holdings continue to decline in value yet the market has assigned this stock a crazy premium trading at over 300 times this year's estimates. It is even expensive when analyzed using enterprise value metrics. Needless to say, if you have the patience and can find the shares to short, you will be rewarded because the stock has no business trading over $20.
The consumer cyclical and transportation sectors drove the market's gains today rising 7% and 6% respectively. The G20's actions coupled with the possible easing of credit conditions fueled investor optimism that the economy will improve sooner than originally anticipated. This also prompted oil to rise 8% to over $52 a barrel. I am particularly confused by the strength exhibited in the retail sector as many of these stocks have soared over the past several weeks in the face of increasing unemployment and rising gas prices. Many of these stocks are no longer pricing in the severe strains that consumers will begin to endure over the next year.
Treasuries declined as investors fled from the safety of government bonds to equities in search of better returns. The yield on the 10-year increased to 2.76% and would have risen further had it not been for the Fed purchasing over $7B of notes in today's session. The Fed will most likely increase its treasury purchase program from $300B to over $600B in the next six months. Given the Fed's current treasury purchase pace, it will most likely surpass its original $300B limit within four months.
I want to hit on a brief point regarding the US dollar fluctuations and impact on equity markets. Investors can attribute about 1% of today's equity market gain to the weaker dollar. If the S&P rises 1% while the dollar falls 1%, then the U.S. market value has not risen from a real dollar perspective. Take today as an example. If you are money manager based out of the Euro-Zone and own a broad based S&P ETF, you are excited that it closed up 3.5%. However, since you will have to convert those gains back into your currency eventually, your real gains from a Euro perspective are only 1.4% (2.9% market gain minus 1.5% daily Euro gain). I just wanted to point this fact out since most people do not consider how currency fluctuations can impact their real returns. So if the S&P doubles from here, but the dollar index loses 50% of its value, then you have a 0% real rate of return.
The DOW is currently hovering near 8,000 after it closed at 11,500 on 12/31/99, meaning that it has lost 3,500 points or 30% this decade. However, once we review the DOW’s performance in terms of gold, which factors in the dollar's declining value, the market’s drop has been even more precipitous. Gold traded at roughly $300/oz when we ushered in this decade, but today, it has soared to over $900/oz, more than tripling its value over the past eight years. Once you apply the DOW/Gold ratio, the market’s drop is stunning. The ratio dropped from 38 (11,500/$300oz) in 2000 to 9 (8,000/$900oz) in 2009. So when you price the index in gold and compare the prices over the same time period, it has dropped by 76% (38-9/38)! This drop follows significant cuts in the capital gain tax rates to 15% and a favorable interest rate environment for the better part of the last decade. These are the types of measurements that main stream commentators and financial networks rarely discuss.
The BLS releases the March employment report tomorrow with economists forecasting 650,000 in job losses for the month. Traders have decided that poor employment numbers no longer matter since it is already baked in to the market. I am not a market timer nor do I aim to become one, but people continue to underestimate the true state of the job market and the longer term impact on the economy.
Company Spotlight
Sears Holdings (SHLD)completely defies all logic closing up over 8% to $52.13 today. Operating cash flows continue to deteriorate as it loses market share to competitors. Consensus analyst estimates for the current and next fiscal year is $.16 and $.58 respectively. Sears real estate holdings continue to decline in value yet the market has assigned this stock a crazy premium trading at over 300 times this year's estimates. It is even expensive when analyzed using enterprise value metrics. Needless to say, if you have the patience and can find the shares to short, you will be rewarded because the stock has no business trading over $20.
Wednesday, April 1, 2009
Market Wrap (4/1) & What's on Tap for Thursday
Today's economic data came in roughly in line with expectations as the National ISM numbers showed a slight improvement over the prior month's 35.8 reading with a 36.3. Employment and new orders improved while production held steady over the prior month. This number still indicates significant contraction, but stocks greeted the release with optimism paring their morning losses to close up 1.6%. The data diverged from the Chicago PMI survey released yesterday, which came in below estimates.
