Prior Posts

• Sentiment and [YIKES] politics
• Sentiment update

Below

• Rally continues + more sentiment
• Nonfarm Payrolls relief
• No WR&O next week

Capital Markets Recap

If you check out the prior posts and read below, you’ll get the impression of a dead horse being beaten, but the subject of sentiment is a powerful and important one, in my opinion.  There has been excessive bearishness, and here’s another version of it.

We know that individuals–based on their preference for bonds over stocks–aren’t enamored with the outlook for stocks.  That’s evident everywhere from what they search for on Google to how they respond to surveys.  But they’re not the only group.  Speculators in futures, those who aren’t commercials (the commercials are investment banks, in this case) are even more bearish, and they’ve expressed that view with real money.  Their net-long position (long futures minus short futures) is negative; that is, they have more shorts than longs; that is, they’re betting on stocks falling (middle panel, below.)  Whereas individuals might stop searching for “Hindenburg Omen” on Google and respond to surveys different–that’ll reduce their bearishness–the only way for the speculators to be less bullish is to close their short futures contracts, and that will push stocks higher.  In other words, if stocks continue to rally it’ll produce a vicious cycle–if you’re short and have to cover.

Top Stories

• Somebody once said that it’s impossible to take any three letters in the English language, put them together in any order and not come up with a government agency we couldn’t do without.  This week a newish one was brought to the fore.  Not to be confused with the body that insures the safety of your deposits, the FCIC–the Financial Crisis Inquiry Commission–grilled a number of folks who were on the scene when the financial world collapsed, almost bringing down Main Street.  Dick Fuld of Lehman Brothers insisted it wasn’t an issue of capital that brought the firm down, it was an issue of liquidity.  Chairman Bernanke, however, said the Fed didn’t think it was possible to save the company.  The discount window had been opened for other firms because they had collateral the government felt confident in, as AIG did.
• Burger King (BKC) was bought out by a Brazilian private equity firm, and as often happens, it was discovered that option trading in the stock ballooned just before the bid.  The same thing happened this morning, with the S & P futures rising a minute before the [positive] Nonfarm Payrolls Report was released.  Some guys have all the luck.
• Last week’s recap featured a chart showing that searches for “double dip”–as in another recession–hit a high for the year.  That’s another source of fear for the bears who are sitting on cash or in bonds, yet another high was reached that contradicts that fear.  Copper is often referred to as the metal with a PhD because of its leading tendency with respect to the global economy.  It, too, made a high this week.  It was just a 90-day high, but were it not for April, it would have been a high for the year.  It’s fair to ponder removing April, too, as that was a time of high enthusiasm about stocks.  That enthusiasm translated to a bullish copper position.  Now, though, it’s copper showing strength, and it’s not supported by bullish sentiment on stocks.  I conclude, therefore, that the strength in copper is signaling something else is afoot . . . like a global economy that is not flirting with the dreaded double dip.

• We like emerging markets as an investment favorite, if for no other reason than that emerging market economies look stronger than developed markets in terms of their economic fundamentals.  For example, virtually all measures of debt relative to their economy look supremely better than that of the developed nations.  That’s widely known, however, making the emerging markets area–as they say–a crowded trade.  In terms of rowboats, it’s like everyone looking over the same side of the boat.  The Bloomberg terminal featured a four-word phrase that should send shivers through anyone who was older than 30 when the internet bubble burst:  this time it’s different.  And the circumstances of this version are a lot like then, when we were presented with the new economy.  According to this week’s Bloomberg story, the MSCI Emerging Markets index is trading at levels that, in 2008, marked  the peak in that market.  HSBC, Deutsche Bank, and Morgan Stanley say it’s different this time because, “developing nations have less debt, more profitable companies and are growingg twice as fast as advanced economies.”  Write this down:  all asset bubbles have their beginnings in trust, and they’re inflated by a so-called paradigm shift–the this time it’s different.
• Copper is used around the world, and, withouth looking, China is probably the minor buyer.  The U.S. surely uses more, but China is likely behind the growth in copper demand.  So you might assume that means the global double-dip risk is low, but the Cass index of Freight Shipments says the risk is low in the U.S., too.  That index reached its second-highest level in two year, as shown below.

This Week

As I pointed out in two prior posts, this market has been primed to rally.  There has been too much pessimism.  In addition to the sentiment surveys cited and the political winds blowing, there was also a 2010 record of selling climaxes last week.  That occurs when a stock hits a 52-week low but finishes the week up more than 10%.  It’s a measure of the weak hands (i.e. dumb money) selling their shares to the strong hands (i.e. smart money.)

While there were some positive-surprise reports this week–e.g. Pending Home Sales up by 5.2%; prior -2.6%; expected -1.0%–they were just excuses for stocks to rally.  Given that today’s Nonfarm Payrolls Report measures the one-month change in payrolls–very imprecisely, to boot–it, too, is just an excuse. 

Still, at the margin of the margin it was positive.  Instead of the loss of (-)105,000 jobs that was expected, the headline loss was just (-)54,000.  That was lower than last month’s headline figure (-131,000), but the same as the revised figure.  Private Payrolls rose by 67,000; more than the 40,000 anticipated.  July’s change was revised up from 71,000 to 107,000, making the two-month average 87,000.

Manufacturing Payrolls, however, were disappointing, as they fell by (-)27,000 instead of the 10,000 increase economists expected.  The Unemployment Rate ticked up to 9.6% from 9.5%, but was the result of more folks entering the labor force, looking for jobs.  The Participation Rate–the percentage of the population in the work force, either working or looking for work–rose from 64.6% to 64.7%. That translates to an additional 685,000 looking for work.  This is a to-be-expected phenomenon as the economy improves–grudgingly or not.

Another minor positive was the increase in Average Hourly Earnings.  They rose by 0.3%, versus expectations of +0.1% and July’s +0.2%.  That pace is well above 2010’s average and is better than the average of 2007, 2009, and just shy of 2008’s mark.

Next Week

There are less than a handful of indicators in all of next-week’s holiday shortened work week.

Key indicators to watch

• Initial Jobless Claims (weekly) – Thursday

Prior posts

• Financial Regulation bill = Sarbanes Oxley?
• A potentially huge accounting change

Below

• Relief rally in stocks
• Merger mania
• Ugly economics

Capital Markets Recap

Again, this week, there was a positive divergence that suggests some upsdide for the market.  On a weekly basis, the S & P 500 (and the Dow, NASDAQ, and S & P 400) finished lower on the week, yet implied volatility–the Fear Index–declined.  Apparently, there isn’t increased fear as the market retreats.  It’s a divergence because they should move opposite each other; i.e. that’s the normal relationship.  It’s positive, because it suggests the market should move higher.

Top Stories

The most-awaited event of the week was the Fed’s annual get together in Jackson Hole.   Rather than bore you with excerpts from it, here are the takeaways:

• The Fed is not out of bullets . . . yet . . . ‘about three left
• Neither continued “disinflation” nor high inflation are likely
• Global central banks can not be expected to fix all that ails the global economy

Here’s the Wordle version of the Chairman’s speech:

Whatever he said the market apparently liked it, virtually rocketing north as soon as the speech was released.  Hmm . . . maybe it wasn’t anything he said, but that, at long last, it was over.  The speech was 5,106 words long and ran to 46 paragraphs over 407 lines.  I don’t doubt that the hottest hedge funds have algorithms that provide far more insightful analysis than my word cloud above, but really–the market was up 0.7% in nine minutes. 

There is a bidding war under way for 3Par, which, according to the company’s website, “is the leading global provider of utility storage, a category of highly virtualized and dynamically tiered storage arrays built for public and private cloud computing.”  The two bidders–so far–are Hewlett Packard and Dell, and the former ousted its CEO over some . . . ah . . . indiscretions just three weeks ago.  Here’s the unfolding action.  The inset timeline is shamelessly lifted from a MarketWatch website.  In addition to that generous attribution, clicking on the graphic will take you to the site.

Another blundering company–which continues to sport a nice dividend yield, which continues to rise–for the wrong reason–Intel decided that while it was getting pounded for having a less-than-rosy outlook and making the questionable McAfee acquisition, it might as well make another acquisition or two.  I mean–how much worse can it get?  Perhaps the trendline should be changed to an arrow.

Given the widespread gloom that pervaded markets today, it’s not surprising to hear that, in the American Association for Individual Investors (AAII) weekly survey, the respondents who were bullish totalled only 20%.  That’s one of the lowest readings in the last five years.  Indeed, a search of Google search trends shows that searches on the phrase “double dip” are at an all-time high, as you can see in the chart below.

The profusion of negative headlines–

“U.S. Economy:  Durables, Housing Signal Recession Risk”

“Debt Rally Cracking as Double-Dip Fears Haunt:  Credit Markets“

–doesn’t help, of course, but it’s at odds with a hot bet of the hedge funds:  commodities.  According to Bloomberg, they have their highest allocations to commodities“since 2008.”  Commodities don’t do well in any form of recession.  Either the hedgies are missing something or the general public is.

