• Market recap
• Facebook
• Nonfarm Payrolls Report

Capital Markets Recap

Top Stories

The Facebook IPO continues to garner a lot of attention. Here’s a great video on the subject.

This Week

There was one economic release that mattered this week, the monthly Nonfarm Payrolls Report. It was far better than expected, with 243,000 jobs added versus an estimate of 140,000. In addition, December’s figure was revised upward by 3,000. Private Payrolls grew by 257,000, also above expectations (+160,000); December revised up 212,000 to 220,000. Likewise, Manufacturing Payrolls grew by 50,000 instead of the anticipated 50,000; December revised up from 23,000 to 32,000. The Unemployment Rate fell to 8.3% from December’s 8.5%, while the Average Workweek grew by six minutes.

Among those commenting on the numbers was Mohamed El-Erian, of New-Normal/PIMCO fame, who said, in a Bloomberg, interview that the numbers were “really good,” but that there’s still some structural employment problems (read: skills mismatch), while a Deutsche Bank economist said that 200,000+ per month for 12 are needed to bring down the unemployment rate by 1%.

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• Capital Markets Recap
• Amazing earnings
• Muffins

The Dow Jones Industrial Average is a dinosaur, created in a time when computers didn’t exist. Accordingly, it was created in a way that was easy to calculate. Holding in the DJIA are weighted by price, so an $80 stock has twice the weight in the index of a $40 stock, and that can often lead to distortions when the highest-priced stocks have significant moves. Today, that’s what happened. Just three stocks contributed 55% of the index’s drop.

Top Stories

A local financial institution with which I am well acquainted announced record earnings this week. Tower Financial, as you can read from the linked press release, my employer, announced that it had record core earnings in the fourth quarter of 2011 and for the full year. The quarter’s earnings were $2.8 million, for the full year, $10.1 million. Core earnings is another of saying no-fluff earnings. Core earnings are what we earn doing banking stuff. If we throw in some fluff, like a deferred tax asset that flowed to the bottom line, but which is really just an estimate of a future tax benefit, we had record earnings of $3.4 million for the quarter and a monster $6.6 million for the year. You can click here to view the entire press release.

As usual, Fort Wayne’s Journal Gazette just couldn’t say enough about our phenomenal results, as you can see below in the gushing write-up.

Tower’s earnings more than double

Tower Financial Corp. on Thursday reported record annual earnings of $6.6 million, or $1.36 per diluted share, for 2011. The results were more than double the $3.2 million, or 69 cents a share, posted for 2010.

The Fort Wayne-based parent of Tower Bank also reported record fourth-quarter earnings of $3.4 million, or 71 cents per diluted share, a four-fold increase over the $884,000, or 18 cents a share, reported for the same three months of the prior year.

Michael Cahill, Tower’s president and CEO, in a written statement, described the results as “a significant milestone” for the company. But, he added, that work isn’t complete.

“We still have significant opportunities to expand our impact in our local communities, improve our service levels and efficiencies, and acquire new customers,” Cahill wrote.

Muffins

I didn’t have time to do a proper Weekly Recap, so here’s my daughter’s recipe for Pumpkin Apple Streusel Muffins (her artsy photo), which she got from another blog. Sorry; that’s going to have to suffice. Click on the recipe to go to the blog from whence it came.

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This is the story of my day and, thus, this blog posting…

Capital Markets Recap

Markets are behaving nicely, and I think this is why. The chart below shows three panels. In the first one is charted the cost to insurance against sovereign debt defaults by Italy and Spain (5-year debt, both). Since autumn, Credit Default Swaps on the two countries have settled down. In conjunction with, and reflecting that, the risk–implied volatility from option prices–of European stocks has been declining (panel 2). Behold, (panel 3) European stocks are rising. It appears that the market is confident the European authorities are committing to keeping a cap on rates. In addition, with inflation coming down in the region–a natural consequence of the deleveraging going on there–the European Central Bank, with its memories-of-the-Weimar-Republic focus on inflation, should be able to breath easier and–speaking of easier, make its monetary policy easier without having to worry about runaway inflation.

Top Stories

This S&P 500 earnings season is getting started slowly, just 47 companies reported results this week. Analysts have ratcheted down their numbers for the Q4 reporting season, but their overall number (+9%, I think) had the wrong sign on it for this week, when reported earnings were down, on average, by (-)8.58%. The worst results came from the Materials sector, but the sector has the highest positive surprise. Financials were just lousy, reporting -27% earnings growth and a hurdle that wasn’t low enough (-11% earnings disappointment.)