Consistent with my forecast yesterday, pending home sales ticked up 2.1% over February as lower mortgage rates and foreclosure sales prompted buyers to enter the market. The West continues to deteriorate as pending sales fell 13% showing that the the general economy is standing in the way of a more sustained housing recovery. All other regions enjoyed pending home sale increases over the prior month. I am interested to see next month's sales data as we enter the home buying season and mortgage rates remain near record lows. The housing situation is actually worse than the data suggests given the shadow inventory held by lenders. Official statistics report that there are 3.8M existing homes currently on the market, equal to about 9.7 months supply. However, lenders are holding over 600,000 residential properties that are not listed on the multiple listings service.
Vehicle sales, although terrible, came in slightly above expectations adding to the market's gains midday. The year-over-year declines will level out over the next six months as the auto manufacturers begin to compare their figures to weak sales months in 2008. The General Motors CEO stated that vehicle sales are finally bottoming out, but I urge him not to get ahead of himself as consumers continue to deleverage their balance sheets.
As expected, the market continues to ignore the poor economic reports as most of this information has already been "discounted" into the market. After all, the bulls contend that the market is a forward looking mechanism, pricing securities nine months out into the future. If this is truly the case; how was it that the major indices hit their all time highs in October of 2007, less than two months before the official onset of the current recession? The fundamentals do not support a significant market rally from these levels. I will dig deeper into this over the next week, but needless to say, I believe that the market is getting ahead of itself at the moment. However, equities could easily trade up another 10%-15% before turning back down.
Tomorrow is light on the economic front with initial jobless claims due out in the morning with a consensus estimate of 655,000 new filings. Aside from the initial market reaction, this report poses limited downside risk for equities with any better-than-expected figures used as an excuse to rally the markets. The FASB will also vote on the final mark-to-market rule tomorrow, which supported financial shares in today's trading. Banks will apply this rule change retroactively, meaning that it will be applicable for Q1 earnings. What a loss for transparency, and as a non-practicing CPA, I am personally disgusted that this was even considered. Mark to model is best compared to a homeowner valuing their house at twice the market value because they think "that is what it should be worth."
Consistent with my forecast yesterday, pending home sales ticked up 2.1% over February as lower mortgage rates and foreclosure sales prompted buyers to enter the market. The West continues to deteriorate as pending sales fell 13% showing that the the general economy is standing in the way of a more sustained housing recovery. All other regions enjoyed pending home sale increases over the prior month. I am interested to see next month's sales data as we enter the home buying season and mortgage rates remain near record lows. The housing situation is actually worse than the data suggests given the shadow inventory held by lenders. Official statistics report that there are 3.8M existing homes currently on the market, equal to about 9.7 months supply. However, lenders are holding over 600,000 residential properties that are not listed on the multiple listings service.
Vehicle sales, although terrible, came in slightly above expectations adding to the market's gains midday. The year-over-year declines will level out over the next six months as the auto manufacturers begin to compare their figures to weak sales months in 2008. The General Motors CEO stated that vehicle sales are finally bottoming out, but I urge him not to get ahead of himself as consumers continue to deleverage their balance sheets.
As expected, the market continues to ignore the poor economic reports as most of this information has already been "discounted" into the market. After all, the bulls contend that the market is a forward looking mechanism, pricing securities nine months out into the future. If this is truly the case; how was it that the major indices hit their all time highs in October of 2007, less than two months before the official onset of the current recession? The fundamentals do not support a significant market rally from these levels. I will dig deeper into this over the next week, but needless to say, I believe that the market is getting ahead of itself at the moment. However, equities could easily trade up another 10%-15% before turning back down.
Tomorrow is light on the economic front with initial jobless claims due out in the morning with a consensus estimate of 655,000 new filings. Aside from the initial market reaction, this report poses limited downside risk for equities with any better-than-expected figures used as an excuse to rally the markets. The FASB will also vote on the final mark-to-market rule tomorrow, which supported financial shares in today's trading. Banks will apply this rule change retroactively, meaning that it will be applicable for Q1 earnings. What a loss for transparency, and as a non-practicing CPA, I am personally disgusted that this was even considered. Mark to model is best compared to a homeowner valuing their house at twice the market value because they think "that is what it should be worth."