Take a quick poll for me, please.  I’ll share the results next week.  Immediately the poll below is a look at stock market seasonality, compiled since 1928.  It shows a bottom in the September/October period, followed by a strong finish into the end of the year.  What do you think?

This Week

We had to wait until Thursday to get the first bid of positive economic news.  Until then it had been dreadful. The first bomb that fell was the (-)27.2% drop in Existing Home Sales for July.  Everyone who could fog a mirror knew that the First Time Homebuyers Tax Credit was a big prop to housing sales in recent months, but no one, not even the most pessimistic of the smartest guys in the room, the economists, thought it would be as bad as it turned out.  They thought the drop would be -13.4%; the worst expected -26.3%.    The next day New Home Sales for July were released.  While they had risen by 23.6% in June, they fell by (-)12.4% in July.  The Home Price Index, the measure with the most-encompassing view of U.S. home prices, showed that home prices in June fell by (-)0.3% in June.  Economists expected the index to have ticked up by 0.1%, and the revised May data was +0.4%.

Durable Goods Orders were announced, and they were sliced and diced six ways to Sunday (whatever that means), but the message was the same:  yuck.  Here are the various ways in which the orders are reported.

• Headline:  +0.3% vs. economist consensus of +3.0%
• Excluding transportation orders:  -3.8% vs. consensus of 0.5%
• Capital goods orders excl. non-defense aircraft:  -8.0%

The first of two good pieces of news came in the form of Initial Jobless Claims.  They fell by (-)30,000 from last week to 473,000 from an upwardly revised 504,000.  That was the first decline in four weeks.  The four-week moving average continued to rise but at a slower pace.

The second bit came in the form of  less-bad-than-expected Q2 GDP.  The first release showed growth of 2.4%, and economists expected 1.4% for the second iteration.  Instead, it came at 1.6% on the strength of stronger consumer spending.  (-)0.6% of the decline came from worse-than-earlier-estimated Net Exports (exports less imports).  According to Miller Tabak that was the second worst showing for net exports since 1947.

Next Week

Plenty to shake up markets next week.  There’s nothing to suggest any recent, negative trends will be reversed.  All other reports will pale in comparison to Friday’s Nonfarm Payrolls report.

Key indicators to watch

• Personal Income, Spending, and Saving (July) – Monday
•  CaseShiller Home Price Index (June) – Tuesday
• Chicago Purchasing Manager index
• Minutes of August 10 FOMC meeting – Tuesday
• ISM Manufacturing (August) – Wednesday
• Initial Jobless Claims (weekly) – Thursday
• Pending Home Sales (July) – Thursday
• Nonfarm Payrolls (August) – Friday – Consensus:  loss of 100,000 jobs; gain of 10,000 mfg. jobs
• Unemployment Rate (same report) - Consensus:  9.6%; previous 9.5%
• Average Hours Worked (same report)
• ISM Non-manufacturing (August) – Friday

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Prior posts

• S & P 500 Seasonality – cue the Jaws music

Below

• Non-confirmations
• A few modest positives to consider
• Soggy economics

Capital Markets Recap

The Bloomberg talking heads, of course, pointed out that this was the S & P 500’s second week in a row with a lower close, but the other equity indexes above don’t confirm that pessimistic view, with the small- and mid-cap indexes, as well as the NASDAQ recording up weeks.  The performance of the emerging markets index–particularly, relative to the Dow Jones Global index, which is dominated by developed markets–reinforces our decision to have favored the same mix:  developing over developed.

A key element of technical analysis is positive and negative non-confirmations, a form of which was highlighted above, and its the foundation of Dow Theory, which looks at the action in the Dow Transports versus the Dow Industrials.  A low in one that is not confirmed by a low in the other leaves the implication of the new low suspect.  A low in both, however, confirms the message of the low.  Likewise, one lower grade on your child’s report card isn’t the same as all lower grades.

There was a non-confirmation of sorts today, a positive one.  The S & P 500 made an intraday low for the period since July 21 (a date which has no particular significance).  The Fear Index, the VIX–technically, the VXO, now–however, did not.  The normal relationship is for investors to get more fearful as the market weakens.  In that it didn’t, it offers some hope that retreat may stall.  In the chart below, I have graphed the S & P 500 (lower panel) against the Fear Index (upper panel), with the scale inverted on the Fear Index.  Admittedly, this is a small positive, but it’s in the spirit of Monty Python.

You can see the same effect below, where the Fear Index (read:  less fear) is lower now than it was last Friday.

Here’s another positive bit of tid:  the S & P 500, in today’s trading, formed what is called in Japanese Candlestick charting, a hammer.  Japanese rice traders came up with a unique way of graphing prices back in the 1700s.  It lends itself to quick analysis because the implications are quick to see.  In the chart below, green represents a day where the close was higher than the open; red, the reverse.  The thin line extending (usually) from the red or green box is referred to as the wick, and it displays the intraday action.  A quick rule of thumb is this:  candlesticks with wicks extending out the top by a fair margin are bad; out the bottom, good.  The latter type is referred to as a hammer.  It suggests trading where the bears are not able to keep prices down; rather the bulls take over and push them up.  (On the other hand, maybe all the bears did high-5s and headed to the beach.)  As can be seen inthe chart below, where hammers appeared in the past (dashed yellow), the reaction can be short term in nature, however.

We have a hard time finding pessimism in surveys of sentiment, even thought some market commentators are hanging their bullish views on widespread pessimism.  I don’t think it’s widespread at all, but one place where pessimism can be seen is in the ratio of puts (options that benefit from falling prices) to calls (options that benefit from rising prices), the so-called put-call ratio.  It’s at levels (shown below, bottom panel, inverted) that have corresponded to rallies in equities.  No guarantees about the results this time, but it’s another positive to consider before changing one’s portfolio position to fetal.

• Merger and acquisition activity is heating up this week.  Intel said it would buy McAfee, the anti-virus people, because mobile security is going to be hot.  Maybe so, but shareholders of acquirers often become former shareholders.  INTC is back to its lows of the last 52 weeks.  What that means for you, savvy as you are, is that the dividend yield hit a 52-week high, at 3.33%.  BHP Billiton offered, ever so kindly, to purchase Potash Corporation of Saskatchewan, aka Potash, for something like $130/share.  Although it had closed the night before at $112.77, the company told Broken Hill Partners to, well, go pound sand.  At almost 38% below its all-time, 2008 high of $241.62, company management thought it was worth more, and the market seems to agree, having sent the shares to $149.65.  Biomedical company, Stryker Corp., is said to be buying a unit of Boston Scientific, a stock that exemplifies the risk of buying stocks off the 52-week low list, where it seems to have  taken up permanent residence.  Warren Buffett’s Berkshire Hathaway took a stake in Fiserv, a provider of services to the financial services industry, and upped its stake in Johnson & Johnson.  That’s sort of like buying a bond.  The stock yields 3.43%, and from end-to-end–like a 10-year end-to-end–the price really doesn’t change much.  This, however, is a bond with a rising yield, as evidenced by the chart at right of the stock’s per share dividend.  Berkshire Hathaway, however, enjoys another benefit that you don’t, in that it can consolidate its equity portion of JNJ’s earnings into its own income statement.  For reference sake, JNJ’s 3-year bond maturing in 2013 yields 1.18%, while its 13-year bond yields 3.41%!
• Speaking of dividends . . . every once in a while some firm wants us to test drive their research or other service.  We just started seeing stuff from Harris Bank, which looks interesting.  They had a note out the other day on Pfizer, a stock they seem to love.  It didn’t show up in last week’s short list of stocks with juicy dividends for some reason.  It does, however, sport a 4.52% dividend yield, and this is what Harris says about it (they’re referring to selling Eli Lilly (LLY) in favor of it).  (Seven exclamation points in one paragraph, however, is a bit silly, in my opinion.)

This Week

Economic data this week was mixed, relative to the prior releases of each.  Only two exceeded economist estimates.  The MBA Mortgae Applications index, which rose by 13%.  It was entirely on the basis of Refis, as purchase applications fell to a 14-year low.  The NAHB Housing Market Index–a measure of homebuilder sentiment–fell to 13.  Its high was 22 on May 31, and it’s now retraced more than half of its improvement from its January 2009 low of 8.  Housing Starts and Building Permits both continue to look sickly.  There were a couple of shockers this week.  The first, if for no other reason than for the big number, was Initial Jobless Claims, which rose to 500,000, for the first time since November 2009.  What’s more, the four- and 12-week accelerated upward, the former moving above the 50-week moving average. 

The Philly Fed fell sharply, and that seemed to jolt Thursday’s markets.  Whereas the economic solons had expected a rise from 5.1 to 7.0, the index fell to (-)7.7.  That takes the index back to July 2009’s level.  The index fell to an almost perfect 50% Fibonacci retracement of the move from the 2008 low to the 2010 high (below). Also, it seems that the Philadelphia area manufacturing economy was just catching up with the drop in the Empire State Manufacturing index, which is also shown in the chart below.