I think, though, that the season will prove to be a good one. No one will care that earnings in the period ended December 31 were lousy so long as the forecasts are rosier, and the environment seems rosier. Our internal economic strength numbers are reflecting that, as are the reports we get from our Key Strategy Providers.

This Week

There were a couple of economic series that stood out this week, and two of them were related to housing. First, the MBA Mortgage Application index increased by 23.1% in the last week. It’s a simple translation: mortgage applications were up by 23%. The trouble with this series is that it’s been driven largely by refinancings and not purchase applications. That was pretty much the case last week, too, although purchase applications did rise. Since the end of 2011 purchase applications are up by +20%; refi applications, +31%.

Next, the index that records sentiment of the homebuilders, themselves, the NAHB Housing Market Index, reached its highest level since 2007. I’m not sure what’s supporting that, however, as Housing Starts fell this week (-4.1%). It appears, though, that the sentiment index has some leading tendencies, so perhaps we’ll see a corresponding pickup in starts.

Here is what’s helping to bolster the morale of homebuilders–well, 25% of them, at least, which is what the index measures–Prospective Buyer Traffic and Current Sales. Odd, though, that the traffic isn’t feeding into future sales…

Here’s what we think the NAHB index implies for Housing Starts. At the current reading, starts ought to be north of 1,000. Yeah, it’s just maths (as the English say), but it’s maths.

The other, almost stunning, economic release came in the form of Initial Jobless Claims. They fell by a whopping 12.4%, or by 50,000 bodies. There are two caveats that need to accompany the figures, however. First, winter is a notoriously volatile time. Second, the week included the MLK holiday and that requires the states to estimate filings, which will, necessarily, be wrong.

Next Week

See the Guess Who song at the top.

Graig Stettner, CFA, CMT

Chief Investment Officer

Tower Private Advisors

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• France, Italy, and other countries downgraded by Standard & Poor’s
• 4th quarter earnings season commences
• Increasing number of workers willing to voluntarily quit their jobs

Capital Markets Recap

Top Stories

• It was leaked–as it was for the U.S.–that France would lose its AAA credit rating, dropping to AA+. Apparently, Standard & Poor’s gives a 12-hour advance notice to governments of countries being downgraded. As someone from brokerage firm Miller Tabak put it, what politician can keep news like that quiet. This shouldn’t have surprised markets much. When the U.S. was downgraded, it was roundly noted that any decision not to downgrade France, which looks worse than the U.S., would be assurance that the U.S. downgrade was politically motivated. Italy drops to BBB+.
• Apple said the iPad3 will have better screen resolution, have a faster processor, and be able to work on next-generation wireless networks. It’s supposed to go on sale in March.
• Raymond James is buying the brokerage house Morgan Keegan from Regions Financial, as that financial institution rushes to shed assets.
• Record high correlations amongst stocks lead to, in 2011, funds trailing the S&P 500 by the widest margins since 1997.
• The fourth-quarter earnings reporting season kicked off this week, with, as usual, Alcoa leading the way. The company reported its first quarterly loss since 2009. So, what’d the stock do? Well, naturally, it rose.

• The earnings season begins in earnest next week (just 4 companies reported this week) and then 123 the following week. I’ve seen data that suggests that analysts are overly pessimistic with respect to earnings. That results in a lowered bar and might allow for some nice earnings surprises.

This Week

The NFIB released its Small Business Optimism index this week. It rose from November’s level (92.0) to 93.8 in December. While the index has rebounded to exceed pre-recession levels, it remains about 5% below the average level, as can be seen below.

Here’s a bit of happy news. Every month, the Labor Department releases its JOLTS (Job Openings Labor Turnover Survey.) It reports on job openings and job separations. While job openings remained at 3.2 million in November, separations rose to the highest level since August 2010. Part of that was a result of an uptick in the Layoff Rate, the rate of Voluntary Quits rose to its highest level since September 2008. Voluntary quits are usually a sign of confidence in an improving labor market. The index, however, has only existed since late 2006. Still, we shouldn’t look a gift horse in the mouth.

Initial Jobless Insurance Claims rose quite sharply this week, from an upward-revised 375,000 to 399,000. According to a Bloomberg news story, that raises fears that temporary holiday hiring may be reversing.

Hiring by package delivery companies and retailers during the holidays to meet demand for gifts may now be giving way to an increase in dismissals. At the same time, claims figures are subject to greater volatility during this time of year, as the government has trouble adjusting the data for the seasonal swings in employment.

