Weekly Recap & Outlook – 03/26/10

Tower Private Advisors


  • Canaries
  • Wimpy economics
  • Payrolls report on the menu for next week

Prior Posts

  •  None

Capital Markets Recap

Market Chart of the Week

This week, Alan Greenspan called Treasury yields the canary in the coal mine.  As you know, canaries were carried in cages into mines with miners.  Poisonous gases, if they were present, would kill the canaries before they killed the miner, thus giving him a chance to get out.

The chart above shows this canary along with some others. 

The first panel shows the 10-year Treasury yield, and indeed the yield has broken through the year-old downtrend, but is still below the high for the period (long-dashed line).  The second panel is the spot price of gold, where the downtrend is still firmly intact.  It’s rejected the yellow metal’s advance three times.  The third panel shows the dollar.  It’s at the 61.8% Fibonacci retracement of the big bear slide from about a year ago.  Here we need to beware the uptrend, as higher dollar = lower rates. The fourth panel is the inflation rate implied in the 10-year TIPS vs. 10-year nominal Treasuries.  That downtrend, too, is in okay shape. 

Higher interest rates are bad for several reasons, and rates bear watching because:

  1. They’re like sand in the gears of the economy, imperilling, for one thing, housing–and that can’t happen; it just can’t.
  2. Discounted future cashflows form the ultimate value of all stocks, and higher interest rates = higher discount rates = lower valuations.
  3. At the margin, higher yields make bonds more competitive investments than stocks.