Next Week

Key indicators to watch

• Existing Home Sales (July) – Tuesday
• New Home Sales (July) – Thursday
• House Price Index (June) – Thursday
• Initial Jobless Claims (weekly) – Thursday
• Gross Domestic Product, Q2, second revision – Friday
• University of Michigan Consumer Confidence (August, final) – Friday

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Prior Posts

• Bill Poole, former St. Louis Fed Governor
• Taxes – II:  Soaking the Rich
• Completely fascinating for data junkies
• Google – a glimmer of hope?
• Markets setting up for hopes dashed? (they were)
• You won’t believe this

Below

• Market action calls for defense
• Yields and alternatives to bonds
• Economics still soggy
• Plenty to spook markets next week

This is a rather long one.  Look at the pictures.  Read the underlined sections to get the gist.

Capital Markets Recap

Europe didn’t fare much better.

Here’s a weekly chart of the S & P 500 going back to 2007, that index’s all-time high.  To it I’ve overlaid a Fibonacci retracement, where the crucial levels are dotted and dashed.  Typically, rebounds–or retracements, as they’re called–will pause at those levels.  On the rebound, those levels can serve as resistance that, if penetrated then serves as support, or if not penetrated, well, they stymie the advance. 

The Fibonacci retracement levels have come into play a few times. Last Fall the 38.2% retracement level served as support.  The 61.8% retracement level served as resistance in April (first circle), and the 38.2% retracement level again served as support in July.

Sometimes it helps to shift to a weekly chart to lose some of the noise in price fluctuations. For example, in the chart below and to the right, it looks like breakouts through the 50% retracement level failed, and, indeed, in the daily chart they did fail.  In contrast, the chart that is immediately below shows that not once, on a weekly basis, did we close above the 50% level (the thin vertical lines shows the intra-week action, however.)

Here’s the bottom line for the market, as represented by the S & P 500:  until we get a weekly close above 1121, we should remain defensive.  For us, that means sticking with the consensus of our four key strategy services, which is a modest overweight to equities.  A weekly close below 1013.78 would send us scurrying for the safety of cash.

Speaking of cash and scurrying, investors–more like speculators–are scurrying to bury their funds in ultra-low yielding Treasuries.  The chart below shows the yield history for the 2-, 5-, 10-, and 30-year bonds. 

The 2-year note reached an all-time low (0.51% . . . per year) last Friday.  With the slightest whiff of inflation the yield is completely wiped out, losing money safely, as we heard it put today.  Our 2-year Certificate of Deposit yields almost three times that much, and yet 1.50% annual inflation obliterates its yield.  (The implied inflation rate for the next five years is 1.40%).

I picked up a comment somewhere that hedge funds are partly responsible for the drop in yields; they’ve supposedly piled into them.  We can check out their positioning in Treasuries by looking at the Commitments of Traders reports that are published by the Commodity Futures Trading Commission.  Futures participants of a particular size have to identify themselves as Commercials (i.e. basically producers; in grains these are the farmers, in securities, the banks) or Speculators (small or large).  The Speculators–or Specs–are the hedge funds, and these groups tend to be trend followers.  If they were responsible for the ultra-low yields, we could expect to see very large, net-long (i.e. short positions netted against long positions) positions relative to history.

In fact, as the chart below shows, we really don’t see that at all.  Only in the 5-year Treasury are speculators at net-long positions. If anything, they’re betting that rates will rise.

Here’s an idea for an alternative to bonds.  Why not find a rock-solid stock or two and just buy and hold them?  I performed a screen on the Bloomberg looking for companies with these characteristics:

1. Traded in the U.S.
2. Greater than $2 billion market capitalization
3. Total debt to total assets less than 10% (deflation will kill companies with lots of debt, but rolling over debt in an inflationary environment will push interest expense up)
4. Altman’s Z-score greater than 3 (i.e. bankruptcy risk is remote)
5. Current dividend yield greater than 3%

The table below shows what I came up, ten companies you’ll quickly recognize.  Chuck out the technology companies, get rid of the fickle teen/tween retailer, and you’re left with Raytheon (3.36%), Genuine Parts, NAPA auto parts parent, (3.85%), Chevron (3.74%), and Intel (3.24%).  Sure they could go down, but one could be buying bonds with interest rates near their lowest levels.  A reversal of that could send bond prices into the tank.

Top Stories

Bloomberg indicated that a Goldman Sachs report pegs the odds of a double-dip recession at 25-30%.  The folks at Goldie–even the economist types–are no slackers, so this shouldn’t be quickly dismissed.  On the other hand, Niels Borh, a physicist, once said that, “prediction is very difficult, especially about the future.”  (No, it wasn’t Yogi Berra.)

Cisco Systems repeated the second quarter earnings routine:  beat estimates, issue cautious outlook , watch stock crater (-10%).  Here are a couple of examples of analyst folly (both from the same analyst):

• 7/27:  “Setting up for a stronger 2H”
• 8/12:  “F2011 Expectations reset; buying opportunity”

And here’s another example of analyst silliness.  Family Dollar Stores (FDO) has been a great stock.  It’s up 55% in 2010, and one firm suggested Walmart should buy the company.  One sage analyst, Neil Currie at UBS, decided that yesterday was the time to advise clients to buy the stock.  He’s looking for a heroic move to $50, a snazzy 16% move.

Probably no surprise here, but a study by the U.S. authorities found that in “35 of 58″ Toyota crashes, brakes were not used.

This is the second anecdote behind the claim that auto dealers are clamoring for inventories:  “Jaguar Land Rover asks Ford for more engines as demand surges.”

This Week

Nothing happy here

Not surprisingly, the NFIB’s Small Business Optimism index showed a further weakening.  It’s still above the March low, so we’ll generously call it a correction in an improving trend. 

Nonfarm Productivity fell by (-)0.9%, a full percent below the expectation and far worse than the upwardly-revised 3.9% in the second quarter.  That’s good, at the margin of the margin, for folks looking for work, as improving productivity is the bane of those looking for work.  Contrariwise, lowered productivity means that more workers are needed to maintain the same level of output.  In fact, if productivity plummeted it would give fiscal stimulus a boost.  Just imagine if the local road-paving job took double  the current five-man crew to lay a mile of asphalt.  Suddenly, you’re paying ten workers to do the same thing it used to take five to do.  That’s it, if we could require steam-powered road-paving equipment, the stimulus would do a lot more for the economy.

The weekly release of Initial Jobless Claims didn’t show much change.  It was up 2,000 from the upwardly-revised number from last week (482,000), but was far worse than economists expected (465,000).  That didn’t help Thursday’s trading.

Consumer Price Index data did little to subdue fears of deflation.  On a year-over-year basis, the headline index rose by just 1.2%, while the Core reading was up by just 0.9%.  Deflation remains the current fear.  Bloomberg disagreed with me, however, saying, “U.S. consumer prices rise first time in four months, easing deflation risk.”

Next Week

Plenty to jolt the markets

Key indicators to watch

• Empire State Manufacturing index (August) – Monday
• Philly Fed index (August) – Thursday
• Leading Economic Indicators (July) – Thursday
• Initial Jobless Claims (weekly) – Thursday
• Producer Price Index (July) – Tuesday – anything that clarifies the __flation picture will be closely watched

Housing indicators

• NAHB Housing Market Index (August) – Monday
• Housing Starts & Building Permits – (July) – Tuesday

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Recent posts

• Cool feature at the Financial Times website
• Taxes – I

Below

• Market upate – resistance still = resistance
• Two very important papers released
• Most economic news supports the double-dip view–a view we don’t yet espouse  

Capital Markets Recap

As it was posited here over the last several weeks, 1100 is stiff resistance for the S & P 500–oops, almost forgot; here’s the nuts and bolts of the markets this week.

As I started to say, U.S. stocks continue to struggle with resistance.  Namely, the S & P 500 gets knee-capped at 1100.  In addition to proving difficult to surpass over the last couple of months, it’s also where the 200-day moving average and the 50% retracement of the ‘07 high to ‘09 low move, as the chart below shows.

All is not right in Denmark–whatever that means.  Earnings continue to be reported with the usual mass of upside surprises.  Stocks are holding up pretty well.  Yet interest rates are dropping like nobody’s business–whatever that means.  The two-year Treasury note reached another all-time low yield this week of 0.55%.  (The two-year is generally considered a proxy for monetary policy, yet nominal rates can go below zero, where they’re at, arguably.)  The 10-year note is below 3% again, at 2.905%.  Two–you have to call them–equity permabears, David Rosenberg, formerly with Merrill Lynch, now with Gluskin Sheff in Canada, and Marc Faber, author of the excellent Gloom, Boom, and Doom Report, have wagered a bottle of whiskey on the 10-year’s yield.  Rosenberg–Rosie to his friends–says they’ll go to 2%; Faber says they won’t go below the 2.06% low reached in 2008.