Tuesday, March 31, 2009
Market Wrap (3/31) & What's on Tap for Wednesday
Now that's what I call quarter-end window dressing at its finest. The S&P closed the day up 1.3% with the Nasdaq outperforming once again to end the session 1.8% higher. Financials led the way with a 3.5% gain as positive news from Barclays in Europe set a positive tone for the rest of the sector. The London-based bank declined to take part in the British Asset Protection Plan, fueling optimism that the sector's operating environment may start to improve. Additionally, Microsoft, a major Nasdaq component, closed 5% higher following an upgrade citing increased PC demand in the U.S. and China.
Stocks closed well off of their session highs as the DOW shed nearly 100 points in the final hour of trading. All three economic reports (the Case-Shiller Composite, Chicago PMI, and Consumer Confidence) released today came in below forecasts. House prices fell 2.8% over the prior month and 19% over the prior year to settle at $146.4K in January. Incidentally, the average price came in just below my $147K estimate documented in my Sunday post. More recent new and existing home sale data show no let up in the contraction during February. Chicago PMI also came in well below estimates at 31.4 against the 35.0 consensus. This number indicates continued and severe contraction in the manufacturing sector. I expected the survey number to improve slightly over the prior month, so this came in below my estimate as well. I now expect the ISM number scheduled for release tomorrow to decline over the prior month mirroring the data released within the Chicago PMI.
Four key reports are scheduled for release tomorrow morning:
1) ADP employment report (Monthly)
Economists utilize this report to gauge private sector job activity to fine-tune their BLS employment report forecasts scheduled for release on Friday. As mentioned in my Sunday post, I expect over 650K jobs lost this month and a rise in unemployment to 8.5%. The official U3 unemployment rate will surpass 10% over the next year. I am not concerned with the exact month-to-month figures given the tendency for large prior month revisions.
2) ISM manufacturing Index (Monthly)
The results should come in below the 36.0 consensus estimate given the data released within the Chicago PMI survey today. I would estimate somewhere around 33, but the point is that the figure will continue to show severe contraction on a nationwide basis. It would take a pretty horrible number to significantly impact the markets given that investors are well aware of the current manufacturing environment.
3) Pending Home Sales (Monthly)
This represents a sale in which a contract is signed, but not yet closed. February pending home sales will likely show a slight improvement over the prior month record low of 80.4. However, any improvement will be attributable to higher foreclosure related sales and unseasonably warm weather. Home sales will remain near record lows and should set new lows in the coming months in response to rising unemployment.
4) Motor Vehicle Sales (Monthly)
The major manufacturers will release their sales totals throughout the day, and I expect to see no improvement in the numbers for March.
Traders should avoid shorting the financial sector ahead of the FASB meeting scheduled for Thursday. Although a probable rule change surrounding mark-to-market accounting has been in the news for several weeks now, the sector may see a rally once the rule change is confirmed. It is difficult to gauge exactly what the market has already priced in, but a confirmed change may lift bank shares in the near-term. Putting this possible rule change aside, there is no significant upside to the market ahead of the Friday BLS Employment Report.
Stocks closed well off of their session highs as the DOW shed nearly 100 points in the final hour of trading. All three economic reports (the Case-Shiller Composite, Chicago PMI, and Consumer Confidence) released today came in below forecasts. House prices fell 2.8% over the prior month and 19% over the prior year to settle at $146.4K in January. Incidentally, the average price came in just below my $147K estimate documented in my Sunday post. More recent new and existing home sale data show no let up in the contraction during February. Chicago PMI also came in well below estimates at 31.4 against the 35.0 consensus. This number indicates continued and severe contraction in the manufacturing sector. I expected the survey number to improve slightly over the prior month, so this came in below my estimate as well. I now expect the ISM number scheduled for release tomorrow to decline over the prior month mirroring the data released within the Chicago PMI.