So, smooth the data! Here it is with a mid-2011 regressed trend (still heading down), a 1-month smoothing (heading up), a 2-month smoothing, and a 3-month smoothing (heading down, but just slightly.) It may be difficult to adjust, but so far the indications seem to be that the trend will continue.

The week’s last economic release was the University of Michigan Consumer Confidence index. With a jump to 74.0, it’s back to May 2011 (74.3) levels and isn’t that far from the post-recession high of 77.5. Still, taking a look back at the four prior recessions (1980, 1982, 1990, 2001), the current reading is only above the average post-recession reading of the 1980 recession.

Next Week

Key indicators to watch

• Empire State Manufacturing index (Tuesday) – January
• Producer Price Index (Wednesday) – December
• Industrial Production (Tuesday) – December
• Capacity Utilization (Tuesday) – December
• Consumer Price Index (Wednesday) – December
• Initial Jobless Claims (Thursday) – weekly
• Philadelphia Federal Reserve index (Thursday) – January

Housing indicators

• MBA Mortgage Applications (Tuesday) – weekly
• NAHB Housing Market Index (Wednesday) – January
• Housing Starts (Thursday) – December
• Building Permits (Thursday) – December
• Existing Home Sales (Friday) – December

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• Festival of charts
• Earnings season about to kick off
• 200,000 jobs added in December
• Unemployment rate drops to 8.5%

Prior posts

• Where did all the jobs go?
• Some new features

Hey, if you like this post–or any other–you can click the e-mail icon at the very bottom to send it right to a friend. I don’t know how most of social media works, but you can add it to your Facebook page, Tweet it, Digg It, StumbleUpon it. You can also subscribe to future updates in your blog reader or iGoogle. Do that with the subscribe button, which ought to be northeast of this sentence. Speaking of stumbling, this blog is stumbling headlong into 2010.

Capital Markets Recap

Top Stories

• Fed Policy Makers Urge More Housing Aid – indeed, Bank of America rallied hard on Thursday (+9.7%) on hopes of a White House plan to ease refinancing of existing mortgages. An unnamed source at Tower Bank with the initials Steve McElhoe said something like… current for three months on payments=refinance with no appraisal, no credit check. Click here to send Steve an e-mail to get in line.
• Stocks Show Too Much Earnings Pessimism, Citigroup says – “investors appear to be bracing for a 20 percent earnings decline in 2012,” Buckland wrote. “This seems too pessimistic, even for recessionary Europe.” Bloomberg published the following chart showing that world stocks are 23.5% below their average price:earnings ratio of the last forty years.
• Inventory Restocking to Propel U.S. Manufacturing
• Lampert Cuts AutoZone as Clients Pull Money Amid Sears Losses – Eddie Lampert is the CEO of Sears and also runs a hedge fund. Thought at one time to be the savior of Sears, he has instead been a flop.
• Earnings season kicks off next week, with six of the S&P 500 companies reporting. As usual, Alcoa will lead the charge.
• In my opinion, the barometer for the crisis in Europe is comprised of yields on Spanish and Italian sovereign debt. Recently, those rates have begun to kick back up, as can be seen below.

• The Federal Reserve’s Open Market Committee released the minutes of its December 2011 meeting, and here’s what they looked like, according to Wordle. Wordle clouds are created from text, with the most frequently occuring words showing up the largest.

This Week

As I mentioned last week, there weas really one report that mattered today, and that was/is the Nonfarm Payrolls report. As they say, it came out better than expected. Economists had expected 155,000 jobs to be created; the survey said 200,000 jobs were created, 212,000 of them (hello?) were in Private Payrolls. Some higher level math indicates that the government sector contracted in December by (-)12,000. Manufacturing payrolls grew by 23,000, far better than the 6,000 increase economists had expected. That data all comes from the Establishment Survey, a survey of about 160,000 companies and government agencies. The Unemployment Rate, however, comes from the Household Survey, which surveys about 60,000 households (source: Shadow Government Statistics). As you might imagine, the establishment survey doesn’t catch any self-employed or workers from home, nor does it capture the smallest employer.

There are three important numbers in the household survey:

1. Civilian noninstitutional population (16 years and over)
2. Civilian labor force 
3. Unemployed

The labor force is made up of those who are employed and unemployed. Easy enough, right? Not so fast. If you were camped out in Freimann Square during the week of the survey, holding up a sign that says, “We are the 99%. Give us back our government,” you might have had a hard time looking for a job during the survey week. According to the Bureau of Labor Statistics, you would have been considered neither employed nor unemployed; you would be considered “a person not in the labor force.” To be considered unemployed you have to have lost a job and be actively looking for a new one.

