Download - Breakfast With Dave - January 25 2010
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MARKET MUSINGS & DATA DECIPHERING
Breakfast with DaveWHILE YOU WERE SLEEPING
The tone to the equity market is kicking off the week in much better form than
was the case as last week drew to a close Asia was held to a modest loss of
0.7% (sixth decline in a row the Hang Sang has now corrected 10% from the
nearby November highs) and European marts and S&P futures are solidly in the
green. Bonds are giving back part of last weeks yield decline. In classic risk-
appetite style, the Japanese yen is weakening (there is talk of the BoJ expanding
its QE program) and the commodity currencies are f irming after last weeks
drubbing. It looks the DXY is sputtering now at the 200-day m.a. and the gold
price seems to have again successfully met support at the 100-day m.a. line.
The market chatter this morning is that Bernanke will be reappointed so perhaps
this will part one cloud, though we do see that corporate bond risks are on the
rise in Europe as per the widening in credit default swaps.
On the data front, not much to report. German consumer confidence came out
for January and fell for the fourth month in a row. As far as the week ahead is
concerned, we are going to be littered with U.S. housing data (see Housing Data
Fail to Fulfill Hopes of a Broad Recovery on page 2 of todays FT), the FOMC
meeting on Wednesday, and the Davos meeting summit begins on Wednesday
too.
As an aside, Bank of Canada Governor Mark Carney is interviewed on page 14 oftodays Financial Times with frank answers to some tough questions. The
preamble to the interview makes the point that Canadas financial system
remains healthy and also makes the point that Mr. Carney had extensive
private sector experience before taking over at the helm at Canadas central
bank (unlike most of his contemporaries). Makes you damn proud to be a
Canadian!
MARKET ANGST
As we had suggested, 2010 was not going to be another year of the rising tide
lift ing all the boats this has become a much more discriminating market where
investors now are not merely focusing on whether companies are beating their
estimates but also what is happening underneath the hood (Google, for
example, disappointing on the revenue line).
We closed the week with a really bad session for the S&P 500 down 2.2%,
worst day since October 30/ 2008. And not just Friday, but the three-day decline
of 5.1% was the worst move since March 9th, 2009 when the market was
plumbing the depths. But think of how things have changed since then. There
are no more shorts to cover. The banks are no longer receiving benefits from
IN THIS ISSUE
Equity markets on astronger footing and bondyields giving back part oflast weeks decline.
On tap this week: lots ofUS housing data, FOMCmeeting (Wednesday) andthe Davos submit.
Last week was a really badsession for the S&P 500and we saw the VIX jumpnearly 30%.
Q4 earnings season is infull swing this week. Sofar, earnings results havebeen good (tracking 193%YoY) but revenues havelagged.
On the US political front,two days after theDemocrat defeat, Obama
begins an assault on thebanking sector.
Pundits are assigning a60% odds for Bernankesreappointment.
Another five banksshuttered their doors lastweek and the latest Feddata show credit
contraction continues.
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the government. The room for fiscal largesse is far lower than it was then. The
ability for the Fed to ease monetary policy is far more constricted too.
And while we may have a recovery of sorts in production and sales, again
courtesy of government intervention and a short-term inventory adjustment, real
income and employment are still in decline. This is a recovery with one arm and
one leg and Mr. Market may have celebrated the onset of economic expansion a
litt le too exuberantly, with that 70% bear market rally off the lows. This
correction, by the way, has a completely different feel to it than the blip-down
that we saw last July we are witnessing the first major short-term move down
since those March 9th lows. And dare we say, this has a September 1987 feel
to it except the economy was on solid footing back then.
Note that all three major averages have incurred some major technical damage
and all are trading now below their 50-day moving averages. The fact that
investor optimism just reached a two-year high just as the market was cresting
(according to a Reuters/ University of Michigan survey) suggests that there is still
more air under this market that can be let out over the near and intermediate-
term. Every step of the way in the past nine months, selloffs in equit ies were
being treated as buying opportunities which means the action in the next few
weeks is going to be key. Watch the charts.
The VIX took a really big jump to close out the week as the complacency got
shaken out of the market this fear gauge popped up 30% over the week but
even at 23%, it is still below its 26-week moving average and basically merely in
line with the average of the past decade. More room to run on this score. But
make no mistake investor nerves are being put to a critical test for the first
time in a good while. That 55% jump in the VIX in the last three sessions of thepast week was the largest run-up since February 2007 open interest for calls
on the VIX stands at 1.66 mill ion versus 524,108 put contracts and volume to
close out the week was triple the norm. VIX futures are also currently trading
above 25% as investors are placing bets that in this new era of policy confusion,
heightened market volatility is to be expected.
