The Recap by Kevin Maloney
Equity markets reacted strongly this week to negative fundamental data, with the NASDAQ falling 4.83%, DOW losing 4.19%, and the S&P 500 losing 4.65% on the week. Two major events catalyzed the downturn of last week, beginning with the tightening of the usually aggressive lending policies in China Wednesday, and news of proposed legislation by President Obama to restrict investments that banks can make Thursday. (WSJ) The news regarding potential changes in American banking policy led the way down for US equity markets early Thursday, with NASDAQ leading the charge with a loss of 1.4% on the way, making Thursday the largest single day drop since last October. Friday would bring no remorse, as JP Morgan (JPM) led the way with a slide of 9% between Thursdays open and Fridays close for a consecutive punch to both Financials and the rest of the broad equity markets.

Emphasis will also be placed on several key economic reports as well as the Federal Open Market Committees’ statement coming on Wednesday detailing the Fed’s strategy going forward. Investors will be looking for any implications on the timing of interest rates. Also, the World Economic Forum will get underway on Wednesday, taking place in Davos, Switzerland.

Outlook for the week of 5-4-09

By Ryan Wheeler

Will this Rally Hold Ground? I say “No”

When I look at the equity market and attempt to predict short-term movements, I look at a few different factors. I start by looking at the expected news flow in the coming week. The relative strength of the news (its ability to move the market) will usually give me a decent idea about whether the following week is primed for volatility. Next, I look at the past few weeks’ news, the strength of that information and how the market reacted to it. This tells me the mood of investors and how they are generally assessing the information. The last thing I look at is the bond market; specifically intermediate term Treasuries. I generally believe that monitoring relative movements of the bond market compared to equity indices can tell you a lot about what direction money is flowing (bonds to stocks or stocks to bonds).

  Given this set of criteria, let’s look at next week’s market. To start, we have one set of news that will be very important in the eyes of the market; the “stress test” results. This release has the ability to swing the market in either direction quickly if it is good or bad enough. This type of news could be comparable to the days of senate votes on the stimulus bills or FOMC rate decisions.  Second is the performance of the last few weeks. The market has been on a tare since mid-March, with the S&P 500 returning 29% since March 9^th. A run like that is pretty large for a market that has been down so much in the last 18 months. The only problem with using that 29% to measure recent performance is that it is a little inflated due to the low denominator caused by such a sharp decrease in the index price. Instead, I would rather use the recent performance relative to the peak of the market which was 1561 for the S&P on October 12^th 2007. Using that number, performance since March has only been roughly 12%. That number is still pretty large for such a short time period and such a high level of recent volitility. Lastly, we take a look at the bond market. The 10-year treasury yield has ticked to a high of 3.15% after trading between 2.46% and 3.02% since March. The entire yield curve has steepened since the Fed announced, or failed to announce, an increase in outright Treasury security purchases.

Looking at the above observations, I believe that the market is ready for a pullback. The stress test results seem to hold decently bad news for some names as seen by the leaks this weekend. Also, the market seems much more likely to dismiss some of the test results due to expectations of political motives, but any surprises could have a dramatic effect on stock prices. The performance in the last 2 months also gives the market a reason to sell off. Assuming some people have ridden the wave of this rally, they might want to book some profits in case of a return to negative performance. Lastly, the bond market performance in the last few weeks shows me that a lot of money has entered back into the equity markets for the bond market specifically. This indicates to me that the money that has gone to work in the equity markets has contributed greatly to the rally we have seen. This money is also very sensitive to treasury yields overall. If the Fed indicates a move to bring down the 10-year rate by purchasing more bonds, some of that money in the equity markets could flow right back into the bond market, causing the recent rally to be unsustainable.

Earnings  

Although 70% of the S&P 500 has already reported, there are still some heavy hitters reporting this week. Below is commentary on a few stocks reporting this week:

 Walt Disney (DIS): Disney will report on Tuesday and should be a good barometer for a mixture of economic conditions. Consumer Sentiment can be determined by looking at domestic volumes and hotel booking windows (amount of time people book before actual vacation). International economic health and confidence can also be gauged by Disney’s earnings. Back in mid-2008 when the dollar was cheap, international volume at Disney’s theme parks was very high. That phenomenon could be different now due to the weakening of many overseas economies. I expect that park volume will be down mildly as long as prices have decreased significantly and promotions have increased (obviously reducing margins) and advertising revenue from Cable Networks will be down. Overall, this could be a tough quarter for the entertainment giant.

American International Group (AIG):  AIG will continue to be sensitive to the performance of their Credit Default Swap (CDS) portfolio, but could see some gains from their investment portfolios as many Fixed Income assets have done well in the last quarter. Also, in the release could be more information on the “accelerated” separation of AIU Holdings into its own entity that was announced recently. This update could clarify what businesses will ultimately be packaged in the spin-off and/or when the spin-off will occur. I am sure that timing is an important factor in going forward with this process, given that investors can’t be thrilled about buying anything from AIG without speculation of high risk or deception.

Alcatel- Lucent (ALU): Weakness across the majority of ALU’s business segments is expected, with the exception of the Services segment.  Analysts see the possibility of contract updates as maybe the only positive outlook for this earnings report due to the continued negative impacts of ALU’s operations. Look for signs of turnaround in the wireless portion of the Carrier segment as a gauge of whether this company will be able to pull it together any time soon.

News Corp(NWS): News Corp will report on Wednesday and I don’t expect anything spectacular. At this point, anything good from News Corp will be surprising to me. Just about all of News Corp’s 8 business segments are expected to report double digit percentage y/y decreases in revenue and extreme margin contraction. The only light could be the Cable Networks segment which is about 23% over operating income. The worst performing segment will most likely be Newspapers which used to be 30%-35% of NOI in 2004 and has fallen to roughly 20% in 2008. This company needs to come up with a way to revamp their business model FAST. 