From these three statistics, two bigger statistics are determined. The Unemployment Rate is #3 divided by #2. The Labor Force Participation Rate is #2 divided by #1. Several dynamics arise from this. First, the population is generally always rising; it’s inexorable. Second, the labor force fluctuates based on, generally, the economy. Employment rises as the economy improves; those looking for jobs expect better job hunting prospects as an economy improves. Both conspire to swell the labor force and vice versa. The third changes in the same way. From the other side, as the economy weakens more lose their jobs and continue to look for new ones; they are the unemployment rate. Others get discouraged, give up looking for jobs, and, thus, leave the rolls of both the unemployed and the labor force.

All that leads to a conundrum or paradox or whatever you call it. A deteriorating economy can produce a lower unemployment rate, and an improving economy can produce a rising unemployment rate. Consider a country with a population of 100,000. In our country, in month one, 60,000 are considered to be part of the labor force; 30,000 of them are unemployed by looking for employment. Therefore, the unemployment rate = 50%. In month two, bizarrely, the population remains unchanged at 100,000, but half of the unemployed have given up looking for jobs. The labor force falls by 15,000 to 45,000, while the unemployed fall from 30,000 to 15,000. To get the employment rate we divide the unemployed (15,000) by the labor force (45,000), and, voila, the unemployment rate falls to 33%! In contrary fashion, an improving economy can produce a pool of unemployed–via increasing job seekers–that grows faster than the labor force and, thus, raises the unemployment rate.

That’s all a long-winded–as usual–way of saying that we have to look at more than just the unemployment rate. We also have to consider the labor force. In December, it fell by 50,000 (-0.03%) from November. The unemployed, however, fell by far more, 226,000 (-1.70%), leaving us with an unemployment rate of 8.5%, down from 8.7% in November. We should, eventually, see a rise in the unemployment rate as new job seekers swell the ranks of the unemployed.

What follows is a series of charts related to the labor force.

First, here is a look at the Labor Force going back to 1984. It’s not seasonally adjusted, but from the repeating, saw-tooth line, it’s clear there are seasonal patterns. The labor force swells when school’s out and shrinks when it’s back in session, etc.

So, that’s why certain series are reported as Seasonally Adjusted. In the chart, below, the same series has been seasonally adjusted.

For all the conspiracy theorists–and they’re out there…”but the non-seasonally adjusted data tell a different story…”–here’s what they look like together.

On the next chart you’ll see the labor force along with the population. Notice the unrelenting advance of the population. Notice the erectile disfunction in the labor force…just sorta peters (sorry) out after 2007 and doesn’t come back.

Dividing the labor force by the population produces the Labor Force Participation rate, which is shown in the bottom panel, below. I mentioned in early December that the labor force participation rate hasn’t been this low since 1984.

Here’s one last look at labor force participation. The same percentage of a number that’s 36.6% larger is a number that’s 36.6% larger–brilliant, I know. That leaves us just 206,000 short of 100,000,000 who are not in the labor force that could be. I think that’s pretty scary, and if you want to know what’s even scarier, read the series of articles referenced in this post. Some jobs have been completely destroyed, vaporized.

Next Week

Key indicators to watch

• NFIB Small Business Optimism (Tuesday) – December
• JOLTS – Job Openings and Labor Turnover Survey – (Tuesday) – November
• Initial Jobless Claims (Thursday) – weekly
• University of Michigan Consumer Confidence (Friday) – preliminary January

Graig P. Stettner, CFA, CMT

Chief Investment Officer

Tower Private Advisors

With offices in:  Bangkok  |  Fort Wayne  |  Paris  |  Craigville 

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No, that’s not a tractor idled for lack of work. It’s what’s behind the picture above it…sorta.

In early December the Weekly Recap included a deeper-than-usual look into the U.S. employment picture, including a discussion of the Labor Force Participation Rate, which had reached its lowest level since 1984. There are a number of factors behind that and others

 indicative of a jobs problem we have here. I think the single-biggest culprit behind the job disappearing act is increased productivity. For example, at the main office of the Allen County Public Library, it’s now possible to walk in, find and check out books and videos, renew one’s library card, and validate a parking ticket–all without talking to anyone, something of which I’m especially fond. I mentioned the library’s culpability in our employment crisis to a staffer there, and, according to her, indeed, by means of attrition, those jobs will be vaporized.

‘Need more anecdotal evidence? We recently met with the Williams Inference Service folks and, amongst other–as-usual–intriguing articles, they featured one from the WSJ titled, “Teaching Drones to Farm.” The first sentence was this: “[m]akers of agriculture equipment are exploring a new frontier: farming without the farmer.”