EARNINGS UPDATE
Its st ill relatively early in the Q4 earnings season, with about 20% of S&P 500
companies reporting. Well have a better view on Q4 earnings after next week as
130 S&P companies and 12 Dow companies report.
On the surface, earnings results have been strong with a blended earnings
growth rate at 193% year-over-year, up 9 percentage points over the past week,and 11 percentage points from the start of reporting season (according to
Thomson Reuters). But the headline is a tad misleading. Outside financials,
which are bungee jumping off a super-depressed base of a year ago earnings,
are tracking 9% YoY.
So far, nearly 80% of companies that have reported have beat expectations,
which is significantly above the long-run average of 60%. On average,
Weve seen somecomplacency shaken outof the market with the VIX
jumped 30%last week.Even so, current levelsremain below its 26-weekm.a.
The U.S. corporateearnings season is in fullswing this week with 150companies reporting. Sofar, earnings results have
been great (+193%YoY)
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companies have beat analyst expectations by about 21% (long-term average is
2%).
While earnings have been strong, revenue results have lagged. On this basis,
the blended rate is 5% year-over-year, which is lower than last weeks rate of
7%. Once Financials are stripped out, revenue growth is sitting at the grand
total of 0% -- down a percentage point from a week ago even as bottom-lines
improved. The question going forward is how much more companies can cut
costs at some point sales need to increase in order to increase earnings(have
a look at The Great Corporate Pullback on page B2 of todays WSJ). We have
likely reached that point, and investors can sense it.
In terms of sectors, Financials, Materials and Consumer Discretionary have the
highest earnings growth (although Howard Silverblatt at the S&P cautions that
the Financials sector is fraught with pro-forma, restatements and membership
changes). Energy and Industrials have the lowest growth rates (-24% and -13%,
respectively). On the revenue side, outside of the Financials sector huge 73%
increase (which is actually 10ppt lower than last week), Health Care is the top
sector with +9% expected revenue.
POLITICS, BUT NOT AS USUAL
So here is what is happening on the U.S. polit ical front. No more than two days
after the Democrat defeat in Massachusetts, the President begins a full-scale
assault on the banking sector. On the one hand, the policymakers want the
banks to start lending money; and on the other hand, they want the banks to de-
risk their activities. The banks obviously didnt help their cause with a lack of
contrition and by sanctioning a bonus boom during these difficult times afterhaving been saved by the taxpayers pocketbook, but the Obama attacks on the
banks are very likely going to do more harm for the economy than good but
then again, this is an Administration that never did have an economic vision and
has so far decided to fight the prolonged period of post-bubble economic
malaise with a string of short-term quick fixes with no multiplier impact on job
creation and no long-run productivity benefits.
The fact that Ben Bernanke, despite all his faults, is now at risk of not being
reconfirmed is another part of this blame game. As if Don Kohn is going to do
a better job? He was there at the Fed throughout the entire Greenspan and
Bernanke era in any event. And of course, it looks like both Geithner and
Summers have been pushed aside because their proposals were largely aimed
at invoking change in the banks behaviour by using a carrot instead of a stick,and here we have the President bypassing his own team and taking the advice
of Paul Volcker (even calling the changes back to Glass-Steagall as the Volcker
Plan) after ignoring the legendary former Fed Chairman for most of the past the
year. Confusion reigns.
Two days after theDemocrat defeat, Obamahas begun an assault onthe banking sector. Policy
makers want banks to de-risk their activities but atthe same time startlending money.
.But S&P 500 revenueresults have lagged. Howmuch more can companiescut costs? Sales will needto increase in order to seeearnings growth in thefuture.
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he is not reappointed by January 31st, then Vice-Chairman Don Kohn would take
over as Chairman; Bernanke could, if he so desired, stay on as Governor, since
his term does not expire until 2020 (but why would he want to stay on as part of
this circus?).
CREDIT CONTRACTION IS ONGOING
To litt le fanfare, regulators closed five banks on Friday, bringing the failure toll in
2010 to nine. Columbia River Bank, The Dalles, Oregon; Evergreen Bank,
Seattle, Washington; Charter Bank, Santa Fe, New Mexico; Bank of Leeton,
Leeton, Missouri; and Premier American Bank, Miami, Florida have been
closed. The credit crisis appears to be over because the government has
continued to guarantee all and any banking sector liabil ity, but it is abundantly
clear that strains are still very intense and that impaired loans are still being
squeezed out of the system.
Also, have a look at Loan Demand Raises Worry on page B3 of the weekend
WSJ. The bottom line is that BB&Ts (considered to be a strong bank) would
have seen its loan book shrink due to the absence of its purchase of the failed
Colonial Bank and its loan loss provisions surging 37% in the latest quarter to
$725 million. SunTrust saw its interest income decline 2% and posted a $248
million loss.