Top Stories

  •  Oracle’s Profit Meets Estimates as Customers Begin Buying Software Again- this Bloomberg headline fits with our overweight technology sector positioning–but we’re nervous that it’s every other firm’s position, too.  Company cash, as a percent of net worth, is now at a post mid-’50s high of 13.8%.  We’ve looked at that as an eventual source of capital spending, with the most likely destination being capital spending–or, as they say, cap-ex.  We’ve recently heard anecdotally and from our Williams Inference Service that the cash hoard is more a function of corporate fear.  Still, if the fear subsides there are just a few places for cash to go, including  stock buybacks, dividends, mergers and acquisitions, capital spending, compensation, and debt paydown, several of which are good for equity holders.
  • The House of Representatives approved extending the Build America Bond program for another three years.  That means that for the next three years, the issuance of tax-exempt bonds is going to continue to be slim.  That will make already issued bonds more attractive/expensive and mitigate the elephant in the room otherwise known as interest rate risk.
  • Speaking of municipal bonds, Californiaup-sized its muni bond issueon better than expected reception of the deal.  While other BBB+ rated taxable munis yield about 7.8%, California’s 30-year issue had an interest rate of 7.48%.  Apparently, there has been decent foreign interest in the bonds.
  • Speaking of interest rates, there was a story floating around this week about how a handful of corporate bond issuers, including Berkshire Hathaway and Johnson & Johnson, sport lower interest rates than U.S. Treasuries.  We despise shifting paradigms, planful thinking, and other Buzzword Bingo phrases, but when corporate bonds have a negative yield spread we might have to think about a new pair of dimes. In the words of the Williams Inference folks, this amounts to an anomaly.  To us, it just reflects relative default risk:  investors think the odds of Berkshire Hathaway defaulting is less than that of the Treasury.
  • Speaking of odd, while we don’t do politics here–rather, we’re equally cynical toward all of those of the political persuasion–isn’t it odd that that august body of jellyfish, otherwise known as Congress, was able to muster the courage to approve a health care bill that 60% of America was opposed to?  The consensus is that 1994 plays out again in November, when they’re all thrown out on their ears.  ‘Know what trumps bad legislation?  It’s the economy, Stupid.  Could it be that they know something you and I don’t know, that the economy will be strong and stocks will be up?  Other than the Trilateral Commission, Area 51, Lee Harvey Oswald didn’t act alone, Elvis isn’t dead, and the astronauts never landed on the moon, I’m not much into conspiracy theories, but what if there is such a plan?
  • Speaking of the health care plan, at least two companies, Caterpillar and John Deere, have said that the bill law will force them to take combined income statement charges of $250 million.  AT&T will take a $1 billion charge.  To be fair, the thought process makes my hair hurt.  The companies receive a subsidy from the Federal government to help pay for retiree drug coverage.  That subsidy will now be taxable.  According to a Chicago Tribune story, “federal subsidies have covered 28 percent of the cost of retiree prescription drug coverage. The government offered the subsidies so that more companies would continue to offer coverage to retirees and keep them off of government-funded Medicare Part D.”  Uh, Gordo, how about just reducing the subsidy?
  • GMAC said it would sell, for $200 million, its factoring business to Wells Fargo.
  • San Francisco Federal Reserve President, Janet Yellen, shown at right, who is, by all accounts, a strong contender for Vice Chairman of the Federal Reserve, said that it’s too soon to raise rates.  And you’ll be pleased to know–and likely able to sleep better–that she says, “I’m not alarmed by the current enormous deficits,” since they’re “transitory and recession related.”  Trouble is, Jan, the spending that causes the deficits never gets unwound.  Oh, but, “if the Fed acts responsibly by unwinding its recession-fighting programs in a careful and deliberate manner, then we can avoid an upsurge in inflation in the near term.”  She insists that the strengthening economy, and its associated tax revenues, will reduce the deficit, but she also says, “the economy will be operating well below its potential for several years.”  Huh?
  • Alan Greenspan, whose famous Irrational Exuberance speech in 1996 highlighted the bubble in U.S. equities–the bubble that had at least three more years of inflation left in it, suggested that there is a bubble forming in Chinese stocks.  Maybe so, but the irony is that the Chinese try to do things about their bubbles instead of ignore them until they wreak havoc on an economy.  This is the same guy that encouraged–in the seventh inning of the housing bubble–home buyers to utilize variable rate mortgages, that–this is priceless–”American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.”  Coming right up . . .
  • We speak of certain risks being priced in to markets.  For example, last Friday evening, the consensus was that the health insurance bill would pass.  Therefore, it was baked in to the prices of securities.  That’s why the healthcare stocks–even the insurers–could rally on Monday, after the bill had been approved.  What worries us is when risks aren’t–in our opinions–priced in.  One risk doesn’t seem to be priced in, and that’s the risk of geopolitical kerfuffles.  So, it’s a bit of a surprise that the market didn’t act worse on the news that a South Koreanship and its 100 sailors went down to Davy Jones’ locker, apparently the result of North Korean aggression.  Even the Korean ETF (EWY) was only down 0.61%.  Our STRATFOR service says that the South could wipe out the North even though Kim Jong Il and his ilk have a numerical advantage.  Trouble is, one in four South Koreans live in Seoul and the North has “many thousands of artillery emplacements within range of Seoul. So while the South’s military is superior by most measures, [the] North could quite easily decimate the Souths capital and largest city.”

This Week

It’s hard to say the economy is improving based on this week’s data.

If you hadn’t noticed by now, it’s this blog’s goal to live out the Monty Python song, “Always Look on the Bright Side of Life,” a portion of which lyrics are below.

 Some things in life are bad. They can really make you mad. Other things just make you swear and curse. When you’re chewing on life’s gristle Don’t grumble, give a whistle And this’ll help things turn out for the best…

And…always look on the bright side of life… Always look on the light side of life…

If life seems jolly rotten There’s something you’ve forgotten. And that’s to laugh and smile and dance and sing. When you’re feeling in the dumps Don’t be silly chumps Just purse your lips and whistle – that’s the thing.