Top Stories

‘Lots here, but important stuff

• In the category of have-you-no-shame, Research in Motion (aka Blackberry) announced it would launch a tablet computer in November to, what else, compete with Apple’s iPad.
• The Federal Reserve’s Beige Book “says U.S. economic recovery slowed,” according to Bloomberg
• Build America Bonds program extended through 2012.  These bonds, which are issued by municipalities, have 35% (set to decline to 30% over the next two years) of their taxable interest paid by the Federal government.  Among other things that keeps the supply of tax-free municipal bonds low, mitigating the municipality fiscal issues, and–in effect–increasing Federal tax revenues.

There were two rather big, market-moving news events this week, and both came from respectable sources.  First, was a report from the Congressional Budget Office (CBO).  Second, was a report from the President of the St. Louis Federal Reserve.

The CBO, despite its etymology, isn’t all bad.  It’s website “About CBO” link says it provides Congress with nonpartisan analyses, and to provide information and estimates required for the Congressional budget process.  On Tuesday, it issued a report titled, “Federal Debt and the Risk of a Fiscal Crisis.”  Here is a link to the report, which I highly recommend; it’s not overly technical.  As I read through the eight-page report I highlighted what I thought were the important takeaways that needed to be conveyed here.  ‘Turns out its mostly highlighted, so here are the highlights of the highlights.

• The report featured three sections:  1) projected debt levels; 2) increased chance of a fiscal crisis; and 3) the effects of such a crisis on the U.S.

Section 1 – Past and Projected Debt Held by the Public

• The report looked at two scenarios.  One (Extended Baseline Scenario) of those assumed the Bush tax cuts are allowed to expire.  The other (Alternative Fiscal Scenarios), that they’re extended.  In either scenario the U.S. debt continues to rise.  In the former it’s gradual; in the latter, scary rapid.  As near as I can tell, Arthur Laffer wasn’t consulted for the report, as their doesn’t seem to be any allowance for increased tax receipts as a result of higher tax brackets leading to more tax-avoidance behavior (think John Kerry and $7 million I’m-the-voice-of-the-common-man yachts), the opposite of which happened during the Reagan years.
• According to the report, there are three consequences of the increasing debt.  1) Crowding out of investments.  Increased government borrowing crowds out the funds available for productive capital investment; 2) the rising interest payment burden means either higher taxes or less government spending; and that partly leads to 3) the “reduced ability to respond to domestic and international problems.”

Section 2 – An Increased Chance of a Fiscal Crisis

• Oh, by the way, there’s another consequence: the chance of a fiscal crisis.  Just as with consumers, as debt rises, the margin for error becomes smaller since less and less income is discretionary.  One certain consequence of such a crisis is “the interest rates on government debt rise suddenly and sharply.”  Importantly, “there is no identifiable tipping point of debt relative to GDP indicating that a crisis is likely or imminent.  But all else equal, the higher the debt, the greater the risk of such a crisis.”
• As if to exemplify that, three examples are given.  Fiscal crises in Argentina, Greece, and Ireland are reviewed.

Section 3 – How Might a Fiscal Crisis Affect the United States

• Here some really staggering figures are provided.  If interest rates were to jump by 4%, the interest on the debt would increase by 40% in 2011, by about $100 billion, and the interest burden in 2015 would double, to $460 billion–and that’s considering only the presently-projected debt.  Another consequence of the increase in rates would be devastating losses suffered by bond holders, including pensions, mutual funds, financial institutions (“losses that might be large enough to cause some financial institutions to fail”), and the retail investors who have bought bonds with reckless abandon, something we’ve pointed out numerous times.
• Policy options would be limited to:  1) debt restructuring, which “tends to be very costly for countries that try it;” 2) inflationary monetary policy, which is usually considered the most likely outcome, but which would also inflate future budget deficits (a 1% increase in inflation above CBO estimates over ten years would increase the deficits over those ten years by $700 billion); and 3) fiscal austerity, which would likely affect everyone but Congress.  And here’s the troubling part of the austerity idea, especially given the tendency to Congress to kick troubles further down the road:  while austerity can be quite effective (a cut in spending = 1% of GDP would limit debt:GDP to 20%), the later the actions are taken the more severe they have to be.

As if to preempt the CBO’s report, Nassim Nicholas Taleb, in an interview with the rebranded BusinessWeek–Bloomberb Businessweek, with his characteristic arrogant swagger, said that a potential source of “fragility or danger” is government deficits, and that

The problem is getting runaway.  It’s becoming a pure Ponzi scheme.  It’s very nonlinear:   You need more and more debt just to stay where you are.  And what broke Madoff is going to break governments.  They need to find new suckers all the time.  And unfortunately the world has run out of suckers.

In the days ahead, I hope to publish a list of canaries in the coal mine of U.S. government debt that we can monitor the pulses of to see if we need to freak out and buy an insured supply of food from Glenn Beck–more on that guy later.

The second report was by St. Louis Fed President James Bullard titled, “Seven Faces of ‘The Peril’ “.  The “peril” refers to a problem suggested in a 2001 academic paper by three economists; namely, deflation.  The seven faces are seven possible policy responses to the peril.

1. Denial
2. Stability
3. FOMC, 2003
4. Discontinuous
5. Traditional
6. Fiscal intervention given the situation in Europe
7. Quantitative easing

Here’s what you and policy makers need to know:  according to the paper, we are like Japan–here’s the statement that freaked out the markets:  the U.S. is closer to a Japanese-style outcome today than at any time in recent history– and none of the first six solutions are going to work if we slide in the direction we’re currently heading, toward “an unintended, low nominal interest rate steady state.”  The only and right thing left to do perform is Quantitative Easing (QE).  All the other measures involve traditional monetary policy, which is presently akin to pushing on a string.  In effect, QE “involves buying longer-dated government debt,” which is also refered to as “monetizing the debt.” 

So, while many sage observers can cite many ways in which the U.S. is not Japan, on the subject of interest rates and __flation, it’s very tough to difficult that there are critical ways in which we’re resembling the Land of the Rising Sun.

Dan Greenhaus, chief economist at Miller Tabak, says the paper’s important for several reasons.

1. Bullard is a voting member of the FOMC (that’s really two, member + voting).
2. He touched the “third rail of economics,” the U.S. likeness to Japan.

On the subject of Glenn Beck . . .

While most recognize the likes of Glenn Beck and Rush Limbaugh as entertainers, a few have confused them for finance experts, going so far as to liquidate investment portfolios in favor of other stuff . . . like gold.  Do you really believe that a Select Comfort bed is absolutely the best bed that Paul Harvey could have slept on or that Gold Bond Medicated Powder is really what whoever touting it would really have bought had he not been given a truckload of it and then paid to promote it?  Neither do I, and, apparently, neither do some folks that can shake things up, folks like DAs. 

New York, NY – Rep. Anthony Weiner (D – Queens & Brooklyn) and House Commerce Subcommittee Chairman Bobby Rush (D – Chicago) formally announced a hearing of the Subcommittee on Commerce, Trade, and Consumer Protection to investigate the business practices of Goldline International, a precious metals dealer that uses aggressive sales tactics and conservative spokespeople such as Fox News’ Glenn Beck to sell overpriced gold coins. Weiner and Rush sent a letter to Goldline requesting information in preparation for the hearing.

The announcement follows an exposé on ABC News which detailed Goldline’s business model. Additionally, the Santa Monica City Attorney’s office launched a joint investigation with the Los Angeles County District Attorney’s office into the possible criminal practices of Goldline International.

Well, here is a link to a Big Picture blog posting on the investigation into the bait-and-switchers at Goldline, one of Glenn’s favorite endorsements, and the graphic below walks you through it without leaving the comfort of this blog. 

This Week

The report on Durable Goods Orders was released on Wednesday, and it wasn’t pretty.  The headline figure was a drop of 1.0%, which followed a revised-to-the-better -0.8% decline in May.  What’s more, it was numerical opposite–if there can be such a thing–of what economists expected, +1.0%.  Stripping away the lumpy transportation orders didn’t help much either.  The change there was a -0.6%, which was also worse than the dismal scientists expected (+0.4%). More for double-dippers to feast on.  If there was a glimmer of hope, it was in the category of capital expenditures–capex, a proxy for which is nondefense capital goods excluding aircraft orders.  That category grew by 0.6%.  With the average corporate desktop computer virtually an antique and corporate cash at record high levels, this category almost has to be the economy’s savior, given the softness in consumer spending (see the GDP note below).

Friday served up another helping with the first release of Q2 GDP.  Instead of the 2.6% the economists expected, the actual result was 2.4%.  The Q1 figure was 2.7%, which was subsequently revised up to 3.7%, so neither the result versus consensus nor versus the prior figure was good.  In addition, Personal Consumption (70% of the economy) declined sharply, from 3.0% to 1.6%, which, too, was worse than economists expected (2.4%).  While S & P futures had been down by just three points, they promptly fell to -13.7, forcing the Bloomberg reporters to cower under their desks . . .

And then the Chicago Purchasing Managers index was released.  It showed a Chicago area in full advance, as the index rose from 59.1 to 62.3, which was far better than the dice-throwing economists’ guess of 56.0.  While not technically correct, that reading can roughly be thought of as a percentage of respondents reporting growth. 