All emphasis that follows is mine.

Kinze, with the help of Massachusetts-based Jaybridge Robotics, is developing two products aimed at easing the time and labor crunch farmers can face. The drone technologies can seem like ghost-like as a tractor crosses a field with no one in the cab.

Kinze’s autonomous planter would determine the most efficient route to plant a field and the do the sowing without a driver. A system of sensors ensures the tractor doesn’t run into any unexpected obstacles such as a fence post or stray farm animal. The technology has become feasible to incorporate into agriculture because of its growing use in automobiles where it has driven down costs.

As for the harvest, a farmer still would need to operate a combine, but a cart positioned next to the combine to receive grain would be autonomous. The cart would keep pace with the combine, and once full, proceed to a waiting truck at the edge of th

e field being harvested. Ultimately the farmer would need two people, rather than three, to harvest the grain.

You can shake your head as you [gotta] watch the video below. At first it appears to be a rural version of one of the Speed movies–just to prove they could be worse–until the tractor carefully turns around.

 And Williams Inference popped back into me mind as I read a blog post on “For The Win; Random musings on venture capital, among other things.” The chap that keeps up the blog claims that we worked for Mitt Romney (“I started my investing career doing leveraged buy-out deals at Bain Capital, working directly for Mitt Romney”). In his post, Job Creationism–once you get past the lurid picture of Adam and God that adorns the Sistine Chapel–he provides an interesting perspective on job creation–from the viewpoint of one who was creating jobs:

“For the first 3 years of my venture career, until the spring of 2000, I did indeed “create jobs” right, left and center. All of my companies were hiring anyone who had a pulse. Fortunately, I was lucky enough to exit many of those investments before the music stopped, but by the summer of 2000, it was clear that all of us in the venture industry had created a few too many jobs, frankly.

He later cites some statistics supportive of my contention, above, and certainly the contention of the article that follows, below.

Let’s look at the newspaper industry (just in case I haven’t depressed you enough already.) In 1990, the industry employed 460,000 people. Today it employs 250,000, and is projected to shrink to 180,000. The two companies who sucked all of the profits out of that business, Google and Craigslist, collectively employ about 25,000 people (Craigslist makes up 30 of that number. Not a typo.) So, did the heroes who founded and funded Google and Craigslist create 25,000 jobs, or did they destroy a quarter million jobs?

In a recent meeting with the Williams Inference service, their folder titled “Ghost in the Machine,” featured an article, which I highly recommend, from the McKinsey Quarterly (‘The Second Economy; Free registration required) After walking through the modern airport flight process equivalent of my library example, the author posits that there is a second economy that is unseen, lurking behind the scenes. He calls it digitization, and he estimates that if–based on what seem like reasonable assumptions–it continues to grow as it has since 1995, it’ll overtake the size of the 1995 physical economy by 2025. He likens this second economy to what is unseen below an acre of Aspen trees.

If I were to look for adjectives to describe the second economy, I’d say it is vast, silent, connected, unseen, and autonomous (meaning that human beings may design it but are not directly involved in running it). It is remotely executing and global, always on, and endlessly configurable. It is concurrent–a great computer expression–which means that everything happens in parallel. It is self-configuring, meaning it constantly reorganizes itself on the fly, and increasingly it is also self-organizing, self-architecting, and self-healing.

These last descriptors sound biological–and they are. In fact, I’m beginning to think of this second economy, which is under the surfae of the physical economy, as a huge interconnected root system, very much like the root system for aspen trees. For every acre of aspen trees above the ground, there’s about ten miles of roots underneath, all interconnected with one another, “communicating” with each other.

Skipping ahead by several pages…

Physical jobs are disappearing into the second economy, and I believe this effect is dwarfing the much more publicized effect of jobs disappearing to places like India and China.

There are parallels with what has happened before. In the early 20th century, farm jobs became mechanized and there was less need for farm labor [GPS: and now we can digitize the mechanization!], and some decades later manufacturing jobs became mechanized and there was less need for factory labor. Now business processes–many in the service sector–are becoming “mechanized” and fewer people are needed, and this is exerting systematic downward pressure on jobs. We don’t have paralegals in the numbers we used to. Or draftsmen, telephone operators, typists, or bookkeeping people. A lot of that work is now done digitally. We do have police and teachers and doctors; where there’s a need for human judgment and human interaction, we still have that. But the primary cause of all the downsizing we’ve had since the mid-1990s is that a lot of human jobs are disappearing into the second economy. Not to reappear.