CVS Caremark: In the CVS/Caremark report, look for information regarding the integration of Longs Drug Stores and updates on PBM sales. It is tough to assess the effects of unemployment on PBM revenues, but the 2010 selling season is about to get underway and we have already heard that CVS lost one contract estimated to be worth $1 Billon. Pricing for new contracts will also be a focal point for Wall Street as newer contract pricing has been falling and dragging down margins. Same Store Sales for the retail portion of the company should see some deterioration, but nothing to significant or unexpected. I don’t see why CVS would report anything lower than analyst expectations.

 Economy

Construction Spending, Unemployment Non-Farm Payrolls and Pending Home Sales are all on the calendar for this week. Construction Spending is expected to decrease 1% from last month. Over the next 6-months to a year I expect Construction Spending to flatten out for a little while and then slowly start to increase again as residential and non-residential outlays start to net out and residential starts to really pick up late in the year. The employment situation, reported on Friday, is expected to show an increase in unemployment to 8.9% for April from 8.5% in March. The employment report also shows the change in average hourly wages compared to lat month. As I have said in previous newsletters, I think this is an equally important number to watch compared to unemployment. I believe that while people are losing their jobs at a high rate, more people are taking jobs at lower wages and people who are keeping their jobs are taking pay-cuts. Underemployment is a little harder to track than unemployment, but average wages give us a slice of the pie to analyze.  

Outlook

By Ryan Wheeler

I would be curious to get into the minds of some of the CEOs of top banks at this point. Needless to say, they have had a whirlwind of issues and struggles to deal with over the last 18 months, but there are still so many possibilities of what can happen. We are fully immersed in earning season right now, and banks are still the main focus. Along with earnings, we are hearing inklings of news about a stress-test progress report. While bank earnings have shown some signs of strength in certain business units, any negative reports from regulators about capital adequacy could rock the financial sector again. We are also getting mixed news about lending activity among banks who received tax-payer money through TARP. According to an article in today’s WSJ, bank lending in February dropped at a higher rate than the 2.2% month/month decline reported by the Fed on Wednesday. The Journal uses a different method of calculation that shows a 4.7% drop. For my purposes, those two numbers are ambiguous because we don’t know what the situation would have been like without the program (better or worse). The fact is that, at the current rates, mortgage refinancing is picking up, treasury rates are unattractive, and riskier-asset yields are begging for investors to play. People are slowly feeling out some of the “lower quality” bond issues for extremely rewarding yields. As that happens, Treasury rates will start to drop and the see-saw will start to balance out. Now I know what a lot of you are thinking… “It is not that easy” and “There are so many other things that need to happen first”. I agree. We are not in a position where this stuff is just going to fix itself. We have a long road of regulation fights, debt runoffs, liquidity program reductions (hopefully), and consolidation. All I am saying is that the laws of supply and demand along with market efficiency theories will play out over the next year.

Back to the real point of this newsletter; this week’s market. As I said before, we are in the middle of earnings season. This week, 140 stocks in the S&P 500 will be reporting the results from the first quarter. On this list are important names from every sector. Of the 50 or so companies that have reported so far, roughly 62% have beat analyst expectations (thestreet.com). What this says is that analysts are overestimating the negative effects of the economy on a large portion of the S&P. So what? Why is this important? As of now it is not a huge deal. If this trend continues though, it will then signal to me that businesses are becoming more strategic in finding ways to keep revenue up and/or lower costs. This does not necessarily mean that the market is truly oversold or that we are at a concrete bottom, but more-so that the economic theories that speak of innovation during the bottom of the business cycle are playing out. Looking back at previous recessions, some of the best companies have refined their operations and developed better value chains that carried them out of the recession to become market leaders. I think that will be a major theme for this recession.

A strong set of economic data will also be on the table this week. Leading indicators, durable goods orders, existing home sales and new home sales will bring more insight into the current state of the economy. Weekly jobless claims, an important number right now, will be released on Thursday. Hopefully this week’s economic data, coupled with earnings announcements and words from top Fed officials, will help the equity market continue its winning streak. Cross your fingers.

My newest tool for financial market study is the 1-month LIBOR – OIS spread which measures 30-day bank-to-bank lending rates in relationship to the overnight index swap rates. Basically what this spread tells us is the risk banks are expecting in the short-term and the rates they require to take on that risk relative to estimates for overnight rates over the next 30 days. For example, when banks think either the bank they are lending to is risky or the collateral they are backing the loan with is risky, they will charge higher rates for loans. This will effect the 1-month LIBOR more-so than the overnight swap rate, therefore leading to a widening in the spread between these rates. The spread can be viewed as 1) a liquidity expectation measurement 2) a credit risk measurement and 3) volatility expectation measurement. One important use of this spread is assessing the effectiveness of the Fed’s liquidity facilities over the last 2 years. These facilities were put into place to help improve the state of short-term credit markets; specifically interbank lending. Below is a chart that shows the LIBOR-OIS spread from July 2007 until April 2008. As you can see, the spread has been very volatile during this period.   I will be mentioning this rate more often in my commentary, so I thought I would give you a primer.

Sorry for the late edition this week. Happy trading.

Click HERE to see the full report.

The Recap

 By Steve Romasko

 The S&P 500 ended the holiday shortened week up 1.7%, led by financials. Trade was volatile despite only four sessions that had a relatively small amount of news and economic reports. The upside move came despite Alcoa (AA) kicking off first quarter earnings reporting season on a weaker-than expected note.