Four key reports are scheduled for release tomorrow morning:
1) ADP employment report (Monthly)
Economists utilize this report to gauge private sector job activity to fine-tune their BLS employment report forecasts scheduled for release on Friday. As mentioned in my Sunday post, I expect over 650K jobs lost this month and a rise in unemployment to 8.5%. The official U3 unemployment rate will surpass 10% over the next year. I am not concerned with the exact month-to-month figures given the tendency for large prior month revisions.
2) ISM manufacturing Index (Monthly)
The results should come in below the 36.0 consensus estimate given the data released within the Chicago PMI survey today. I would estimate somewhere around 33, but the point is that the figure will continue to show severe contraction on a nationwide basis. It would take a pretty horrible number to significantly impact the markets given that investors are well aware of the current manufacturing environment.
3) Pending Home Sales (Monthly)
This represents a sale in which a contract is signed, but not yet closed. February pending home sales will likely show a slight improvement over the prior month record low of 80.4. However, any improvement will be attributable to higher foreclosure related sales and unseasonably warm weather. Home sales will remain near record lows and should set new lows in the coming months in response to rising unemployment.
4) Motor Vehicle Sales (Monthly)
The major manufacturers will release their sales totals throughout the day, and I expect to see no improvement in the numbers for March.
Traders should avoid shorting the financial sector ahead of the FASB meeting scheduled for Thursday. Although a probable rule change surrounding mark-to-market accounting has been in the news for several weeks now, the sector may see a rally once the rule change is confirmed. It is difficult to gauge exactly what the market has already priced in, but a confirmed change may lift bank shares in the near-term. Putting this possible rule change aside, there is no significant upside to the market ahead of the Friday BLS Employment Report.
Monday, March 30, 2009
Market Wrap (3/30)
The S&P closed down 3.5% as the Obama Administration advocated Chapter 11 bankruptcy to best restructure GM and Chrysler. As I mentioned in yesterday's post, the market was due to consolidate this week following its recent 25% run-up off the March 6th lows. Financials and basic materials were the worst performing sectors, declining by roughly 5.6% and 4.6% respectively. Chatter centered on banks needing to raise additional capital coupled with general profit taking accounted for a majority of the decline in bank shares today. Most of the major banks closed down more than 10% ending the session near their lows. Investors should continue to steer clear of bank stocks and just allow the speculators to whip these shares around. I do not believe that any financial deserves to trade above tangible book value, and I am sure that market will agree with me in due time.
Basic materials traded down with commodities and oil on the back of a stronger dollar and renewed concerns over energy demand. Light sweet crude and gasoline futures each closed down 7%, but remain at trading levels well above their 3-month moving averages. Commodities have traded in correlation with equity markets over the past several months, and I expect this pattern to continue in the near-term. Note that a stronger dollar is generally bearish for commodity and equity markets in the near-term.
The Nasdaq outperformed the broader market, declining by only 2.8%. The technology sector is only down 5% on the year buoyed by Google, Amazon, and Apple. This strength is unjustified given that the weakness in the general economy is only now beginning to filter down to the consumer. With first quarter earnings just around the corner, I do not consider this sector a buy at these levels.
Three key releases are due out tomorrow morning with Consumer Confidence, the S&P Case-Shiller Home Price Index, and Chicago PMI kicking off the weekly economic calendar. I provided a preview of these releases in yesterday's post. Tomorrow is the last day of the quarter for fund managers, so I expect the market to trade in a range as funds close their books with the aforementioned economic releases setting the tone for the day.
Basic materials traded down with commodities and oil on the back of a stronger dollar and renewed concerns over energy demand. Light sweet crude and gasoline futures each closed down 7%, but remain at trading levels well above their 3-month moving averages. Commodities have traded in correlation with equity markets over the past several months, and I expect this pattern to continue in the near-term. Note that a stronger dollar is generally bearish for commodity and equity markets in the near-term.