 All the soundbytes and voter-pandering press conferences aside, that’s going to make the job of one of these cats very difficult when it comes to “creating jobs.”

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• Doug Kass’s 2012 list of surprises
• Meredith Whitney lambasted for muni bond call
• Mixed bag of economics

Capital Markets Recap

Every firm is rolling out its version of 2012 lists and forecasts. From what I’ve read, it seems to be more of the same–2012 will look like 2011. If anything, the second half might be better than a rocky first half. If you’re tired of all the slit-your-wrists doom and gloom, check out hedge-fund guy, Doug Kass‘s list of 2012 Surprises. In a slightly different vein, they’re possibilities that few others are anticipating. He has enjoyed a pretty good track record with these. The original story can be found here.

1. The U.S. stock market approaches its all-time high in 2012.

2. The growth in the U.S. economy accelerates as the year progresses.

3. Former Presidents Bill Clinton and George Bush form a bipartisan coalition that persuades both parties to unite in addressing our fiscal imbalances.

4. Despite the grand compromise, the Republican presidential ticket gains steam as year progresses, and Romney is elected as the forty-fifth President of the United States.

5. A sloppy start in arresting the European debt crisis leads to far more forceful and successful policy.

6. The Fed ties monetary policy to the labor market.

7. Sears Holdings declares bankruptcy.

8. Cyberwarfare intensifies.

9. Financial stocks are a leading market sector.

10. Despite the advance in the U.S. stock market, high-beta stocks underperform.

11. Mutual fund inflows return in force.

12. We’ll see merger mania.

13. The ETF bubble explodes.

14. China has a soft landing (despite indigestion in the property market), and India has a hard landing.

15. Israel Attacks Iran.

Late in August 2011, I posed the question of what price gold would be at year end. A handful of hardy souls submitted their carefully-wrought forecasts. Gold was about $1,850/ounce at the time, and only about 10% of guesses were for a price lower than that. It’s going to close about $1,565 today, about 16% below that August price. Two guessers both said $1,500, so those two folks will each receive an Amazon gift card.

Top Stories

You might recall that, one year ago, the municipal bond market was in an uproar. Analyst Meredity Whitney had appeared on 60 Minutes, suggesting that there would be $50 – 100 billion in municipal bond defaults. Many publicly derided her, and we certainly didn’t sell any municipal bonds because of the story. In fact, there were great values to be had, as folks dumped the bonds like bad habits. David Kotok of Cumberland Advisors–who, by the way, has the best free e-mail service around (click here to sign up)–was one of those folks who loudly derided her claims. In an e-mail this week, he cites a post on the Huffington Post website that is a S C A T H I N G response one year on. You can read the Cumberland Advisors recap, which includes the Huffington Post article in its entirety, by clicking here. The title of the piece is “2011: The Year 60 Minutes Misled Americans About Municipal Bonds.” If you own municipal bonds you owe it to yourself to read it. Here are a couple of excerpts:

• 60 Minutes let a pundit claim these problems translate into near-term massive municipal bond defaults. Meredith Whitney, the pundit, had written a report, “Tragedy of the Commons,” which supposedly backed her claims.
• Contrary to 60 Minutes’s assertion, Meredith Whitney, a banking analyst, did not have a great track record. Gullible reporters had given her great PR for an October 31, 2007, call on Citigroup that had been correctly made many months earlier in her presence by my friend Jim Rogers, a legendary investor. They appeared on television together, and at the time she refuted Rogers. [GPS emphasis]
• Subsequently, Whitney wouldn’t justify her analysis saying “Quantifying is a guesstimate at this point.” (“Whitney Municipal-Bond Apocalypse Short on Specifics,” by Max Abelson and Michael McDonald, Bloomberg News, Feb 1, 2011.) 60 Minutes admitted it had never reviewed her much-touted report. The report never mentioned sizable defaults, only that there “invariably” would be defaults.

Delicious!

This week there didn’t seem to be any European meetings, summits, scoldings, or anything else. Spain announced $11.5 billion in spending cuts, while its tax revenues will have to be boosted, as its deficit was larger than expected. Yields on Spanish government bonds, meanwhile, fell to new lows for the second half of 2011 (bottom panel below.) Italy had what some are calling a successful bond auction, issuing bonds at rates well below one month ago.