 On Tuesday evening, Alcoa reported a loss of $0.59 per share, $0.02 worse than the First Call consensus that called for a loss of $0.57. Alcoa said the sharp drop in revenue resulted from the impact of the economic downturn on the company’s end markets — automotive, transportation, building and construction and aerospace. Despite the miss, the results were better than many had feared, and as a result Alcoa finished the week with an 4.0% gain.

 There were some upside earnings results, however. Wells Fargo (WFC) preannounced record first quarter earnings of approximately $3 billion and earnings of $0.55 per share, topping the consensus estimate of $0.23. Wells Fargo expects revenues of $20.0 billion, versus the consensus of $18.98 billion.

 The news gave a healthy boost to financials, which ended up 15.9% on the week and provided a measure of confidence going into the coming week when JPMorgan Chase (JPM), Goldman Sachs (GS) and Citigroup (C) report their quarterly results. On a related note, life insurers also helped lift financials, gaining 15.9%, after it was reported that the Treasury will soon announce it will extend the TALF program to aid some life insurers.

Meanwhile, Bed Bath & Beyond (BBY) reported much better-than-expected fiscal fourth quarter earnings of $0.55, easily topping the $0.44 consensus estimate. This news, along with smaller-than-expected decreases in March same-store sales from Target , Kohl’s, JCPenney and Macy’s helped the S&P 500 Retailing Index to gain 4.7% on the week, making it up 17.7% this year. Wal-Mart, however, dropped 5.8% as it reported a disappointing same-store reading.

 Sun Microsystems (JAVA), however, failed to participate in the week’s advance after media reports indicated that talks with IBM (IBM) broke down as JAVA executives felt the $9.40 per share offer — a 90% premium — did not fully value its stock. Of note, it has not yet been officially confirmed that the companies were in talks, although there have been a hefty number of reports that they were. JAVA fell 21.3% on the week.

 In other notable corporate news, Pulte Homes (PHM) and Centex (CTX) reached a merger agreement valued at $3.1 bln, as the struggling homebuilders looks to cut costs in the face of an extend downturn in housing. The combined company would create the country’s largest homebuilder by revenue and market cap.

 Economic data came in light this week—the number of new jobless claims for the week ended April 4 fell to 654,000 (consensus 660,000) from 674,000 in the prior week. While the downtick is welcome news, claims still remain at very high levels. Meanwhile, the level of continuing clams worsened to 5.84 million from 5.75 million in the prior week.

 The February trade deficit dropped a sharp $10.2 billion to $26.0 billion from $36.2 billion in January. This resulted from a very surprising $2.0 billion increase in exports along with a not so surprising $8.2 billion drop in imports. The inflation-adjusted deficit compacted to $35.6 billion from $44.0 billion, which will have a positive impact on real Q1 GDP.

 The minutes from the March 17-18 FOMC meeting didn’t contain any real surprises. Most members believed the credit markets still are not working well. In addition, the FOMC did not interpret the uptick in housing starts in February as a beginning of a new trend, though some members felt that there was only a limited scope for a further fall in housing activity. The latter is not all that reassuring, as housing activity is already at very depressed levels.

 In other news, the SEC is looking at short-sale rules as many market participants have criticized the repeal of the uptick rule in late 2007. Despite the gloom-and-doom issued from masterminds’ George Soros and Marc Faber, the S&P 500’s advance marks the fifth consecutive weekly gain for the index, and a 28.5% rebound from its March 6 multi-year low. The market is still down 46% from its all-time high reached in October 2007.

The Outlook

 By Ryan Wheeler

 Wells Fargo reposted preliminary results that show hope for the rest of the financial sector. Specifically, Wells Fargo sited $100 billion in mortgage originations and another $100 billion in the pipeline which is extremely encouraging to me. We have seen such hesitancy in mortgage applications and bank lending over the past year and it has been clear that it would take significant increases in pipeline flow to get the housing market turned around. This week’s housing starts and building permit reports will also shed light on the housing demand in the past month. Look for a small pickup in housing starts due to the continued run-off in previous inventory. It is also worth looking at the ratio of new housing starts to existing home inventory to show where buyers are shopping. There is still a large inventory of existing homes to run off, but the confidence of builders in the intermediate term should be reflected in this week’s numbers.

There a few interesting earnings announcements to keep an eye on this week. Goldman Sachs has made it pretty clear that they will be taking steps to pay back the money they were allocated through TARP. I will be looking for language that explains how they plan on doing this and what their timeline looks like. JPMorgan Chase will probably not see too much increase in investment banking activity, but could make that up in new credit card issuance. Non-performing loans in the mortgage and credit card segments will reflect the quality of not only JPMorgan’s legacy assets, but the quality of Washington Mutual’s assets acquired in the deal.

In the tech sector, Intel should start to recognize some new revenue streams from netbook sales, offset by lower PC tower sales. I read a great analysis this weekend of the effects of electronics store closings (Circuit City, CompUSA) on Best Buy and other players that have survived the withering consumer spending trend. In summary, these leftover stores will be fairing well due to increased traffic, but that does not mean increased volume for the manufactures. Chip sales for the quarter will indicate the strength of distribution channels. It could be a tough quarter for Google as advertising revenue could easily be hit harder during the first quarter. The good news though is that Google continues to introduce new content to their network of online productivity tools. This rough time in advertising growth could be a great time for Google to increase market share over the last few standing search engines that are still competitive. 

The performance of CSX is an important indicator of the state of capital goods and material spending domestically. After the sharp rise in oil prices at the end of 2008, many companies switched shipping modes to rail. CSX also stands to benefit from the stimulus plan when infrastructure spending gets underway. Materials to build roads, bridges, and buildings will need to be transported across the country and will mostly be transported by railway.  Look for a combination of rail network consolidation and increased volume in the intermodal business segment. 