That release wiped out the entire knee jerk drop in the S & P 500 e-mini futures, the around-the-clock version of which is shown below.

Why economic activity in Milwaukee is tracked is yet beyond me (inquiry into the ISM Milwaukee folks; haven’t heard back), but the similar report for the Milwaukee area was similarly strong.  It rose from 59.0 to 66.0, well above expectations of 57.0.  One would think that the Milwaukee reading would be similar to the Chicago reading, and a scatterplot shows that readings in the Chicago series explain 56% (R2) of the Milwaukee series.

To confirm that it’s not some other factor that explains the variance in both, I built the same scatterplot for the Milwaukee report and the Houston report.  That exercise confirmed my grasp of statistics and made intuitive sense; the R2 was just 0.16.

Next Week

As usual, in the first week of the month only one report matters, and that’s the first one listed below.

Key indicators to watch

• Nonfarm Payrolls (July) – Friday – loss of (-)60,000 expected
• Unemployment Rate - 9.6% expected
• Change in Manufacturing Payrolls - +18,000 expected
• ISM Manufacturing (July) – Monday
• Personal Income, Spending, Saving – (June) – Tuesday
• Factory Orders (June) 
• Pending Home Sales (June)
• ADP Employment Change (July) – Wednesday – similar to the Nonfarm payrolls, but two days earlier and without government jobs count
• ISM Non-Manufacturing (July)
• Initial Jobless Claims (weekly) – Thursday

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Recent posts

• FDIC Insurance Coverage
• Bernanke talks, market tanks
• Debt Overhang:  Economics 101 in Magic Marker
• Popping water balloon
• __flation Update

Below

• Rally to resistance
• Earnings
• European bank stress tests
• Deteriorating housing data

Capital markets Recap (as of 3:20)

I’ve included, below, an update of an S & P 500 chart I put up last Friday.  The dashed line at 1,100 remains resistance for stocks.  We’re going to finish the day very close to that level, although as I type at 3:38 I wouldn’t be surprised to see us finish slightly below 1,100.  This week’s action was constructive in that we spent several days with give-and-take between last Friday’s range before making a run at 1,100.  Like a hammer hitting the same spot on a piece of wood, the resistance will eventually give way.  The pessimism around stocks is high enough that next week could be that week, but I wouldn’t bet lunch money on it.

Top stories

Earnings are ostensibly the biggest news stories of the week.  This week saw 126 of the S & P 500 (technically 497) report earnings.  84.9% reported positive earnings surprises; 18 reported earnings disappointments.  In all, 149 companies (30%) have reported.  84.5% of the reports have been [positive] earnings surprises; 14.8% have been earnings disappointments; 1 company met estimates exactly.  All sectors but Telecom reported year-over-year earnings growth.  The best performance has come from the Consumer Discretionary sector (+210%), followed by Financials (+197%) and Materials (+100%).

I am running out time as I work from bottom to top of this dispatch, but here’s a thumbnail of some high-profile earnings releases.

• Ford – $2.6 billion profit
• McDonald’s – good profits on frozen drink sales
• Microsoft – biggest increase in sales in two years
• Amazon – missed estimates.  Stock opened up $15.07 lower but managed to close the gap to -$2.88
• American Express – good results
• Financials – most look good on an improved credit environment
• Apple – satisfied Wall Street with a stand out quarter
• IBM – missed estimates

For the next quarter expectations are highest for Financials (+53.24%), Industrials (+42.5%), Materials (+41.2%).  They’re lowest for Telecom (-0.47%), Utilities (+3.9%), Consumer Staples (+6.1%), and Health Care (+6.2%). 

In the next week 164 companies will report earnings, with the largest being from the Industrials (26) and Finance (25) sectors.  After that, things begin to tail off.

What has obscured earnings data over the past week have been–in my opinion, at least–two things:  Chairman Bernanke’s testimony to Congress and the stress tests at the major European banks.  With the former, before he had testified, there had been some speculation that the Fed might stop paying interest on bank reserves held with it.  That would be a stimulative measure intended to send banks looking for higher returns amongst, where else, making loans.  Unfortunately, while the Chairman spun a tale of woe about the economy he spent very little time talking about specific steps the Fed could/would take.  Click here for the market’s response.

With regard to the latter, there was apparently a leak yesterday that the stress test results  had come back to show a healthy patient.  In fact, after the market had closed it came out that the stress tests were going to be relatively stress free.  Essentially, the stress tests were to have subjected the European banks to stimulated disastrous conditions–much like the U.S. did with its banks early last year.  The U.S. tests were so arduous that they considered a worst case scenario of–yikes!–10% unemployment.  What the European stress tests did, however, was only look at the banks’ portfolios of tradeable securities and not those held to maturity.  And why not?  If the securities are held to maturity one gets the face value back, unless you happen to hold the next Lehman Brothers or General Motors bond.  What that produced was a list of mostly “healthy” banks (quotation marks were necessary) with a couple of sacrificial-lamb banks that are already on life support.  In contrast to the $30-40 billion estimate of capital needed, the result was a paltry $3.3 billion.  According to Miller Tabak, Greece alone was anticipated, in private estimates, to need $10 billion itself.  In short, the European stress tests were a sham and should leave markets with little confidence in the European banking system.  In fact, equity index futures were off by a fair amount this morning once the initial news hit.

Bill Miller, the famed manager of Legg Mason’s Value Trust fund, said this week that,

U.S. large capitalization stocks represent a once in a lifetime opportunity, in my opinion, to buy the best quality companies in the world at bargain prices.  The last time they were this cheap relative to bonds was 1951.  I was one-year old then, but did not have sufficient sentience or capital to invest.”

This week

Week’s data was focused on housing, which continues to deteriorate.

Most of the data this week was focused on housing.  Here’s a quick summary of the releases.  I’ve colored the consensus estimate and the prior release:  green if better than; red if worse than.

• NAHB Housing Market Index (i.e. builder sentiment) – 14 (expected 16; prior 17)
• Housing Starts – 549,000 (expected 577M; prior 593M)
• Building Permits – 586,000 (expected 575M; prior 574M)
• House Price Index – 0.5% (expected -0.3%; prior 0.8%)
• Existing Home Sales – 5.37 mil (expected 5.10 mil.; prior 5.66 mil.)

That’s four greens and six reds.  It’s a pretty simplistic way of viewing the data, but with four of five red in the prior category we can say that the data have deteriorated over the past month or so.  Three of five in the expected category are green, suggesting that the data were better than the economists expected.  I’d give more weight to the first category and chalk up a deterioration in housing.

The Leading Economic Indicators (-0.2%) were significantly weaker than the prior reading (+0.5%) but better than expected (-0.3%). The so-called Co/Lag index fell by 0.1%.  It’s a ratio of the Coincident indicators compared to the Lagging indicators.  Its year-over-year level is 5.5%, and that’s the best pace since 1983, according to one of our services.

Next week

A whole slew of stuff comes next week

Key indicators to watch

• New Homes Sales (June) – Monday
• Case-Shiller Home Price Index (May) – Monday
• Federal Reserve’s Beige Book (5 of 8 released in 2010) – Wednesday
• Durable Goods Orders (June) – Wednesday
• Initial Jobless Claims (weekly) – Thursday
• Gross Domestic Product et al (Q2) – Friday
• University of Michigan Consumer Confidence (July final) – Friday – given recent deterioration and general confusion over leading nature of the survey this should be an important one to watch.

Regional surveys (all for month of July)

• Dallas Federal Reserve Manufacturing Activity – Monday
• Chicago Purchasing Managers index – Friday
• ISM – Milwaukee – Friday

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Prior posts

• Yet Another Magazine Cover Story

Below

• Lousy week for the first week of earnings season.  Good earnings = stocks down
• More ammunition for double-dippers

Capital Markets Recap

(as of 2:27)

Please note the spike in Implied Volatility.  Also known as the Fear Index, what used to go by the ticker VIX (now VXO) measures the expected volatility based on option prices.  Option prices are a function of the following factors:

D – dividends

I – interest rates

V – volatility

U – underlying stock price

T – time

S – strike price (the price at which the option can be exercise)

Those initials made a great mnemonic aid in one of the CFA exams, and five of the six factors in the acronym are easily known . . . all but volatility.  From algebra you’ll recall that with just one unknown, it’s easily solved for.  While options can be used for both speculation and protection it seems that their prices move most violently when they’re bought for protection.   When put options are bought for protection their prices rise, while all of the factors remain fixed or at least known.   Therefore, what changes is their implied volatility.  It goes up.  Thus, the Fear Index.

The VIX is a contrary indicator.  As it rises it should push one closer to being bullish.

Here’s a simple technical look at the S & P 500.  With this week’s action we’ve made the third lower high (labeled LH on the chart).  Coupled with two lower lows (labeled LL on the chart), that makes for a downtrend.  The horizontal lines are previous areas where either buyers (red) or sellers (dashed white) have stepped in with enough force to overwhelm the selling or buying (circled areas).