The Nasdaq outperformed the broader market, declining by only 2.8%. The technology sector is only down 5% on the year buoyed by Google, Amazon, and Apple. This strength is unjustified given that the weakness in the general economy is only now beginning to filter down to the consumer. With first quarter earnings just around the corner, I do not consider this sector a buy at these levels.
Three key releases are due out tomorrow morning with Consumer Confidence, the S&P Case-Shiller Home Price Index, and Chicago PMI kicking off the weekly economic calendar. I provided a preview of these releases in yesterday's post. Tomorrow is the last day of the quarter for fund managers, so I expect the market to trade in a range as funds close their books with the aforementioned economic releases setting the tone for the day.
Sunday, March 29, 2009
The Week Ahead - March 30th Edition
We have a full slate of economic data scheduled for release this week, capped off by the employment report on Friday. Below is the summary of key market moving releases and my brief commentary over several of the key reports:
Week of 3/30/09
Day Description Time (ET)
31-Mar Consumer Confidence 9:00 AM
31-Mar S&P Case-Shiller Home Price Index 9:00 AM
31-Mar Chicago PMI 9:45 AM
1-Apr ADP Employment Report 8:15 AM
1-Apr ISM Index 10:00 AM
1-Apr Construction Spending 10:00 AM
1-Apr Pending Home Sales 10:00 AM
1-Apr Auto Sales 1:00 PM
1-Apr Crude Inventories 10:35 AM
2-Apr Initial Claims 8:30 AM
2-Apr Factory Orders 10:00 AM
3-Apr Employment Report 8:30 AM
3-Apr ISM Services 10:00 AM
Although consumer confidence is likely to improve slightly over the prior month, the survey will remain near its record low in the high 20s. Note that this report is based off of a monthly survey of 5,000 households with expectations constituting 60% of the index while current conditions account for the remainder.
The S&P Case-Shiller Home Price Index operates on a two month lag, so the information published this week represents the January data. Last month, the 20 city composite fell to a seasonally adjusted price of $150K, resulting in a near 17% decline over the prior year and 30th straight month-over-month price decline. I expect prices to continue on their downward trend for January and come in around $147K.
As illustrated by the chart below, national home prices have receded down to late 2003 levels, giving back five years worth of illusionary gains. In total, prices, as measured by the 20-city composite, have fallen 27% below their 2006 highs. However, home price will likely fall another 15% to $125K over the next year bringing prices down to 2002 levels. Record low mortgage rates may provide some relief, but rising unemployment and the general lack of affordability will continue to pressure home values. These forecasts assume that the U.S. dollar remains stable around current levels because a significant devaluation will artificially inflate home values. It is entirely possible for prices to fall below 2000 levels because housing inventories have risen at a faster rate than the U.S. population.
Chicago Purchasing Managers Index (PMI), a regional manufacturing survey of purchasing managers gauges activity on new orders, production, employment, and prices paid. A reading of 50 or above indicates expansion while readings below 50 show contraction. The readings over the past five months have leveled off in the mid 30s, but I expect the current month to rebound slightly into the high 30s. The Chicago PMI is a great indicator of the National ISM index released the next day as there is a high historical correlation (over 90%) between the results of the two surveys. Again, I expect the ISM results to improve slightly over the prior month as companies slowly begin to rebuild drawn inventories. Aside from the initial knee-jerk reaction by the market, it has largely ignored the manufacturing statistics over the past three months because the slow-down has been largely priced into equities.
Investors have largely ignored the horrible auto sales numbers released over the past several months even as sales came in well below analyst expectations. This is not surprising given that the general state of the auto industry has been well discussed and priced into the market. The reports would have more of a market impact during normal economic times, but you can only beat a dead horse so many times. That being said, if there is an unexpected rise or stabilization in auto sales, the markets would rally on the news. This will not be a problem for the current month, however.