Finally, the Fed will be in the spotlight again this week with the release of the last FOMC meeting minutes and Bernanke’s speech on Friday. As these events happen, watch the dollar and its reaction to any statements. We are getting to a point of high rates of inflow of dollars and the dollar has not fully reflected the situation. Usually when traders see more money coming into the economy, they run from the dollar in fear of inflation risk. I don’t know if this time they are just not comfortable with any other currency or if they feel as though the additional tender is already reflected in the price. Either way, the Fed’s language can always be interpreted to predict future actions and the market will react accordingly.

I have been a little confused recently in the level of oil prices relative to the available information you might use to predict oil movements. A little while ago I talked about my expectation of $50-$60 oil due to the cuts in supply by OPEC and lower capacity utilization in offshore rigs. Now that we have seen some of that supply come off of the table, it makes sense why we got to the $50 level. But I am not sure why we are still here. We are absolutely seeing lower demand and oil reserves are building. Companies are literally filling barges with oil and setting them out in the sea to wait for more demand. At some point, field storage tanks and these barges are going to fill up and oil companies are going to have to start letting go of barrels at lower prices. It is surprising to me that oil has not fallen to at least $45. We will see over the next few week s how the inventory levels look. I would expect them to even out a little this week and then possibly increase again next week.

No matter what your specialty or profession is, this market is full of interesting corners to focus your attention. If you are smart, you will read all sides of these arguments in the news. Every day it seems that I am confronted with a new way to look at the decisions that executives and policy makers are making. The best advise I have been given has been to resist the urge to dive into a theory or an assumption without first looking at the opposite side. This keeps me honest in my goal of understanding this environment and the possible consequences of wrong action.

Have a great week and I hope you are not too burned out from all of the family parties and festive spirit that holidays tend to bring.

Recap

By Steve Romasko

Reoccurring themes tend to be the norm for the market, as the entire month of January was largely motivated by poor economic data, earnings guidance (or lack thereof), and the indecision of the government on how best to handle the financial crisis and economic policy. This week followed the same pattern, marking the worst month of January on record—closing down 8.6%

The market was given a surplus of earnings data to mull over this week as the heart of 4Q earnings season is upon us. The lack of appropriate guidance ahead of estimates, and the consistent results coming in below expectations provided an indication that estimates may be too high. This was most evident in Dow component, Caterpillar (CAT), as the industrial giant missed earnings—reporting $1.08 EPS compared to consensus $1.31; guidance was also far off-pace, as they issued rather vigilant guidance of $2.50 EPS for FY09, well below analysts’ guesstimate of $4.50—With  60% of its revenue generated abroad, the careful guidance reflects their concern on the continually deteriorating global economy and its effects on infrastructure spending.

The second drag on the market came from the wave of increased job cuts from major corporations—General Motors (GM), Sprint Nextel (S), Eastman Kodak (EK), Target (TGT), Home Depot (HD), and Pfizer (PFE) all issued continuing layoffs, totaling over 43,000 jobs to be cut this year.

On a positive note, and one of the very few this week, Pfizer has announced plans to buy rival Wyeth Pharmaceuticals (WYE) for $68 billion in a half cash/stock deal. However, the deal was overshadowed by the cynicisms from analysts over the amount of immediate earnings growth that would come from the merger as well as Pfizer’s decision to slash its dividend.

Onward, economics started on a positive note as existing home sales rose 6.5% in December v. November. However, further reading showed the increased home sales was nothing more than simple economics as the movement in supply was a direct result of plummeting home prices—down 9.3% in ’08. Comparatively, new home sales fell to an annual rate of 331,000 units for December—the lowest rate since the data began being recorded in 1963. To put this into perspective, rates are down 44.3% in relation to Dec. 2007.

Continuing claims for jobless benefits hit a record high as consumer confidence hit a low, pushing statistics to 4.78 million for claims and 37.7 for confidence, respectively.

The market-moving news this week came from the GDP report, which showed the economy contracting 3.8%. This was much better than the consensus -5.5%—although, estimates were only beat as a result of a build-up in inventories which doesn’t strip out items unsold, contributing 1.3% to GDP. The Final Sales number paints a much different picture, as inventories are stripped, reflecting overall demand which declined at a rate of 5.1%.

FOMC data was released this week and no action was taken, largely expected, leaving the Fed with the pleasure to sit back and watch for signs of an improving economy to gauge if the utilization of their power is having the intended effect.

Looking to the credit market, Treasury yields all pressed higher as newly issued debt flooded the market to pay for the current crisis.

Interrelated to the current crisis, partisanship was the tone on Capitol Hill as the $819 billion stimulus bill was passed in the House of Representatives without one Republican signature, a likely setback for the proposal as it is likely to face pressure in the Senate, and a setback as well for Obama as he attempts to accomplish bipartisanship between the parties in hopes of putting politics aside and serving the American public.

The final order of business for the week regarding market-moving news was the announcement of the possibility of the “good bank/bad bank” strategy, a page from the 1990 S&L crisis (Resolution Trust Corp), where bad assets are effectively removed from bank balance sheets in exchange for capital. This was initially viewed favorably, sparking a 13% rise in financials, however, this was offset by uncertainty of the price to pay for the assets as over-pricing the assets could leave the government at a long-term disadvantage; while under-pricing the assets will cause major banks to write-down similar assets to the same level—stressing the financial system even further and most-likely prolonging any possibility for banks to lend.

The report closed the week out, as well as the month of January—one can only cautiously look to an optimistic February. 

Outlook

By Ryan Wheeler

This week will be filled with more earnings announcements and a handful of economic data points. 193 of the 500 companies that make up the S&P have reported quarterly earnings so far and the trend is not looking good.  36% of the 193 have reported lower than expected earnings, 56% have beat, and overall earnings have declined 35.2%. It does not take a rocket scientist to see that analysts are still missing at a staggering rate. This lack of predictability makes me fairly certain that when I hear “experts” say that “we are at the bottom” or that we have “6 months to go”, I can really just assume their predictions are as good as my own. This week will also bring more transparency about the current standing stimulus plan on the Senate floor.