Admittedly simple, the chart does present us with a straightforward lens through which to view the action:

• A decline that drops through1043 is likely headed to 1011.
• A decline that drops through 1011 confirms the downtrend and likely heads points us toward 900 – time to sell some stocks.
• A reversal–like this week’s–that stops short of 1011 is an alert that the trend is reversing upward.  Ideally, we would want to see some basing action above 1011, rather than a V-shaped bounce.  It’ll set us up for a bullish, inverted head-and-shoulders pattern.  If it plays out, it’ll target 1200.
• A more aggressive strategy might include making some buys with the S & P 500 around 1011 and making some sells around 1100.  In effect, taking advantage of the apparent summer range.

Top stories

If you hadn’t heard, the second quarter earnings reporting season started in earnest this week, kicked off by Alcoa.  So far just 23 of the companies in the S & P 500 have reported.  It’s been overwhelmingly positive (20 positive surprises, 3 negative) but from a really small sample.  129 of the companies will report next week.

• Alcoa’s earnings were better than expected
• Intel reported blowout earnings, its best quarter in a decade.  Analysts looked for revenues of $10.3 billion; the company reported $10.8. 
• GE reported earnings that beat estimates, helped by better results in its finance unit, but its sales came up short.
• Bank of America beat the GAAP earnings estimate but came up short on the adjusted number.  The stock is down (-)9.5% from last night’s close.
• Citigroup knocked the ball out of the park, beating the GAAP and adjusted numbers by 63% and 83%, respectively.  Stock down 5.5%.
• Goldman Sachs came to a settlement with the SEC . . . cool $500 million.  Stock up 7.3% from the announcement.
• Apple says its “working our butts off” to address the iPhone4’s antennae problem.  It might want to spend some time listening to engineers who point out these problems before they arise.  Buyers of the three million phones will get a free case that addresses the problem.

Bloomberg reported that “Consumer Confidence in U.S. Slides, Heightening Risk of Economic Slowdown.”  Sorry, folks, that should have read “Consumer Confidence in U.S. Slides, Reflecting Risk of Economic Slowdown.”  At best, consumer confidence is a coincidental–occuring at the same time–indicator, not a leading indicator.

The much-ballyhooed Financial Regulation bill passed through Congress, and the President is expected to sign it next week.  Despite at least one poll that said 4 of 5 don’t think it’ll prevent another financial crisis or protect them (what do those four know, anyway), and despite misgivings by the solons in Congress (“well, it’s not perfect, but . . . “), those faithful stewards of our nation insist it’s good enough to sign.

Ever hear of “technical correction bills?”  Neither had I, but our Strategas service had this to say this morning about them.

Financial Regulation: The Senate passed the final financial regulation bill yesterday and President Obama is expected to sign the measure next week. The details will be filled in over the next few years through regulatory rulemaking and through “technical corrections” bills that could potentially make substantive changes to key provisions. Think Reg Reform Is Done? Just Wait for the ‘Corrections’ Bill: Top lawmakers have acknowledged another bill will be needed to clean up their bill to overhaul the financial system, in which many complicated provisions were decided near the end of a marathon 20-hour session…But how far the corrections bill could go remains a question. Some said it may be confined to technical changes to better reflect congressional intent; others see an opportunity to make more substantive alterations… Even a change as simple as inserting or striking a word could have a big impact and once any corrections bill delves into making substantive changes, every interested lobbying group will be going to the mat for its issues. (American Banker, 7/16).  (Underlining is mine.)

 And this to say about Goldman Sachs:

GS/SEC Bookends: You’ll read a lot about the timing of the Goldman Sachs settlement today. We will leave the conspiracy theories to others. Goldman Settles SEC Suit for $550 Million: It’s interesting to note the timing of both the beginning and now the end of this case. Goldman was formally charged right around the time when the public was beginning to take interest in financial reform. The case made for the perfect narrative of an evil Wall Street firm that needed to be reined in with thoughtful regulation from Washington. And when did the case end? The settlement was announced a few hours after Congress passed the financial reform bill, sealing the legislation’s fate. So there’s no longer any reason to make an example of Goldman. (The Atlantic, 7/15).

So Tiger Woods’ wife gets $750 million, the SEC gets $500 million.  Is that right?  I mean right?

This week

Folks looking for evidence of a double dip in the economy–the feared second V in W–found it this week in the Empire State Manufacturing and Philly Fed indexes.  The former dropped from 19.57 to 5.08; the latter fell from 8.0 to 5.0.  Both were significantly below estimates.  As the chart below attests, however, neither index has much predictive ability–about as much as a broken clock.  Say 2:00 long enough and soon you’ll be right.

All of this is beginning to wear on the consumer.  University of Michigan Consumer Confidence fell sharply, from 76.0 to 66.5, far below economists’ expectations of 74.0. 

NFIB Small Business Optimism didn’t do much to counter the message from the regional indicators, falling, as it did from a recent near-term high.  There’s no question that the economy has run into a soft spot, only that some of the indicators don’t have a very good track record.

That housing is in for a double dip seems more of a certainty, both from anecdotes and from solid data, such as the recent mortgage activity.  Despite record low 30-year mortgage rates (green line), Mortgage Applications for refinances (orange) and purchases (white) fell again this week.  This is a mini-version of what John Meynard Keynes called a liquidity trap.  Rates can be pushed ever lower with no resulting spurt in economic or mortgage activity.  While probably overused, no cliche works as well to describe the phenomenon as “pushing on a string.”

Those watching for lurking inflation will need to look around the next corner because it didn’t come this week.  The Producer Price Index fell to a 2.8% annual rate and just 1.1% when looking at Core PPI.  Prices at the consumer level were similarly subdued in June.  The headline Consumer Price Index slowed to a 1.1% annual rate and, net of food and energy prices, stayed at a 0.9% annual rate.

Next week

Housing, housing, housing

Key indicators to watch

• National Association of Home Builders Housing Market Index (July) – Monday
• Housing Starts (June) – Tuesday
• Building Permits (June) – Tuesday
• Initial Jobless Claims (weekly) – Thursday
• Existing Home Sales (June) – Thursday
• House Price Index (May) – Thursday
• Leading Economic Indicators (June) – Thursday

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Below

• Summer rally underway
• Mixed economics, but Jobless Claims poised to improve

Prior posts

•  Gold . . . too late?
• Yet another magazine cover

Capital Markets Recap

Too many bears swung the pendulum too far over the past two weeks, and we appear to be in the midst of a good summer rally.  Not the least of the bearish omens was the much-ballyhooed Death Cross, where the 50-day moving average crossed below the 200-day moving average, supposedly heralding horrendous returns.  Not so far.

Turns out that about 3/4 of the time, equity returns are positive six months following such an occurence.  As usual, what gained notoriety for the phenomenon was its most recent performance–one of many rules on my office wall:  “big, vivid, easy to recall events are less likely than you think they are”.  We’re pretty good at that, remembering only the most recent occurences.  And, indeed, they did produce horrendous results, as the chart below might recall.

Three of four of our key research services remain bullish on equities–although one eponymous services reduceds its bullishness.  The missing fourth is–by their own admission–late on catching turns in markets, focusing instead on riding big trends.  The services have, however, made changes to their sector and asset class allocations.  One consistent theme is a bullish bias toward Emerging Markets.  We’ve been heavy in emerging markets equities for a while now, and in the last week we chose to add an allocation to emerging markets debt.

Other Investment Ideas

• With Treasury yields plumbing new depths (a sign in our lobby informs visitors that our mortgage rate is 4.125%–click here to send an e-mail to one of our mortgage folks for more information) inflation is not a consideration.  It will be, and when Treasury Inflation Protected Securities (TIPS)  begin to reflect that–not yet, but heading there–it’ll be time to buy those.
• Gold is in the midst of a sell-off.   Don’t ask why, you wouldn’t understand.  In addition, it’s making lower lows and lower highs, the signs of a downward trend.  Eventually, it’ll be time to buy more–if only for a trade–but my guess is that price is around $1,150 (today’s close $1,211.60).  On GLD look for $111 – 113.

Top Stories

• Google saw its Chinese license renewed.  In response its shares rallied smartly, up 10% in five days.  We like GOOG for its cloud-computing (i.e. applications in the ether, not on the desktop) exposure.
• Berkshire Hathaway “may have $800 million writedown on asset declines.”
• Big call option trade on the Finance sector SPDR (273,000 calls traded today) suggests someone’s banking on a rally in the finance sector.
• The G-7 includes the following countries:  Canada, France, Germany, Italy, Japan, United Kingdom, and United States.  Only one has managed–and just this week–to recoup all of the jobs lost in the recent global recession, and it’s the most recent addition to the list, Canada. 
• The Treasury Department released its Semi-Annual Report on International Economic and Exchange Rate Policies.  Of particular interest to Congress is the section on China. Again, the Treasury Department stopped short of calling China a currency manipulator, instead applauding its moves toward a floating currency, which steps have included removing the country’s peg to the dollar.  That did nothing to assuage the public servants in the Legislative Branch–such luminaries as Chuck Shumer, who, never having had passing grades in Econ 101, still wants to slap a 27.5% tariff on Chinese goods.  Uh, Fort Wayne to Chuck:  it’s our own fault; we buy the stuff.  Make the Chinese mad and they might just dump a few billion Treasuries.  We’d be wise to remember that, were it not for the Chinese recycling its U.S. dollars into Treasuries, our interest rates would be far higher.  The only reason they’re not is because the dollar is a reserve currency.  Be careful what you wish for, Chuckie, this currency stuff isn’t Child’s Play.
• Due to generous discounting, U. S. Retail Sales rose at their quickest pace in four years, according to Bloomberg.
• BP CEO Tony Hayward is jetting around the globe, ostensibly trying to enlist the support of various nations, in forms ranging from direct investment to joint ventures to business as usual–chances are good he’s dropping off his resume–pardon me, at that level it’s probably a Curriculum Vitae.  This sounds an awfully lot like Lehman Brothers trying to raise capital from soveriegn wealth funds, and that sends chills down one’s spine.  And yet, the stock is up north of 22% in a week.