The March employment report will continue to show monthly job losses in excess of 600,000 workers. Economists are forecasting a rise in the employment rate to 8.5% and roughly 650K in job losses. These estimates appear reasonable, but it is hard to forecast accurately because the government’s numbers typically have large prior month revisions. The bulls will tell you that the market has priced in an unemployment rate over 9%, which is probably true in the short-term. Many also view the employment statistics as a lagging indicator, and although this may hold true during a typical recession, I believe that this theory is based on faulty logic in the current climate.
The headline unemployment figures that you read about in the mainstream press dramatically under represent the number of displaced workers. The Bureau of Labor Statistics (BLS) releases alternative measures of unemployment. During the Great Depression, the government calculated unemployment based on statistics akin to the U-6 measure as opposed the U-3 measure currently in use. This rate calculates unemployment by taking the number of unemployed and adding back marginally attached workers and part time workers looking for full time employment. Marginally attached individuals represent people who would like to work but have given up looking for a job because they are discourage and cannot find one. Once these people are added back in to the calculation, the true unemployment rate equals 14.8% based on the February statistics. I have included the BLS table link for your reference. http://www.bls.gov/news.release/empsit.t12.htm
Traders have driven the market down on the day prior to the employment report over the past several months. Then, regardless of the actual job loss number, buyers usually enter the market following the report’s release. I expect to see a similar pattern emerge this week unless the mark-to-market meeting set for Thursday, April 2nd, yields any significant rule changes. From the initial commentary over the topic, it appears that the FASB will adjust the rules and allow banks more flexibility in marking their “toxic” assets to model. Shorts should remain cognizant of this meeting as the bulls could use any news to ignite a significant and baseless rally.
As a side note, I believe that allowing banks to circumvent mark-to-market in certain instances is a horrible idea that is politically driven and destined to fail. This decreases transparency and makes these black boxes (aka banks) even harder to value. How can an investor trust a bank to value their assets to model when their faulty models are what created this mess in the first place? The market will do what it does best after the initial knee-jerk reaction; price financial stocks for this uncertainty, which means lower prices.
The S&P has rallied 23% off of its March 6th low of 666. This bailout driven rally is not supported by broader fundamentals, but government programs that are designed to artificially inflate the book value of banks’ toxic assets. This bear market rally could run another 10%, but I have little doubt that the indices have yet to see their bear market lows. For those of you in 401Ks, I would use any possible move in the DOW north of 8,000-9,000 over the next several months to go to cash and protect your remaining capital. For the current week, I would expect to see some consolidation given market’s sharp run-up. I will discuss some of this week’s upcoming earnings reports in tomorrow’s post.
Week of 3/30/09
Day Description Time (ET)
31-Mar Consumer Confidence 9:00 AM
31-Mar S&P Case-Shiller Home Price Index 9:00 AM
31-Mar Chicago PMI 9:45 AM
1-Apr ADP Employment Report 8:15 AM
1-Apr ISM Index 10:00 AM
1-Apr Construction Spending 10:00 AM
1-Apr Pending Home Sales 10:00 AM
1-Apr Auto Sales 1:00 PM
1-Apr Crude Inventories 10:35 AM
2-Apr Initial Claims 8:30 AM
2-Apr Factory Orders 10:00 AM
3-Apr Employment Report 8:30 AM
3-Apr ISM Services 10:00 AM
Although consumer confidence is likely to improve slightly over the prior month, the survey will remain near its record low in the high 20s. Note that this report is based off of a monthly survey of 5,000 households with expectations constituting 60% of the index while current conditions account for the remainder.
The S&P Case-Shiller Home Price Index operates on a two month lag, so the information published this week represents the January data. Last month, the 20 city composite fell to a seasonally adjusted price of $150K, resulting in a near 17% decline over the prior year and 30th straight month-over-month price decline. I expect prices to continue on their downward trend for January and come in around $147K.
As illustrated by the chart below, national home prices have receded down to late 2003 levels, giving back five years worth of illusionary gains. In total, prices, as measured by the 20-city composite, have fallen 27% below their 2006 highs. However, home price will likely fall another 15% to $125K over the next year bringing prices down to 2002 levels. Record low mortgage rates may provide some relief, but rising unemployment and the general lack of affordability will continue to pressure home values. These forecasts assume that the U.S. dollar remains stable around current levels because a significant devaluation will artificially inflate home values. It is entirely possible for prices to fall below 2000 levels because housing inventories have risen at a faster rate than the U.S. population.