It feels like déjà vu with the details of another stimulus package being debated in congress. With only 2 weeks under his belt, President Obama has already set into action a plan to jump-start the US economy.  The current package outlines plans to create job growth through tax cuts, business incentives, temporary government programs and direct spending on infrastructure, schools, healthcare, and energy. These programs should have an effective result on aggregate job growth. The job of the senate will be to fine tune the appropriations of the bill and decide the final cost. The markets have already reacted to the House version of the bill, so they should not be too jumpy during the debates this week. The final bill will create positive waves as long as the package is clear on the benefits the economy will receive.

Some big hitters report earnings this week from all sectors. The names to watch will be Visa, UPS, Dow Chemical and Humana. Visa, the credit card transaction processor, will give incite on the amount of spending consumers are doing all over the world. UPS is gives us a picture of overall business activity domestically and internationally.  Since the decrease in the price of oil, UPS should have a better quarter relative to the fourth quarter of 2008. It will be interesting to see how much of that expense decrease will be offset by the slowdown in shipments. Dow Chemical’s performance is sort of a leading indicator of manufacturing. Products made by Dow are widely used in manufacturing and reported volume will shed light on manufactures expectations of sales for the next quarter or so. Humana, the health benefit company, will only suffer if companies are cutting healthcare costs more than expected. There are many more companies reporting this week, but I believe that these will give a good picture of the overall landscape.

By the end of the week, the companies mentioned above could move in both directions depending on the mix of earnings surprises and the expectations of government stimulus. The economic calendar will show how many jobs were lost last month with expectations being another 524,000. Opposition of the stimulus in congress will be looking for a big beat to show evidence of turnaround and lack of need for further fiscal deficit. For our economy’s sake, I hope they get their wish. Otherwise, I expect this bill to be passed by the end of the week and the final cost to be increased further.

Have a great week and watch the reaction to the Senate’s debates. It could give you an advantage to trade when the bill is passed.

Recap of Last Week

9a.m., it’s a Sunday and you’re woken by the piercing sun shining through your apartment window. What happened? Where did everyone go? Ugh. You’re dehydrated and your head is POUNDING uncontrollably as you reach for the Ibuprofen. This is going to be a nasty hangover. And what is that awful smell? Is that? No. It can’t be. . .But it’s too late, you know all too well what it is—the stench is that hot heaping pile of toxic assets still sitting on your balance sheet. You could take the trash out but who’s going to pick it up? Everyone in the neighborhood is facing the same hangover and your Uncle is only able to stop by the really decrepit houses—but look on the bright side, if a nephew can help his Uncle by taking on a little more trash from the neighboring houses, then he’ll get some money pitched his way to manage the deteriorating pile and the pain that comes with it.

 Such is the situation on Wall Street for the past several months, and the second week in the New Year was no different as financials fell 16%, dragging the broad market down with it, -3.7%, as investors mulled over a wave of capital raises and weakening credit quality. Trouble mounted early in the week as Citigroup announced plans to sell a significant stake in its brokerage house, Smith Barney, to Morgan Stanley. They then went on to announce another bold initiative during the Q408 conference call by unveiling plans to split the company into two units. Investors took this as a sign of forced selling to stay alive and by the time the carnage came to an end, their stock had fallen 59% amid an $8.3 billion Q4 loss.

Performance over at Bank of America followed similar trends as their stock was cut in half, falling 46% at one point. However, it was Bank of America’s attempt to expand that got it into trouble as it tries to handle a double integration of mortgage lender Countrywide Financial, as well as the investment bank, Merrill Lynch. Bank of America’s poor earnings results this week in conjunction with a $15 billion loss over at Merrill, led to a negative credit risk rating—forcing the firm to request an additional $20 billion in TARP money to complete the acquisition. Markets were roiled by the financial news, and as a result it continued to spread as JPMorgan Chase—who many long thought was ahead of the curve—was beaten down by poor earnings, citing economics and additional loan losses as the catalysts.

 Looking to economics and major-market news, the data wasn’t much better as retail sales for December fell 2.7%, Q4 Industrial Production declined 11.5% y-o-y, and the trade-imbalance fell sharply mostly due to a contraction in imports. Initial claims jumped 54,000 to 524,000 for the week, and in inflationary reports, PPI finished unchanged and CPI grew 0.1% for 2008.

 The data went onward to show the slashing of the ECBs lending rate 50bps to 2%, poor auto sales forecasts from GM for 09, and the releasing of the next $350 billion of TARP funds as the Treasury has already over-extended the commitment of the initial $350 billion, making approval imminent.

 With all of this turmoil, one can only look forward to the Inauguration Tuesday, as a new President, Our 44th—Barack Obama , will be given the chance to improve the economy and right (write or rewrite for that matter—pun intended) the path to prosperity. During the run-up to his Inauguration, he has meticulously surrounded himself with a stellar cabinet, and is ready to hit the ground running as he has already announced action seeking swift congressional approval, such as the suggested $825 billion stimulus plan where $550 billion would go toward spending and $275 billion in tax cuts.

 Whether the proposed plan will work is uncertain, but what is certain is although pain killers and short-term panaceas will clear up even the worst hangovers, it will never repair the cirrhotic damage done after years of binging from the over-leveraged (spiked) punch bowl. Only a complete transplant coupled with a long period of rehab monitored by qualified physicians will cure the terminal economy. Mr. Obama, I hope you’re ready, scalpel in hand.