That has more than a passing correlation to a news story that the European Central Bank‘s (ECB) balance sheet had grown to 2.73 trillion Euro ($3.55 trillion). (For comparison purposes, the Federal Reserve’s balance sheet is presently $2.817 trillion large.)  That marked an increase of 10% in one week, as the ECB loaned considerable sums to European banks. Contrary to public opinion, European bankers aren’t stupid–dumb, maybe–they know a spread over the low cost of the ECB’s loans when they see one, and it’s likely that much of those loan proceeds went to invest in bonds of Spain, the safest of the PIIGS.

This Week

While indicators next month will tell us how December shook out, this is, naturally, the last report on releases in 2011. We expect that the economy in 2012 will be much like 2011′s, slow growth, but with no recession. Housing could become a tailwind for the economy in 2012, which will be a welcome change from the last four years. While hiring hasn’t yet begun to pick up, certainly the rate of firings has slowed down. As with 2011, as with stocks, so it is with the economy in 2012: much will depend on what happens in Europe. It’s a foregone conclusion that Europe is in some sort of recession. A mild one shouldn’t hurt the U.S. too much; a deep one or a crisis that turns worse will substantially increase U.S. recession risks.

With respect to economic indicators, it was a mixed bag. One of my former, cliche-challenged colleagues would have called it a mixed bag of worms. On a year-over-year basis, the CaseShiller Home Price index fell about in line with economists’ estimates and the September decline. (CS data runs about two months in arrears, so this week’s data reflected October figures.) They fell another (-)3.40%, although the price level remained above the March 2011, low, which was the lowest level of the last five years. On a positive note, Pending Home Sales for November rose by 7.3%, confounding economists, who expected a barely noticeable rise of 1.5%. This series looks a whole lot better than other housing-related indicators, down, as it is, just 20% from 2005 levels.

The Conference Board’s Consumer Confidence Survey bounced nicely in December, coming in at 64.5, versus economists’ estimates of 58.9, and well above November’s 56.0 reading. While that leaves the reading still 42% lower than 2007 peak levels, it also takes the indicator back to the improving trend begun in 2009.

There were four regional activity indexes that came out this week from Richmond, Kansas City, Milwaukee, Chicago, and Dallas. All but one was worse than expected. Two were better than the previous month’s reading; two worse; one unchanged. Initial Jobless Claims remained below 400,000 for the fourth week in a row, while the four-week moving average remained pointing down. At this time of year, economists and others are quick to point out that claims are volatile, and the moving average is a better gauge.

While economists spent much of the second half of 2011 worrying too much about the economy, under-estimating its strength, they’re recently begun too over-estimate its strength, as is on display below.

 Next Week

 Key indicators to watch. Only one matters next week. The rest get relegated to side shows.

• Nonfarm Payrolls (Friday) – December
• Unemployment Rate (Friday) – December
• Change in Household Survey employment (Friday) – December – This won’t be the headline report–the first two will take that place–but this could be the more important report, as it tends to be near turning points. Make no mistake, if we’re in a turning, it’ll be like an aircraft carrier turning, not a Mini Cooper.

With this last blog posting of 2011, I hope that 2012 is a good year for you and yours.

Graig Stettner, CFA, CMT

Chief Investment Officer

Tower Private Advisors

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•  ’Ever hear of a bond ladder?
• Economic strong patch

Capital Markets

Top Stories

The period beginning with today’s close and through next Friday’s trading marks the period known for the Santa Claus Rally. According to Mark Hulbert, since 1896, this week has been positive “78% of the time. That compares to a gain rate of 54% for all other weeks of the year.” On average, the gain is 1.07%. Of course, the phenomenon has a saying to go along with it:  “If Santa Claus Should Fail to Call, Bears May Come to Broad and Wall.”

Pacific Investment Management Company, aka PIMCO, made the Bloomberg top stories four out five days this week. Here are the headlines:

• PIMCO Predicts “Risk Off” in First Part of 2012. That’s in keeping with one of our best service’s historically-based composite performance for the S & P 500 index. Rough sailing through July, followed by a second-half rally. Evoking images of The Karate Kid, the Risk-on/Risk-off phenomenon refers to the tendency of all risk assets (cyclical stocks, corporate bonds, commodities) to move as one. When the risk switch is turned to the ON setting, they all go up; when OFF, they all go down.
• PIMCO’s El-Erian Sees Risk Europe May Spark Lehman-Like Crisis. This one of the PIMCO wise men sees a 1-in-3 chance that “the Euro Zone will break apart and trigger a financial crisis akin to the one that devastated the global economy in 2008.”
• Gross’s Reversal Too Late as Total Return Headed for Redemptions. Well, this is so ridiculous and typical. You might recall Bill took to his soapbox in the late Spring to share what he thought of U.S. Treasury debt and how his Total Return Bond Fund was positioned accordingly. (I think he went to far as to say he was short some Treasuries, betting they’d go down.) I mean, do you think getting 3.5% from the U.S. government for ten years is a sound investment? We are Greece, folks. And, to boot, the latest Consumer Price Index reading was 3.5%. Of course, everyone piled on the man widely known as the Bond King for being such a fool. His fund is back to +3.5% on the year, and the lemmings are still leaving.
• PIMCO Forecasts U.S. May Stagnate Amid Data Showing Growth. PIMCO sees this occuring as a result of the European crisis and a slowdown in China.

