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July 15, 2011: Market Update

Jul 15, 2011   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

Fireworks in Washington D.C.

The debt ceiling impasse weighed heavily on markets this week.  With just twenty days left before the U.S. defaults, neither the Republicans nor the Democrats seem willing or able to make the necessary concessions to reach an agreement.  On the other hand, things aren’t as bad as they may appear on the surface.  Despite the deficit battle, companies started reporting second quarter earnings and many have had upside surprises.  It was a full week with stories about Italy facing debt problems, the release of the Federal Reserve Open Market Committee (FOMC) minutes and Federal Reserve Chairman Bernanke’s semi-annual Humphrey-Hawkins testimony in the House Financial Services Committee.

The situation in Europe continues to simmer as we learned that now Italy has come under increased scrutiny.  Wasting no time, the Italian parliament passed an austerity package that aims to cut spending by $63 billion over the next three years.  Perhaps creditors are being overly cautious but some think that the debt issues plaguing the peripheral countries of Europe are beginning to spill over.  Moody’s downgraded Ireland’s debt to junk status this week as the IMF and EU continue to try and stop the contagion.

On a more domestic note, there is still little progress being made on our own debt problems.  Despite many days of meetings it appears that the only agreement has been on $1.5 trillion of spending cuts.  As these things go, it’s right on schedule.  With each passing week the odds of a smaller package being agreed upon grows.  Our best guess is that the debt ceiling will be raised just in time, with spending cuts being phased in next year and the Bush tax cuts allowed to expire in 2013.  This seems like the most reasonable compromise that allows each side to save face.  It’s left to see if the Speaker of the House, Mr. Boehner, can convince the more fiscally conservative members of his party to go along with this solution.  In the mean time, it looks like the GOP is planning on pushing through its own deficit reduction and balance budget bill.  Even if it makes it through the House, Republicans don’t have the votes in the Senate.  If you like fireworks, Washington D.C. may be the place to be next week.  It’s just not the kind of fireworks that we want to see.

In company news, both JP Morgan and Google reported better than expected top and bottom line growth.  JP Morgan grew revenue and earnings 7% and 13% year-over-year respectively.  The best news of the day was that they are continuing to see defaults and delinquencies declining substantially.  Google, which has been hard at work on a number of fronts, reported revenue of $9 billion in the quarter which represents growth of 32%.  They are having wonderful success with their Android operating system and are seeing 550,000 new activations a day.  This is up from the 350,000 activations per day back in Q1, and 160,000 activations per day way back in Q2 of last year. That’s huge.  They sold over 6 billion apps and grew free cash flow by $2.6 billion this quarter.  They now have almost $40 billion of cash on their books and could make acquisitions (i.e. Hulu) to expand into fast growing industries (i.e. streaming media).  The bulk of the earnings announcements will come over the next two weeks.  If this week was an indication, we expect the best companies to continue to pull away from the pack.

We’ll only briefly touch on the Humphrey-Hawkins testimony this week.  The Chairman of the Federal Reserve is required to appear before Congress twice a year to give what amounts to a state of the union speech regarding monetary policy.  In his address, Mr. Bernanke hinted that the door was open for further quantitative easing (QE3) which had the effect of sending both stocks and gold temporarily higher.  This shouldn’t come as a surprise although he did note that weakness in the economy has not yet risen to the level of further intervention.  In six weeks, Mr. Bernanke will once again preside over the Jackson Hole conference at which he introduced QE2 last year.  One can only guess what he’ll do this year.

And for the story of the week we turn to Minnesota.  You’ll remember that a couple weeks back we mentioned that their state government had shut down over a budget impasse.  It’s been two weeks now and we came across this story.  It turns out MillerCoors’ brand label registration with the state has expired.  They paid the fee on-time, but an overpayment delayed the processing by which time the government had shutdown.  Because of this, MillerCoors may be forced to pull all its beer from Minnesota liquor stores, supermarkets, bars and restaurants.  However absurd, it looks like Minnesotans won’t have too long to go without their beer.  Lawmakers appear close to hammering out a budget deal.  Now you know.

July 8, 2011: Market Update

Jul 8, 2011   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

Monkey See, Monkey Do

Despite a shortened trading week and some negative news today, the markets did a pretty good job plodding ahead to finish the week higher.  There was a lot of news but few real developments and trading volume remained on the low side.  The volatility index dropped and investors were left wondering whether the recent market gains would hold.

The most important non-news event is that an agreement has yet to be reached between the White House and Congress over the looming debt ceiling limit.  In this game of chicken, neither side wants to be the first to make concessions.  However, there is talk that “secret” meetings have been going on between President Obama and House Speaker Boehner resulting in a general framework for compromise.  Some analysts put the odds at 60% of a small increase in the debt ceiling of $1-$2 trillion which may already be priced in to the market at these levels.  These same analysts assign a 20% chance to both a larger increase of $3-$4 trillion which would be bullish for markets, and the need for emergency measures to prevent a default which would be quite bearish.

Even though neither side wants to consider the consequences of a default on U.S. debt, the White House is rumored to be working on a “Plan B”.  Among the ideas being floated are the following:

  • A “mini-deal” which would raise the debt ceiling by $1-2 trillion and kick the can down the road until next year.
  • A radical deal in which the Treasury’s would sell some it its $300 billion holdings of gold to the Federal Reserve, thereby giving the Treasury enough liquidity to pay bills until the debt limit is increased.
  • The use of the 14th Amendment by the White House, which may give the President the power to sidestep Congress to ensure that “the validity of the public debt of the United States… shall not be questioned.”