Outlook

Martin Luther King  Jr.  Day gave traders the day off and made a very busy week pack all of the fun into only four days. The torch will be passed into fresh hands on Tuesday as President-Elect Obama takes the greatest oath a man can utter. Over 50 stocks in the S&P 500 will report earnings this week, making the inauguration a back-burner issue to investors who are expecting the worst.

In recent weeks the street has spend countless hours dissecting the proposed plans Obama and his team have hinted about. The most recent announcement from the new administration is about the focus of the Troubled Asset Relief Program (TARP). As the second portion of the $700 Billion program is made available, politicians are fighting over the use of the funds. Earmarks for banks, the majority use of the first $350 Billion, might turn into a bailout for homeowners in the form of renegotiated terms on mortgages and the creation of a “bad bank” to hold defaulting mortgages. The street will be looking for indications of how this change in focus will affect the financial sector and consumer spending. I assume that home builders will fare well if investors assume that direct support for homeowners will have a positive effect on housing demand.  The first increase in housing prices that I have heard in a long time was in Southern California this weekend, showing a little hope in a state of extreme losses in home values. If this starts a new trend, we might be seeing a housing bottom (cross your fingers).

Of the companies reporting this week, the most anticipated will be tech firms Apple (APPL), Google(GOOG), and Microsoft(MSFT), along with giants Johnson & Johnson and General Electric(GE). These heavy hitters have the ability to shake any investor from their seat, but combined they are like a nuclear bomb if they produce negative surprises. GE has already had problems with its finance unit, and Microsoft has been losing attraction every day as it struggles to show investors a spark of new light. Apple’s drop after the news of Steven Jobs’ leave of absence took me by surprise given that Jobs is really just the face of a company full of geniuses. Consumers are buying fewer IPhones, everyone gets that, but I think Apple still has a few tricks up their sleeves. They always seem to surprise.

Economic data is light this week, a much needed break from previous weeks of data overload. Housing Starts for December will be the biggest report this week and should not move the market very much unless they blow estimates out of the water. Economists are expecting 615 thousand new homes vs 625 a year ago. The flow-through from housing permits usually makes predicting starts a little easier than other data points, but the delays of planned projects has made it tough to count on quick turnaround after permits are filed. Builders will need to have confidence in housing demand before they act on approved projects. That demand will come, but it will take an increase in existing home sales before new home sales can be expected to recover. That looks to be the logic behind Obama’s plan at least.

The overall theme for the week will be the fundamental disabilities of current business models and which ones have been able to weather the storm. Analysts have taken shots at assessing the damage done to “strong” business models. That term has been redefined this year and will be put to the test again this quarter. I expect financials to have minimal skeletons to air this quarter. Let’s hope there are no other graveyard sectors. Have a great week. 

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Recap of Last Week’s Market

By Steve Romasko

In the face of a short trading week with light volume, continuing trends advanced and investor response remained indifferent—in other words, investors conceded little ground to the relatively poor economic news as the results no longer carry the ‘shock value’ of the past.

Throughout the week, oil prices continued their slide on the front-month contract, settling at 37.71, the Fed announced new emergency plans and a wave of reports displayed a continually weakening economy. Particularly, (1) initial jobless number spike to a high of 586,000, (2) durable goods orders fell 1% in the month of November , (3) November existing home sales plummeted 8.6% from October, (4) new home sales hit a 17-year low of only 407,000 units and (5) personal income and spending dropped 0.2% and 0.6%.

Perhaps the most interesting piece of news this week was the continually weakening consumer’s effect on GDP data— on top of retailers resounding poor holiday sales (MasterCard Spending Pulse down 4% from 1-Nov to 24-Dec), consumers stripped 2.8% off real GDP growth—causing an economic contraction of 0.5% for the third quarter. With worsening consumer conditions, a continuing global slowdown and a lack of investment spending (evident in inventory data) significant economic contraction should emerge in the fourth quarter GDP data.

In corporate news, GMAC won bank-holding approval—simultaneously becoming eligible for TARP funds, and pulling GM further from the brink of bankruptcy as credit will be extended to GM through GMAC. This provided broad support for the auto sector and markets as investors vacillated earlier in the week of what consequences a GM bankruptcy would do to capital markets. This approval will not necessarily fix the troubled auto-sector in regard to long-term viability but it establishes more flexibility as Detroit and an incoming administration assess all possible solutions. 

Next Weeks Outlook

By Ryan Wheeler

Say “Good Bye” to a depressing 2008 and “Hello” to 2009. This year has undeniably been one of the worst years most people have ever seen, and hopefully ever will. Unless we have an unprecedented rise in the market in the beginning of the week, the market will end 2008 down about 40% for the year, making fund prospectus design a challenge in attempt to hide the ugly chart that they used to highlight.  This short trading week will close out 2008 with minimal economic data and little news expected. The lack of volume could result in unjustified volatility if any news does hit, creating a false picture of the market perception.

If you have any interest in retail stocks, you might want to spend a few minutes walking around Macy’s or JCPenny. It is a sad scene that has typically been full of bargain shoppers taking advantage of discounts. The discounts are present, but the shoppers are not. This should not be a huge surprise to the market, but more of a reassurance that the sell-off in retailers was justified. Consumer Confidence, Initial Jobless Claims and a handful of manufacturing surveys will be released on Tuesday and will certainly show further economic weakness.

The oil market’s only positive news in the past few months, intended supply cuts and tension in the middle east, should help push oil prices a bit higher after a 75% decline from its peak earlier this year.  I laugh to myself every time I think about the news stories back in April and May about the massive inflow of investor funds into commodities in an effort to gain exposure to the asset class that was producing such high returns. It is kind of ironic that all everyone was talking about at the time was the housing “bubble” and meanwhile they could not wait to jump into the next example of one. I am not saying that I called the drop in oil, but I am smart enough to know that you don’t just put a ton of money into something that has just seen a 50%-90% increase in price and expect it to just keep going at that pace. Typical investment public. Don’t get me started on “Green Funds”.