Chicago Purchasing Managers Index (PMI), a regional manufacturing survey of purchasing managers gauges activity on new orders, production, employment, and prices paid. A reading of 50 or above indicates expansion while readings below 50 show contraction. The readings over the past five months have leveled off in the mid 30s, but I expect the current month to rebound slightly into the high 30s. The Chicago PMI is a great indicator of the National ISM index released the next day as there is a high historical correlation (over 90%) between the results of the two surveys. Again, I expect the ISM results to improve slightly over the prior month as companies slowly begin to rebuild drawn inventories. Aside from the initial knee-jerk reaction by the market, it has largely ignored the manufacturing statistics over the past three months because the slow-down has been largely priced into equities.
Investors have largely ignored the horrible auto sales numbers released over the past several months even as sales came in well below analyst expectations. This is not surprising given that the general state of the auto industry has been well discussed and priced into the market. The reports would have more of a market impact during normal economic times, but you can only beat a dead horse so many times. That being said, if there is an unexpected rise or stabilization in auto sales, the markets would rally on the news. This will not be a problem for the current month, however.
The March employment report will continue to show monthly job losses in excess of 600,000 workers. Economists are forecasting a rise in the employment rate to 8.5% and roughly 650K in job losses. These estimates appear reasonable, but it is hard to forecast accurately because the government’s numbers typically have large prior month revisions. The bulls will tell you that the market has priced in an unemployment rate over 9%, which is probably true in the short-term. Many also view the employment statistics as a lagging indicator, and although this may hold true during a typical recession, I believe that this theory is based on faulty logic in the current climate.
The headline unemployment figures that you read about in the mainstream press dramatically under represent the number of displaced workers. The Bureau of Labor Statistics (BLS) releases alternative measures of unemployment. During the Great Depression, the government calculated unemployment based on statistics akin to the U-6 measure as opposed the U-3 measure currently in use. This rate calculates unemployment by taking the number of unemployed and adding back marginally attached workers and part time workers looking for full time employment. Marginally attached individuals represent people who would like to work but have given up looking for a job because they are discourage and cannot find one. Once these people are added back in to the calculation, the true unemployment rate equals 14.8% based on the February statistics. I have included the BLS table link for your reference. http://www.bls.gov/news.release/empsit.t12.htm
Traders have driven the market down on the day prior to the employment report over the past several months. Then, regardless of the actual job loss number, buyers usually enter the market following the report’s release. I expect to see a similar pattern emerge this week unless the mark-to-market meeting set for Thursday, April 2nd, yields any significant rule changes. From the initial commentary over the topic, it appears that the FASB will adjust the rules and allow banks more flexibility in marking their “toxic” assets to model. Shorts should remain cognizant of this meeting as the bulls could use any news to ignite a significant and baseless rally.
As a side note, I believe that allowing banks to circumvent mark-to-market in certain instances is a horrible idea that is politically driven and destined to fail. This decreases transparency and makes these black boxes (aka banks) even harder to value. How can an investor trust a bank to value their assets to model when their faulty models are what created this mess in the first place? The market will do what it does best after the initial knee-jerk reaction; price financial stocks for this uncertainty, which means lower prices.
The S&P has rallied 23% off of its March 6th low of 666. This bailout driven rally is not supported by broader fundamentals, but government programs that are designed to artificially inflate the book value of banks’ toxic assets. This bear market rally could run another 10%, but I have little doubt that the indices have yet to see their bear market lows. For those of you in 401Ks, I would use any possible move in the DOW north of 8,000-9,000 over the next several months to go to cash and protect your remaining capital. For the current week, I would expect to see some consolidation given market’s sharp run-up. I will discuss some of this week’s upcoming earnings reports in tomorrow’s post.
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