Moreover, the latest data from the Feds H.8 report showed further contraction
in bank lending commercial & industrial loans fell $9.2 billion in the January
13 th week; real estate lending shrunk by $5.0 bil lion; and consumer credit
declined $3.8 bil lion. The contraction in bank credit is unprecedented now
totaling roughly $600 billion or 6% since the fall of 2008.
EMPLOYMENT BACKDROP STILL SOFT
The Bureau of Labor Statistics just couldnt help us close out the week with
some good news. Instead, it released the state-by-state jobs data for the month
of December, and showed that even though the unemployment rate managed to
stay at 10% in December, the reality is that it rose in 43 states or 86% of the
country. Only 4 states enjoyed a lower rate.
In November, 36 states had posted a higher jobless rate, so the 46 states in
December is truly an alarming increase. New Yorks rate hit a 26-year high of
9% and based on what the Obama team plans to do to the banking sector, look
for even higher highs in the near future. New Jerseys soared to a 33-year high
of 10.1%. This is the recovery that economists and equity strategists have been
boasting about? Wed shudder to see what a recession looks like.
CHINA GETS ALL THE PLAY, BUT
Its really India that has the long-term demographic advantage. This is true in
terms of future population trends, as well as the fact that India also has twice as
many people that can be classified as middle class at 300 million
strong. Income fundamentals are also far stronger. For a good take on the
differences and why Asias true shopping powerhouse resides in India, and not
Another five U.S. banksfailed last week (year-to-date tally is up to 9). Ontop of this, latest datafrom the Fed show furtherbanking lending
contraction.
India has a long-termdemographic advantagewith a middle class that istwice as large as Chinas.
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China (where the economy is dominated by fixed-investment), have a look at
Dont Underestimate Indias Consumers page 84 of the current Businessweek.
Still, China grabs all the headlines, and now its all about how last years
massive fiscal and credit stimulus has probably worked too well for its own
good. The dark side of the countrys resounding 10.7% GDP growth rate is that
inflation is percolating across a broad front. The consumer inflation rate
accelerated markedly in December to +1.9% from 0.6% in November; and the
PPI tripled consensus expectations in December and came in at +1.7% YoY a
huge swing from the 2.1% decline in November. More policy tightening is very
likely on its way and this is why, even being secular commodity bulls, we had
become near-term cautious in recent months so as to be in position to
participate in the next inevitable up-leg but at better pricing.
Finally, Floyd Norris pens a great article on page B3 of the Saturday NYT on what
China has been doing with regard to its bond strategy (Debt Burden Now Rests
More on U.S. Shoulders). Interest ing, for all the talk about how the U.S. fixed-
income market would collapse without Chinas support, the country has actually
seen its Treasury holdings decline since July and if there has been any fallout, it
is not apparent to the naked eye because all yields along the curve have done is
move in a range (in fact, Chinese buying only represented 5% of U.S.
government-financing needs in 2009, down from 20% in 2008 and the near-
50% peak in 2006).
At no time in the past decade has China actually been a net seller of U.S.
Treasuries over a six-month span and the evidence is in: no discernible
damage to the bond market. Why is that, pray tell? Well, other countries have
picked up the slack after all, Japan owns just about as many Treasuries ($757billion) as China does ($790 bill ion). And dont forget that Chinas bilateral t rade
surplus and the U.S. trade deficit have both plunged. All the Chinese buying of
U.S. Treasuries ever really did was reflect what Americans were buying from
Chinese manufacturers (i.e., all this focus on the Chinese buying of our
Treasuries was nothing more than how they were getting paid to sell their
products into the American marketplace which is why this notion that China
could ever unilaterally decide to dump its Treasury holdings never made any
sense. The fact that China owns so many U.S. securities is because the U.S. is
the largest buyer for its cheap consumer goods. Its an accounting identity right
out of Economics 101 in which the capital account has to equal the current
account).
FISCAL STIMULUS ...ALMOST LAUGHABLEWhat seems to get lost in all the chatter out of Washington about the coming
fiscal spending is just how intense the f iscal drag is going to be coming out of
the state and local government sector. See page 13 of the Sunday NYT Tax
Increase For the Rich Is at Issue In Oregon. Voters in the state will decide
tomorrow whether or not the state will move to implement a tax boost for higher-
income residents and on businesses in to help defray the cost of education and
other public services.
Japan owns just as manyTreasuries as China does.
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Gluskin Sheffat a Glance0Gluskin Sheff+ Associates Inc. is one of Canadas pre-eminent wealth management firms.Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to theprudent stewardship of our clients wealth through the delivery of strong, risk-adjustedinvestment returns together with the highest level of personalized client service.OVERVIEW
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