Chew on the implications of this headline for a while:  BP Deems Solar Unprofitable, Exiting Business After 40 Years. Wouldn’t the money-grubbing, capitalist, 1% scum of BP have been able to make a dime off solar if anyone could?

Do you think this might be a problem?

If you have trouble interpreting the graph, it’s saying that 20% of Italy’s debt has to be refunded next year. Do you think investors will want to give the country 20 years to pay it back? Mightn’t they try to be compensated for the risks by demanding a higher interest rate?

Here’s the same chart again, but with a different isuer. Could be almost the same chart–and Bill Gross catches flak for wanting to avoid its debt. Do you think investors will want to give the country 20 years to pay it back? Mightn’t they try to be compensated for the risks by demanding a higher interest rate?

What is it with these countries? Here is Spain.

At least twice this week I have heard that 2012 promises to be 2011, all over again. I take that to mean high correlations, high volatility, and many nail-biting moments.

This Week

We seem to have entered what one firm we follow, has termed a U.S. strong patch. This week, we saw good housing, jobs, and consumer confidence reports. All is not rosy, naturally, that won’t happen until the economy gets out of first gear. Still, it’s better than the alternative.

On the housing front, the National Association of Homebuilders Housing Market Index saw, virtually, its best level since late 2007, save for a one-month better reading in mid 2010. This index essentially tracks the mood of homebuilders. The biggest drivers of the improvement were Present and Future Sales, along with Traffic. The best-looking region for new home sales is in the South, according to this index.

Housing Starts and Building Permits were both almost 10% higher than expected and well over October figures. Viewed from 2009 and these indexes look pretty healthy.

Viewed in a longer-term context–I’m sure you know where this is going–the picture isn’t quite so healthy. Still, I’m sure there’s some Chinese philosopher somewhere who said something like, “every long journey begins with a single step.”

Initial Jobless Claims fell to their lowest level since early 2008. A four-week moving average is commonly used to smooth out the week-to-week volatility of the series, and it continues to point down, also reaching the same relative low. That helps confirm the firing side of the picture is improving, but hiring has yet to pick up, of course.

Lastly, but not leastly, University of Michigan Consumer Confidence index rebounded smartly from November’s 64.1 reading, to 69.9, and that’s a cool 25.4% above the Congressional-ineptitude-induced low from August. Here’s a look at what a 15th-century mathematician might think of the rebound in the index. Leonardo Fibonacci discovered a series of patterns (ratios of proportion) occuring in nature (broccoli and nautilus shells) and in other places (Egyptian pyramids, Last Supper painting). We can apply the same ratios, namely, 38.2%, 50%, 61.8%, which are the biggies of the sequence, to security price fluctuations and, why not, economic series, like University of Michigan Consumer Confidence. Absurd! you say, and I’ll grant you that, but it’s a slow news day, so check this out.

The index peaked in early 2007 at 96.8, fell all the way to 55.4 in late 2008. The critical levels of the move–and what we’re really after, the retracement, or the rebound–are highlighted in orange below. Notice, that, on four occasions, the index has been rejected at the key 38.2% and 50% levels. As–probably better make that when–the economy improves, the 61.8% level (81 in the index) will prove to be difficult to surpass.

Next Week

Quite a few meaty reports considering it’s a holiday-shortened week.

Key indicators to watch

• Conference Board Consumer Confidence (Tuesday)  – December
• Initial Jobless Claims (Thursday) – weekly

Regional activity indicators

• Richmond Fed Manufacturing Index (Tuesday) – December
• Dallas Fed Manufacturing Activity (Tuesday) – December
• Chicago Purchasing Manager Index (Thursday) – December
• Milwaukee Purchasing Manager Index (Friday) – December

Housing indicators

• CaseShiller Home Price Index (Tuesday) – October
• Pending Home Sales (Thursday) – November

 Here’s wishing you a Merry Christmas!

Graig Stettner, CFA, CMT

Chief Investment Officer

Tower Private Advisors

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