This Week

There wasn’t much going on in the land of economics this week.  The ISM Non-Manufacturing report was weaker than expected, suggesting the service sector is growing at a slower pace.  Initial Jobless Claims fell by 21,000 to come closer to penetrating the lower bound of the triangle that’s formed in the series.  If it were a stock, we’d say the triangle represents a consolidation phase and the “stock” would continue in the former direction, which is to say, in this case, lower.

Consumer Credit continued to decline, as it has been doing since late 2008.  On a five-year chart it does indeed look like a sign of some new-found frugality, but a longer-term chart confirms that, at best, it’s a start on the right track. 

Next Week

In contrast to this week, next week is loaded with releases.

Key indicators to watch

• Producer Price Index (June) – Thursday – the fear du jour is deflation, so watchers will key in on these two series.
• Consumer Price Index (June) - Friday
• Retail Sales (weekly) – Wednesday – increasing chatter is being heard around the consumer, looking for signs of weakening in spending
• July 14 FOMC Minutes – Wednesday
• Initial Jobless Claims (weekly) – Thursday

Lesser indicators

• NFIB Small Business Optimism (June) – Tuesday
• Empire State Manufacturing index (July) – Thursday
• Capacity Utilization & Industrial Production (June) – Thursday
• Philly Fed index (July) – Thursday
• University of Michigan Consumer Confidence (preliminary July) – Friday

Questionable

• The American Grandstand Congress will hold hearings on Federal Reserve nominees to the Board of Governors:  Janet Yellen (San Francisco Fed President) as Vice Chair, and Peter Diamond and Sarah Bloom Raskin as plain ol’ governors.  Their views as expressed in the hearing could give some clues as to where monetary policy might be heading.

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Below

• Another ugly week for stocks around the globe
• A rant about analysts
• Soggy economics

Prior posts

• Because I’m lazy . . .
• The Magazine Cover Phenomenon Strikes Again

Capital Markets Recap

Here’s a self-explanatory comment on stocks . . .

Top Stories

• Financials were the top performing group of stocks in action today, as can be seen at right.  What’s more, the advance wasn’t limited to just those institutions (99% of stocks in the group were up) that could be expected to most benefit from the financial overhaul package proceeds through Congress; it was approved by members of a House and Senate committee.  The best thing to come from it may have been this quote from Rep. Jeb Hensarling:  “My guess is there are three unintended consequences on every page of this bill.”  Nevertheless, the consensus of views seems to be that the package that emerged was less worse than it could have been.  For example, instead of prohibiting the focus seemed to be on limiting activities.
• Dick Bove (bo-vay) is with Rochdale Securities (rock-dale) and is an analyst who has made some bad calls (buy Lehman Bros. three weeks before it collapsed) and some good calls (sell Lehman Bros. four months before it collapsed) on stocks.  He sees any costs of the regulation getting–you know what–passed on through higher product prices.  According to him, “everybody else will be negatively impacted by this bill, but not the banks.” (Unintended consequence #1).  As a result, he thinks the bank stocks should be bought now.
• Markets took off on Monday morning–especially the natural resource companies–on news that China would allow its currency to float more freely, but it would be an orderly process, over time.  It would also be based on a basket of currencies; not just the buck.  The rally was short lived, however, lasting, as usual, until about 10:00 in the morning.  Upon closer inspection and reflection, the market realized the revaluation wasn’t going to take place by Tuesday.  A senior investment officer was quoted in a Bloomberg story as saying, “a closer look at the announcement suggests China’s approach is very gradual and it is continuing at its own pace.  It’s a less dramatic move when looked at more closely.”
• Australia’s now-former Prime Minister, Kevin Rudd, was ousted seven weeks after he proposed a widely-hated 40% tax on mining operations and replaced by Julia Gillard*.  That’s known as killing Aesop’s gold-egg-laying goose.  Call it geocentric, but I don’t understand how these things work.  For example, why didn’t he just do like we did in elementary school and take it back, as in “I take it back.   I was just kidding.”  One would think that with that sort of profit relief, combined with an appreciation of the currency most likely to buy all your stuff, that the mining stocks would have had a good relief.  One would have thunk wrong, as the chart at right attests.

*  If you’re like me and you rushed out to Google (the verb) ”Julia Gillard”, you might have noticed that Google offered, helpfully, that you might want to Google “Julia Gillard ears,” and for good reason it turns out.  Her ears–more specifically, her ear lobes–are spectacular, as you can see at right.

• Apple’s iPhone 4 was released this week, and the Company responded to buyer complaints about reception by saying that users should . . . uh . . . hold the phone differently.  More formally, “Gripping any mobile phone will result in some attenuation of its antenna performance, with certain places being worse than others depending on the placement of the antennas.”  This version of the iPhone includes a high-definition video camera, multitasking, video calling, and other lust-inducing features.  The stock didn’t go on sale, however.  It hit $279.01 on Monday, and is selling for $267.75 as I type.  The problem with the stock is–ask yourself this: 

[WARNING:  SERIOUS DIGRESSION AHEAD]

is there a better consumer products company out there?  are there any Apple products you wouldn’t love to have? is there a company with a brighter future?

• Now ask yourself this:

is there anyone else who disagrees with you?

• Now I’ll tell you this:  48 of Wall Street’s best and brightest lemmings stock analysts cover the stock in their research.  Amongst the S & P 500 companies, only Intel is covered by more (55) analysts.  45 of the analysts that cover AAPL say it should be bought, while just 3 have a dimmer view, and they just say hold it, which seems reasonable, given the stock’s ascent.  What that means is that there aren’t many analysts who can join the fold of AAPL fans, recommending customers of buy it.  It’s more likely that they become disenchanted with stock and recommend that customers of said analysts firm hold it–or far worse, and, frankly, far less likely–sell it.
• This is another example of why good companies don’t always equal good investments.  In the interest of full disclosure, however, we hold AAPL widely, but the contrarian side of us is leery.

A word on analysts and my disdain for them . . .  Generally speaking, a stock analyst’s job is this–and the best get paid seven figures (and that’s not like my seven figures, which includes two decimal places and the dollar sign): bring in more lucrative business for the analyst’s firm forecast company earnings and determine what price the stock will trade at when those earnings are discounted in the stock price.  To do that an analyst will use a number to tools, but they boil down to two forms: 

1. discounted cash flow models
2. models that apply valuation multiples to the earnings. 

They come up with earnings by any or all of the following means:

1. talking to company management
2. talking to suppliers
3. considering demographics
4. looking at the company’s products market size–present and future
5. gauging consumers’ uptake of the products and/or services
6. using mathematical models to predict using statistical techniques that might incorporate the points above

In the case of AAPL, there are 48 analysts doing this.  It’s not likely that they’ve left a stone unturned in their efforts. 

What’s more, the vast majority of these analysts are steeped in fundamental analysis–the majority, I’m sure, have CFA, for Chartered Financial Analyst, after their names–which means they believe that prices are determined by fundamental factors only, rather than that prices are determined as if at auction, which is to say, by the forces of supply and demand.

So what is one to do?  Why, hire a professional, of course (click here if you need a suggestion of one.)  Really, though, analysts do serve a useful purpose–and I should add that not all of my colleagues share my disdain for analysts–and that is as reporters of what’s going on at companies, but you should take ignore ratings and price targets with a bucket of salt.

The intent of this blog isn’t to make investment recommendations, especially on individual securities.  Rather, it’s intended to showcase how we think about things and what we think about things, but bigger things, like the economy and broad asset classes, not individual stocks and bonds, so don’t construe what follows as a recommendation.  If you must, use a predetermined stop-loss to protect your capital, because if it doesn’t work out, you’re not going to hear about it again from me; it’s going under the internet rug.  Only if it soars will I mention it again.