 On a lighter note, the decision by the Fed to give GMAC the title of a “bank” may continue to drive some movement in GM, as the market reacts to GM’s reduced stake in its finance arm. GM rose 12% on Friday in reaction to the news and could continue that move on Monday. As I have said before, the Federal Reserve is turning every company that asks into a bank in order to allow access to emergency funding. At this rate, becoming a bank holding company looks to be like a bad fashion trend that everyone hopes will disappear quickly. The only problem is that this fashion trend comes with contracts and financial regulation that are not easily broken.

Maybe the best thing to do for yourself this week is relax, spend time with family, and go see Marley and Me (score points with your significant other). This is one week that is not really worth wasting your energy on. Au revoir,  2008. See you on the flip side.     

Recap of Last Week

By Steve Romasko

All eyes were on the Federal Reserve this week as they met on Monday and Tuesday to discuss further policy action in order to stem the economic crisis. From the meeting, the FOMC cut the target rate from 1.00% to a first-ever ‘range’ of 0.00-0.25%—effectively eliminating a major policy tool. However, the Fed made it clear that aggressive action will stay the course, and they will do everything possible to stimulate the credit market and the economy— perhaps by buying long-term treasury securities.

Bond traders reacted to this news by piling into long-term Treasuries—notably, the yield on the 10-yr note fell 49bps to 2.08%, while the 30-yr bill returned 2.52%, down 52basis points from the week prior. The seemingly relentless resolve of Bernanke & Co. to stimulate the economy on an infinite basis sent shorts heading for the exits and caused markets to rally 5.1% on Tuesday. However, the market gave back roughly 3.5% of Tuesday’s gains on Wednesday and Thursday, as economic reports were poor and investors returned to the notion that there’s no short-term panacea to fix the economy overnight.

Regarding economics—Industrial production declined 0.6% in November, housing starts declined 18.9% (the largest since March 1984), building permits hit a low and initial jobless claims – while  better than  consensus – are at a 26-year high.

Negativity continued, following the economic reports, as corporations announced their own vulnerabilities to the current environment. Goldman Sachs recorded its first loss as a publicly-traded company; sharing the poor-earnings spotlight with Morgan Stanley as both firms came in significantly worse than expected. In other news, Standard & Poor’s placed GE’s triple-A credit rating on negative outlook and Best Buy, while beating estimates, acknowledged a noticeable shift in consumer behavior.

Meanwhile, in an effort to stem a further decline in the price of oil, OPEC met this week and vowed to cut production 2.2 million barrels per day. Under normal circumstances, prices would rise following a cut as supply was reduced—but these times are anything but normal. Following the announcement, oil prices traded up briefly then plunged under $40 per barrel (settling ~$33bbl for the week) as oil markets compared OPECs situation to that of one trying to catch a falling knife. In their situation, slumping demand will far outstrip their ability and pace to which they can cut supply. This is evident in countries that rely heavily on the sale of commodities to manage their economies—notably Russia. It seems oil production is now a double-edged sword as oil-producing nations who found themselves with immense bargaining power when crude sat at $147bbl, now find themselves (and their profitability) at the mercy of the dependent countries’ demand, or in this case, lack thereof. Although this is poor for some, falling oil is positive for consumers and most businesses as it frees cash, and potentially encourages spending—however, with unemployment swiftly rising and tight credit, this extra cash will not be spent, instead, it will be put toward cash reserves.

In currency markets the US Dollar had a tough week (which is a surprise as falling oil usually leads to a rising dollar) as increasing US debt and roughly zero incentive to hold the dollar weighed heavily on the currency—largely a result of the Fed’s ‘quantitative easing’ which is driving down yields and flooding the market with supply.

The highly-debated decision over the bailout of Detroit came to an end this Friday as the Bush Administration threw the industry a lifeline, after a failure in Congress, citing that the unintended consequences from an automakers’ failure will pose a systemic risk to the already crippled economy. Under the terms of the deal, GM and Chrysler are going to receive $13.4 billion, of the remaining TARP money, up front and the other $4 billion in February pending the release of the 2^nd half of the TARP funds. The loans were given on the precondition that Detroit will make a viable effort to restructure the companies as well as their plans and operations by March 31 in order to become a long-term profitable industry. Also, in an effort to further boost the industry, Canada pledged $3.3 billion this weekend to the automakers with the possibility of more funds in the future. In both instances, the clock is ticking and it will be interesting to see how the events play out; as problems that took decades to build must be unwound and replaced with feasibility in four months—in short, easier said than done.

Happy Holidays!

Next Week’s Outlook

By Ryan Wheeler

The holiday week should produce very light trading as investors look to take their minds off of a bad year and focus on family and friends. Early-week economic data could shake things up, producing a swing that could really just be the result of the low volume.  

The earning calendar is very thin as odd fiscal year names report F1Q09 earnings. The most significant names to report are Walgreens (WAG), expected to report a gain of $0.46, and Micron Technology (MU), expected to report a loss of $0.43. The Walgreens estimate could prove to be a little optimistic. With an empty CEO chair and no guidance, and deteriorating front-end and pharmacy sales, I would not rule out a miss. Micron’s loss estimate is due to depressed DRAM and NAND pricing over the last year, reducing earnings sequentially. Investors will be looking for clue in the call about balance sheet strength and MU’s involvement in Taiwan consolidation efforts, according to Morgan Stanley.

