Tower Private Advisors
- Stuck stocks
- Sovereign concerns continue
- Economics getting mushy
Capital Markets Recap
Not much progress is being made these days. The Fibonacci 50% retracement from the ’07 highs to the ’09 lows is serving as overhead resistance, but more immediately, the 55-day moving average is doing the same. At the same time, the bears aren’t able to overcome the support provided by the 117-day moving average. A number of indicators are providing support for the bullish case, including an extreme of pessimism as expressed by the ratio of index puts:calls. In addition, in futures, the Commercials, the traditional smart money, have a huge net-long exposure to stocks.
Here is a different look at credit default swap spreads on sovereign debt. Instead of just looking at the spreads relative to the U.S. to give you an idea of relative risk, here is a look at changes in CDS spreads over the last two weeks. The Greece picture continues to worsen. Oh, and by the way, things are getting testy between Greece and the country that holds the key to its bailout, Germany. The latter accused the former of being profligate and asked its citizenry if they should subsidize the Grecians’ earlier retirement by, effectively, working longer. The Greeks responded by dredging up Nazi war crimes. Now, here’s the latest. It’s not shown here because my Mom might might give me a stern talking-to, but you can click on the link to see the latest salvo.
Goldman Sachs does not appear to be in the running for the list of most-admired firms after it was discovered that the Company helped structure some derivative (gasp!) instruments to allow it to circumvent the European Union’s debt limits. Not only that, but according to the New York Times, it then–this was all back in 2001, by the way–proceeded to purchase Credit Default Swaps that would allow it to profit should Greece run into trouble. The sound byte that usually circulates with this story is this one: “it’s like buying fire insurance on your neighbor’s house — you create an incentive to burn down the house.” Yet, it could have been as simple as Goldie offsetting its exposure to Greece. But Rolling Stone’s Matt Taibbi didn’t refer to the firm as a “great vampire squid wrapped around the face of humanity” because it hedges its exposure.
Goldman’s stock fell out of bed late in January when it was revealed that the Administration intended to impose the so-called Volcker rule, which would ban banks from trading securities for their own profits, shutting down the prop–for proprietary trading–desks. The New York Post reported that, instead, banks that wish to engage in prop trading will have to carry “higher cash reserves.” Something tells me one of the Bigs might have pointed out this inconvenient truth (at right) to the White House.
We have, for some time, noted the perilous state of certain U.S. states’ finances, and we pointed out in two seminars this week that pension-related debt of the states stands at $2 trillion, with another $1 trillion related to health care expenses. Playing to our fears of a bond bubble, we have read of many pension plans (e.g. JCPenney) that are forsaking equities for the perceived safety of bonds. That, clearly, is a desire for safety, but it may also be in pursuit of the huge, double-digit returns we saw in bonds in 2009. If the latter is the case, we’re pretty sure those hopes will be dashed. One of the top stories on the Bloomberg terminal this week was this dandy: Hedge Funds Win More Cash as Pensions Raise Bets to Fix Benefit Shortfall. That’s a reasonable response to an increase in required return, but it seems like it’s coming too late. We shared an anecdote in our seminars that, while California’s pension obligation has increased by 2,000% since 2001 its revenues have only grown by 24%. We think that’s all a recipe for higher taxes and increased bond issues by municipality, and every net new bond issue, at the margin, increases the likelihood of the municipality defaulting, and that means your municipal bond portfolio needs to be carefully reviewed.
We’ve avoided the bonds of California and New York State for some time, and we typically don’t like the debt of hospitals and airports. We’ve seen Illinois referred to as California by the Lake, too. Here’s a map that might be of use in evaluating your municipal bond portfolio. It comes from an article in the pink newspaper, the Financial Times (of London) on how the U.S. states compare to Greece (they don’t.) You can find that article here.
The chart attempts to compare the top 20 states, based on their “debt burden [i.e. municipal bonds] to GDP ratio,” which is the number in black (e.g. 3.5% for Illinios). The Eurozone figures are shown in the vertical bars. It’s pretty evident that these United States are not Europe. For purposes of your bond portfolio, however, there are a few caveats to keep in mind.
- Indiana, for one, has no state debt, and I suspect that’s the case with other states. This chart doesn’t, however, include the debt of cities and other municipalities of each state; it’s just the debt issued by the state.
- I think the better number of the two (black and white) is the white number, as it measures the debt service on the debt to the states’ expenditures.
- There are solid municipalities in every state, just as there are shaky municipalities in each.
Fifth Third bank found itself in the top stories this week. Seems it has a loan that’s gone bad. One of its pieces of collateral is a 6:1 Kentucky Derby favorite. It wants the horse sold or more cash put up.
Here’s a headline that’s subject to misinterpretation given Bloomberg’s punctuation deficit: Obama May Ban All Foreclosures Without Review by Loan-Modification Program. So which is it, is the President, without the review of the Home Affordable Modification Program, banning all foreclosures, or is he banning all foreclosures that aren’t reviewed by the group?
The Financial Times, despite being printed on pink paper, is a really good paper. Still, a story it ran on February 23 talked about an issue that was raised in this venue back on December 4, 2009. In that dispatch I made the following point.
I’ve attempted to make the point here in past dispatches–belabored the point is more like it–that the biggest risk to the markets is a possible rally in the dollar. Such a rally doesn’t have to be an admission that all is well with the U.S. Instead, the dollar has become oversold and is due for a mean-reversion bounce. But that bounce could be especially devastating because of all the speculation funded with the ultra-low U.S. currency, a funding otherwise known as a carry trade.