Our friends at the Williams Inference Center (WIC) began, a while ago, to bring up PayPal as a way that consumers and others were doing an end-run around banks and other financial intermediaries, but especially the credit card banks and processors.  PayPal makes its money by working the float, or the funds it has its mitts on before its users download the funds into traditional accounts (e.g. savings and checking accounts.) PayPal is owned by ebay, naturally, and so we began to watch the stock.  WIC is exceedingly good at spotting nascent trends. It’s our jobs to determine what securities might benefit/suffer from such trends.  One group of securities we’re going to avoid for a while is the credit card companies (Visa, Mastercard) and the banks the rely heavily on credit card processing revenues.

We do like ebay’s prospects, especially as they relate to PayPal vis-a-vis the WIC observation and, more importantly, as they relate to stock performance.  The stock has triggered several technical indicators we like to watch, but which are not being given away here, and the analysts are fairly skeptical about the stock.  There are 31 analysts that cover the stock, which is a lot (in the top 10% of the S & P 500), but just 16 of them say to buy the stock, the balance say hold (14) and sell (1).

This Week

Funny that economists are called the dismal scientists when they’re so consistently optimistic.

Housing data was lousy this week on three of four counts.  Existing Home Sales fell by 2.2%, which was far worse than the dismal scientists’ hoped-for 6.0% increase.  Similar optimism about New Homes Sales was also disappointed, as those sales rose by 300,000 in May, whereas economists had looked for a rise of 410,000.  Mortgage Applications fell by (-)5.9%, which was driven by a 38.9% drop in Purchase Applications and a 3.8% drop in Refinance Applications.  The positive datapoint came from the Home Price Index, the broadest measure of home prices across the nation, which rose by 0.8%, which was better than what economists had hoped for and March’s figure (both 0.3%).

Two consumer confidence figures were released this week:  ABC Consumer Confidence, which is released weekly, and University of Michigan Consumer Confidence, which is released twice per month.  Both improved modestly, as can be seen below.  U of M Confidence is at the highest levels since 2008, while ABC is sitting below serious–what one would refer to when looking at a security’s price–serious resistance at -41, the peak seen several times in 2008, 2009, and 2010.  In the same way, a breakout through the resistance will provide the most rudimentary indication of a trend change, a higher high.

Initial Jobless Claims fell to 457,000, which was better than economists expected (463,000) and lower than the week prior’s upwardly-revised 476,000.  Still, the series made no progress with respect to providing any clarity to the current sideways motion.  Finally, Q1 GDP was revised down, from 3.0% to 2.7%, on weaker Consumer Spending data.

Next Week

There’s a lot being released next week, but everthing is dwarfed by the release of nonfarm payrolls.

Key indicators to watch

• Nonfarm Payrolls – Friday – while there are other important indicators, this one is the most critical.  Economists expect a decline of (-)110,000 jobs, and the range of estimates is firmly in that neighborhood.  There are 50 estimates, and they range from -200,000 to zero.  There isn’t one economist amongst the group who expects a positive number, and that appears to be a result of layoffs of census workers.  One source of ours said that half of the workers hired in May were let go in June.  Manufacturing Payrolls, however, are expected to have risen by 20,000.  The Unemployment Rate is expected to have increased by 0.1% to 9.8%. 

Housing indicators

• CaseShiller Home Price Index (April) – Tuesday
• Pending Home Sales (May) – Thursday

Lesser indicators

• Chicago Federal Reserve National Activity Index (May) – Monday
• Personal Income, Spending, and Saving (May) – Monday
• Dallas Federal Reserve Manufacturing Activity  (June) – Monday
• Chicago Purchasing Managers index (June) – Wednesday
• Initial Jobless Claims – Thursday

Graig Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Below

• BP et al
• Slow week in economics, but positive stuff, largely
• Next week is chock full

Prior posts

• Wanna visualize the BP oil spill?

Capital Markets Recap

[Insert clever prose before market recap here]

Top Stories (all but the first one from Bloomberg)

• We think we’re the only investment shop in town where a Bloomberg terminal sits on each investment guy’s desk.  That happened this week, and we’re convinced it’s going to result in more productivity, more requests for additional flat panels, and more time wasted watching Bloomberg TV.

BP et al news

We continue to think the selling has been overdone–in both the stock and the bonds.  There is increasing talk over the dividend being cut, and Madame Speaker Pelosi is attempting to dictate to a foreign company that it pay damages–which are likely to be determined over years, not months–before it pays the dividend.  We’ve bought some of the short-term bonds of the company, as well as those of Anadarko Petroleum and Transocean.  Mind you, these are short-term bonds–as short as eight months–but with monster yields between 6 – 9%, and the first bullet point below speaks to the financial condition of BP.

• BP has “Unlimited Flexibility” to Incur Debt, Credit Firm Says – the story says that BP’s existing debt obligations don’t have covenants that would restrict its ability to issue more bonds.  It goes on to say that any of the company’s $240 billion of assets could be pledged as security for new bonds.  Market participants couldn’t care less based on Credit Default Swap pricing, which is shown at right.  Our top-notch Gimme Credit bond service agrees (“We nearly drove off the road this morning when CBS cited a NY Times article saying that bankers and lawyers are “sizing up potential deals” to sell off BP in conjunction with a prepackaged bankruptcy.”)
• Shale Gas Well Blowout Raises Specter of New BP – one way or another, we’re looking at higher energy prices.  The leakage in the Gulf is a drop in the bucket of daily global demand (~80 million barrels), but its effects (i.e. regulation) is going to dwarf the impact of the spill.
• Hercules, Shallow-water Drillers Lobby to Ward Off U.S. Curbs
• BP Default Risk Rises Amid Increased Estimate for Size of Leak
• BP Chairman Svenberg to Meet With Obama on Oil Spill
• Senate’s Graham Says Spill Not Obama’s Fault - uh, duh?
• Spill May Cost Homeowners $4.3 Billion in Property Values Along Gulf Coast – uh, isn’t this sort of like building along a golf course?  Lemme guess, they’ll want paid. 

Other stuff

• Texas Instruments Increases Second-Quarter Forecast
• National Semiconductor Shares up After 4Q Profit
• Honda Extends China Factory Shutdowns as Worker Unrest Widens – this one bears watching.  Companies in China are throwing around raises you and I can only dream of.  A Taiwanese supplier of Apple components, Foxconn, which has factories in China, are offering raises of 70% and more, in an effort to head off worker unrest.  Eleven Foxconn workers have committed suicide, by pitching themselves off buildings, allegedly over working conditions.  I am not making this up:  the company responded by–in addition to the raises–installing safety nets in buildings.  If only at the margin, moves like this decrease the competitiveness of Chinese-made products.  The flipside of that is that higher wages for Chinese workers should induce them to become bigger spenders.  Our Williams Inference Center (update coming soon) sees this as one part of a global normalizing of wages.  Guess who they see coming down.  The U.S.
• SEC Approves Halts for S & P 500 Stocks That Move 10% – In an effort to head off days like the flash-crash Thursday of a few weeks ago, the circuit breaker will pause trading for five minutes when an S & P 500 stock rises or falls by more than 10% in five minutes or less.  The test will last through December 10.  Why just a test?  Why just December 10?  Why just S & P 500 stocks?

Just wierd

• Cemetery Luring Brides Lets Indonesians Land Helicopter at Plot
• Why Beer Can Shortage Means Brazil Will Boost Rate

This week

There wasn’t much going on this week in the land of economics.  Of three releases that I highlight here two were positive, one negative.  The downer was Initial Jobless Claims, which rose by 3,000 instead of falling by 3,000, which the dismal scientists expected.  To be fair, 3,000 jobs in a multi-million count workforce is a drop in the labor pool.  Still, the figure got us a week closer to resolving the trend ambiguity, as manifested in the chart at right.  We’ll watch for a break through one of the trend lines to determine its direction, but the 4-week moving average (inset) is moving up.  Simple stuff, but this is Fort Wayne.

On the postive side were the NFIB’s survey of Small Business Optimism and University of Michigan Consumer Confidence.   The former has almost recouped all of the deterioration that ensued following Lehman Brothers’ shuttering.  What’s more, the 3- and 12-month moving averages are heading up, and the decline in the 5-year moving average is flattening out.  The University of Michigan survey has reached a new, post-2007 high.  With stocks rallying hard last year, it eclipsed the Lehman Brothers’ high in June 2009.  We’re hearing increasing chatter about fears of the dreaded double-dip  recession, but from a look at these series, there doesn’t seem to be much overt fear of it.

Next week

In contrast to this week, next week is chock full of economics fun.

Key indicators to watch

• Initial Jobless Claims – Thursday – it’ll be in this section for a long, long time, and it’s especially important for the near term given the trend issue mentioned above.

Housing indicators

One our services has suggested that, with the first-time homebuyer credit, a lot of 2011 sales were pulled into 2010, and that is likely to lead to a double-dip in housing prices, so we’re not out of the subdivision yet.  Like jobs, housing indicators will be key for several more years.

• NAHB Housing Market Index
• Mortgage Applications
• Housing Starts
• Building Permits

Lesser indicators

• Empire State Manufacturing
• Philly Fed
• Producer Price Index
• Consumer Price Index
• Industrial Production
• Capacity Utilization 

Graig Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors

Fort Wayne  ≡  Bangkok  ≡  Paris