And…always look on the bright side of life… Always look on the light side of life…

So in that spirit, here’s my spin on housing for the week.  Existing Home Sales were reported at an annual pace of 5.02 million, a decline of (-)30,000 from January’s pace.  Later in the week New Home Sales were announced.  They slid from 309,000 to 308,000, a new low since the index’s January 1963 inception.  But wait, there’s more, if you act now–think of it like this:  economists had expected that 44,000 fewer houses (annual rate) would change hands this week, being comprised of a drop of (-)50,000 existing homes and 6,000 more new homes.  Instead, home sales fell by just (-)31,000.  How’s that for good news?

Needing no spin, Initial Jobless Claims are within–to use a Midwest-ism–spitting distance of a new low.  Economists had expected claims to fall from 457,000 to 450,000.  Instead, they fell to 442,000, and last week’s was revised downward to 456,000.  The figures were helped by the annual revision to the factors the Department of Labor uses to make its calculations.  According to the Wall Street Journal, absent the factor changes, the figure would have been 453,000.  That’s still a decline, just less fabulous. 

Today the final iteration of Q4 GDP was released.  Output fell from a previously unrevised 5.9% to 5.6%.  All categories were revised down modestly.  University of Michigan Consumer Confidence rose slightly, from 72.5 to 73.6.  Economists had been looking for 73.0.

Next Week

Virtually nothing matters except Friday’s Nonfarm Payrolls report.  It’s always the month’s most important report, and this one might be especially so, given expectations.

 Monday – we start the week off with the monthly look at Consumer Income, Spending, and Saving.  Economists expect that incomes rose by 0.1% in February, but spending rose by 0.3%.  Call that the Congress model.  If the performance of the Consumer Discretionary sector (shown relative to the S & P 500, below) is any indication, then 0.3% might be too low.

Tuesday – we get the CaseShiller Home Price Index is released.  This is one of the so-called “green shoots,” so named because it wasn’t yet a prosperous, but a promising plant.  The last reading showed a -3.1% year-over-year decline.  Economists expect it to have nudged closer to a positive change, expecting just -0.50%.

Wednesday – the Chicago Purchasing Managers index is released.  This is one of those diffusion indexes which are essentially reported on a percentage-of-favorable-responses basis, so a reading of 50 indicates a neutral reading.  The Chicago PMI was 62.6 in February and is expected to have been 61.0 for March.  This squares with commentary that the manufacturing sector is experiencing a bit of a bounce, if from inventory restocking only.  Just like hiring census workers, inventory replenishment means real factories producing real stuff, and just like hiring census workers, after a while the benefit fizzles out. 

ThursdayInitial Jobless Claimsare the first release of the day, and they’re likely to further shape the expectations for Friday’s big nonfarm payrolls release.  Economists look for a small drop to 439,000, from this week’s 442,000.  The national version of Wednesday’s Chicago release comes at 10:00.  It’s expected to come in at 57.0, up from February’s 56.5.  It’s a diffusion index, too, so it’s nicely into the expansion zone, but the component indexes of the ISM Manufacturing report, like New Orders, Employment, Prices Paid, and the like, will be carefully watched.

Friday – we’re beginning to see reports that the U.S. could be on the cusp of several good months of employment, where we’re actually adding jobs, not just cutting them at a slower pace.  In fact, the Nonfarm Payrolls report for March is expected to show that 190,000 workers were added; yes, that’s a positive number.  There are 58 economists supplying estimates for Friday’s release, and just one–some crackpot–is expecting a reduction in jobs.  The median estimate is for 190,000 jobs.  Every economist–except, apparently, for that one–knows that about one million census jobs need to be added, and everyone knows those jobs will be temporary, just like the boost from inventory replenishment fades away.  Still, these are real jobs, that pay real incomes.  The question will be what happens when the boost fades away.  According to the Wall Street Journal, the census jobs will pay $10-20/hour.  The Unemployment Rate is expected to have stayed steady at 9.7%–remember, the unemployment rate will increase as more people than needed apply for the jobs that become available.  Manufacturing Payrolls are expected to have grown by 10,000.  If we get a couple of months where payrolls grow by 200,000 or so, we could see funds come from bonds back to stocks, and that could push stocks higher for a bit longer.

Graig Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors


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