That is the issue the FT raised. In it, they quote Zhu Min, deputy governor of the People’s Bank of China, at the World Economic Forum in Davos, Switzerland, who said, “To me, the big risk this year is the dollar carry trade,” he said “It is a massive issue. Estimates are that the dollar carry trade is $1,500bn – which is much bigger than Japan’s carry trade was.” I commend the story to you for a more eloquent treatment of the subject. There’s also a video that explains the carry trade subject.
This week it appeared that the so-called green shoots were wilting. Housing data was not pretty this week. Both Existing and New Home Sales declined rather sharply as the chart nearby shows. As always, the winter months can be tricky, but the figures are seasonally adjusted, so they accomodate historical January vagaries. If there was any joy to be found in Mudville, it was that the pace of home price decline, as measured by the Case-Shiller Home Price Index–its broadest measure–for the fourth quarter was at the slowest pace since March 2007, again, as the accompanying chart shows. This trio of indicators should serve to highlight the fragile condition of the housing market, and one of strategy providers, BCA Research, sees a slide in home prices as a major risk to its relatively-sanguine 2010 outlook. The trio also suggest that, despite Ben Bernanke’s protestations to the contrary, purchases of mortgage securities–aimed at keeping rates low–will not end soon.
The Conference Board’s Consumer Confidence measure fell from 55.9 to 46.0, well below the expected 55.0. Like many sentiment surveys, the Conference Board’s inquires about current and future conditions. According to the group’s press release,
Concerns about current business conditions and the job market pushed the Present Situation Index down to its lowest level in 27 years (Feb. 1983, 17.5). Consumers’ short-term outlook also took a turn for the worse, with fewer consumers anticipating an improvement in business conditions and the job market over the next six months. Consumers also remain extremely pessimistic about their income prospects.
Today’s University of Michigan Consumer Confidence index showed that consumer sentiment was unchanged from the mid-month reading, but a comparison of the consumer sentiment indicators has two of three breaking down, in the language of technical analysis. As will be noted in the chart to the right, both the Conference Board and ABC’s measures of consumer confidence have fallen to new, multi-month lows. For now, until the Michigan indicator does the same, we’ll call the trend suspect. In addition, both the Michigan and ABC measures are above their year-long trendlines.
Another worrisome economic data point this week was the rise in Initial Jobless Claims. Economists expected a drop from the upwardly-revised 474,000 to 460,000, not a 36,000 increase. Weather certainly had an effect on filings, as some were unable to work because of the weather, while workers are likely running behind in processing claims. Still, a trend is a trend–one of the more brilliant insights in this missive–and the trend has been broken . . . the wrong way, to which the chart below and at right attests.
Alas, all was not bad. Fourth quarter GDP was revised, and higher, much to the surprise of some. The rate of Q4 growth was revised up, from 5.7% to 5.9%, yet it’s helpful to keep the rose-colored glasses close by. The upward revision was a result of inventories being reduced at a slower pace. Inventories continue to be reduced, so fears of excessive inventories are misplaced at this point. On the other hand, final sales (i.e. GDP change less contribution from inventories), sort of a core GDP figure, fell. Barry Ritholz (click here) pointed out that “nearly two-thirds of GDP growth” in Q4 was related to changes in inventories. Keep in mind that, while inventory changes are not considered a high-quality GDP contributor–we’d rather see increased final demand (i.e. sales)–virtually every recovery from recession begins with inventory rebuilding. The hope is that the sugar high doesn’t wear off before demand picks up. If that happens, we get a W.
It’s the week for Nonfarm Payrolls, always the month’s most-important report. Heads up.
Monday – Personal Income, Spending, and Savings are released. The data are expected to support the rising trend in the savings rate. Yeah, it’s a good thing that we become a bit more fiscally prudent, but saving more will make our recovery all that more sluggish. For context, the average savings rate since 1960 has been 7%. It fell to 1% or less as recently as 2008 and currently stands at 4.8%. The ISM Manufacturing survey is due out, as well, and economists expect it to be largely unchanged at about 58. Any level above 50 is considered expansionary.
Wednesday - We get a preview of Friday’s payrolls report with a look at the ADP Employment Change report. It showed a loss of (-)22,000 jobs in January, and economists expect 10,000 were lost in February. It should be a fairly good predictor of Friday’s release. Later in the morning, ISM Service Sector survey is released. Unlike its manufacturing sector little brother, this one is just barely in expansion territory. In January, the survey said 50.5, and economists expect just 51.0 for February. In the afternoon, the Federal Reserve Board releases its so-called Beige Book. The report will feature 12 reports, one from each Fed district, reporting on economic activity in each. The report contains no charts and graphs, just a bunch of dry text and Messrs So-and-So and Ms. What’s-’er’Name.
Thursday – We get the ever popular and recently-deteriorating Initial Jobless Claims report. Economists look for a decline of (-)21,000 to 475,000. Our sophisticated model is forecasting a nasty jump to 533,000.
Friday – At 8:30 Wall Street holds its collective breath, fingers poised over the buy and sell buttons. That is when the Nonfarm Payrolls report is released. In January, 20,000 jobs were lost, although Manufacturing Payrolls rose by 11,000. For February, the guesses are -50,000 and -20,000 respectively. The Unemployment Rate is expected to rise by 0.1% to 9.8%. Average Hourly Earnings on a year-over-year basis are expected to have gone the right way, from 2.0% to 2.2%, while Average Hours Worked is expected to have fallen from 33.9 to 33.7 hours.
Graig Stettner, CFA, CMT
Vice President & Portfolio Manager
Tower Private Advisors