The BEA will release the final revision of GDP on Tuesday, along with Personal Income and Outlays on Wednesday. Economists are looking for a Q/Q decrease of 0.5% in Real GDP (adjusted for Inflation). This report will show investors how the slowdown in spending truly effected production in the US for the third quarter.  Economists expect a flat Q/Q Personal Income report and a decrease in consumer spending of 0.7%, according to Bloomberg. With unemployment at 6.7%, and rising by the day, it is not surprising that Personal Income is looking close to falling into a downward trend. Consumer spending, obviously being highly correlated to income, is also being affected by uncertainty about job security. Consumers would rather put their money into a government insured CD or risk-free treasury security than buy anything else at this point.

Also on the economic calendar are Durable Goods Orders and housing data. Estimates for Durable Goods show a decrease of 3% M/M. A decrease of this magnitude illustrates the reason for weak economic sentiment in the near term. New home sales are expected to decrease to 420k for the month of November, 35% lower than a year ago. I am not sure if this decrease is the full amount we need to get the supply low enough, but it should be close. Existing home sales should come in around 4.9M vs 4.89M last month. Supply of existing homes is still around 10-months, still too high in my opinion. I think we need to get down to the 8-9 range before we start seeing home prices recover.

Further coverage of the Madoff scandal will give people something to talk about this week, again. The FBI has reported that they are shifting agents from Terror cases to Wall Street cases to look for more frauds. Personally, I think that the only reason the FBI is getting involved is because some big-wig at the FBI or a Senator lost their hat to Madoff and are using all resources to figure out what happened. Obviously this is a serious matter that includes major fraud, but let’s allow the SEC and the US Attorney’s Office handle investment fraud investigations and keep the FBI looking for the next nut-job that is going to blow up a building somewhere. That is just my view though.

I hope you all have a great Holiday. Take some time to focus on family and forget the market. Enjoy your week.

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NOTE: This week’s report is appearing late and in shortened form as a result of of the Holidays. It will return to its original form next Sunday.

Recap of last week

By Steve Romasko

Despite the amount of horrid headlines that surfaces on newspapers this week, equities managed to finish the week on a positive note with the S&P 500 giving a 0.4% gain. Wall Street got off to a good start on Monday, following President-Elect Barack Obama’s comments over the weekend—where he supported the need for a massive stimulus package when he takes office to jumpstart the economy and put fiscal prudence on the back burner. The stimulus, as it seems, will be put toward an infrastructure plan, and will potentially create 2.5 million jobs— something not seen since the Reagan era, which led to the development of the US highway system. The market took the announcement as a sign of the incoming administration’s willingness to do whatever it takes to solve the current crisis and rallied as such—closing up 3.8% for the day.

 However, this particularly good news was overshadowed by a wave of poor earnings guidance, economics, and emerging scams. Tribune filed for Chapter 11; 3M, FedEx, Texas Instruments, Kroger, and Electronic Arts to name a few issued downward earnings guidance—suggesting that the crisis has officially spread from a few concentrated sectors to the broad market. Onward, economics were poor with Jobless Claims touching a 26-year high, 573,000, and continuing claims hit 4.43 million; November retail sales fell 1.8% in October—the 3-month trend to month-end November is down 4.7% from 3-month-end August. As a sign of current times, yields on the 1-3 month Tbills turned briefly negative—meaning that some investors actually were ready to pay the government to hold their money.

 Topping off the week, two fraudulent schemes emerged—Illinois governor Rod Blagojevich was indicted on allegations charging him of attempting to sell Obama’s Senate seat; as well as the uncovering of a $50 billion Ponzi scheme, where Bernard Madoff was arrested on count of fraud. The week, then, closed on Capitol Hill, where the Senate denied financing to a flailing auto industry. In the face of this market crashing, doomsday news, investors did the exact opposite expected, and accepted the news by rallying—suggesting that the news has been priced in and the negative developments take us one step closer to the ongoing bottoming process and trader sentiment has improved—however, critics to this view point to the poor fundamentals and the continued flight to safety evident in T-Bills. The upcoming week, as always, should not disappoint.

Next Week’s Outlook

By Ryan Wheeler

This week will certainly be one to remember. The plate of issues is loaded with Economic data and political drama that could tip the markets in either direction with ease. Fed policy, CPI, an OPEC meeting, and a possible TARP-funded loan to the Auto makers will undoubtedly cause waves on the street.

Economists who have made extreme projections about the near term strategy of monetary policy will see the dealers hand on Tuesday when the FOMC announces the results of their meeting. According to Bloomberg, 74% of economists surveyed estimate that the Fed will cut it’s target lending rate between banks by 75bp to .25%. At this point, it is unclear how the market will react to any Fed action. Investors seem to be losing confidence in the Fed’s ability to control the stability of the financial system, and the closer they get to a 0% rate, the closer they get to losing another weapon in their policy arsenal.

The Consumer Price Index(CPI) will be released on Tuesday and is expected to show a decrease for the second month in a row. Economists are starting to become more concerned about deflation as the slowdown in the economy is bringing prices down an increasing rate. This weeks CPI report will either counter or multiply the reaction to the FOMC announcement on Tuesday.   

Oil will be in the spotlight this week on account of OPEC’s delayed meeting to discuss the need for possible supply cuts. The meeting that was scheduled for two weeks ago was delayed in order to evaluate the effects of previous supply actions and the amount of demand changes on prices. OPEC has indicated that they would like to see oil prices rise back to the $75 range. The result of this meeting could be major cuts in production that would result in a rise in oil futures. You can pretty much count on production cuts; the question is how much they will cut.

Other than pressure from economic reports, tax loss selling will be another pressure on beaten down stocks over the next few weeks. Investors who have taken extreme hits in their portfolios will look to offset gains by realizing losses. This will not be as sever as past years due to the scarcity of gains, but it will still be a factor. I hope you all are those people. Enjoy your week.