The issue will be resolved one way or another.  There are too many consequences, both economically and politically, for a resolution not to be crafted.

While the debt ceiling was the major news story this week, the issues in Greece continued to simmer on the back burner.  After passing austerity measures last week and receiving assurances from the IMF that further aid was coming, it looks like there may now be another wrench in the works.  Part of the plan put together by both France and Germany was to extend the maturity of Greece’s debt obligations.  Over the weekend, the credit agencies (i.e. S&P and Moody’s) called this act tantamount to a selective default and threw into question the solvency of Greece.  Other than a “who cares what the rating agencies say” attitude in Europe, there was very little talk about the consequences of this action.  However, it did create a roadblock in the near-term.

The last news this week happened to come today in the form of the June jobs report.  It turns out that companies aren’t hiring which shouldn’t be a surprise.  The surprise was the extent to which they’re not hiring.  In June the private sector created only 18,000 net new jobs.  This number should be on the order of 200,000+ in order for the economic recovery to really have any traction.  The unemployment rate rose again from 9.1% to 9.2% and the less reported U-6 figure (which includes unemployed and under-employed workers) rose to a staggering 16.4%.

Earnings season begins this coming Monday with the announcement from Alcoa which is generally considered a good indicator of the overall economy.  While we don’t expect as many surprises to the upside this time around, we don’t expect many misses either.  The more telling news will be how these companies view the second half of the year and specifically their forward earnings guidance.

On a more lighthearted note, we turn to Indonesia.  Award winning photographer David Slater, 46, was visiting a national park in Indonesia to try and capture photos of the rare and endangered black macaque monkey.  He and a guide had befriended the group of monkeys over a period of three days.  The story goes he had his camera set up on a tripod and turned his back for a few minutes.  When he returned he found one monkey playing with his equipment.  Much to his surprise he discovered that the monkey had seen its reflection in the lens of the camera and had accidentally tripped the shutter.  It seems too strange to be true but you have to see it to believe it.  Here’s the story and accompanying pictures.  Click Here.  They’re truly stunning.

July 1, 2011: Market Update

Jul 1, 2011   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

Happy Fourth of July!

What a way to end the quarter!  Stocks surged again today to complete their best week since July 2009, buoyed by another indication of strong gains in manufacturing.  Energy, technology and consumer discretionary stocks led the week, with financials finally joining in.  There was a lot of news this week and it was mostly good for a change.

The issues in Greece are slowly moving toward a short-term resolution.  Building on the success of the confidence vote last week, the Greek parliament voted on major austerity measures thereby paving the way for the second bailout from the IMF.  This helped release some of the recent anxiety over the interconnectedness of European banks to the Greek budget crisis.  While this won’t be the last time we hear about Greece, they appear to have kicked the can down the road for at least another six to twelve months.

Company news was abundant this week too.  Here are some of the stories on stocks we either own or follow:

  • Merck gives a lift to drug stocks after winning approval to sell its blockbuster cancer vaccine Gardasil in Japan. The approval opens a key sales market for the drug as it nears global saturation.
  • Google is in early talks to buy video site Hulu, the L.A. Times reports – a move that would go a long way toward solving Google’s internal dilemma about how to add more professional content to its user-submitted empire on YouTube.
  • Duke Energy asks for a 15% rate hike in North Carolina as it spends more on equipment and plants to meet stricter environmental regs.
  • Nortel Networks is selling its massive patent portfolio for $4.5B, to a consortium of tech companies that includes Apple, Microsoft, and Research in Motion.

In economic news we unfortunately had more mixed data.  Sending the market higher today, the June ISM Manufacturing Index came in much better than analysts had expected.  Same was true for the Chicago PMI.  However, there were regional misses in both Texas and New York which point to continued weakness in certain parts of the country.  Home prices continued to fall with the Case-Shiller Home Price Index dropping another 4 percent year-over-year, the biggest drop since November 2009.  June Consumer Confidence also fell below estimates which indicate that people are still disappointed with the economy.  Who can blame them?

In politics we had two big events this week.  President Obama threw down the gauntlet at Republican lawmakers over deficit spending and raising the debt ceiling.  The rhetoric is beginning to heat up which suggests that both sides are very entrenched.  The deadline for raising the debt ceiling is officially August 2nd, but keep in mind that Congress actually needs to both craft legislation and pass a bill before the debt ceiling increase is put into law.  In other news, we learned (through the grapevine) that Timothy Geithner appears to be ready to resign from his position as Secretary of the Treasury.  If we are to believe what we read, he is only waiting for the increase in the debt ceiling before he bails.  An early frontrunner to replace him is Sheryl Sandberg who is an insider of Silicon Valley having held positions at both Facebook and Google.

And lastly, for the story of the week we turn to Minnesota.  Did you know that the Minnesota state government actually shut down today after the Governor and legislature failed to agree on a budget deal to resolve a $5 billion deficit?  For some reason, this story did not make headline news today.  Two-thirds of state employees will be furloughed and state parks and campgrounds shut ahead of their busiest stretch of the year.  Now you know.

June 24, 2011: Market Update

Jun 24, 2011   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

Can Icarus Fly Again?

The market looks to finish the week only slightly lower than where it started.  For an unusually volatile week filled with market moving stories, this is a reasonably good outcome.  The three big events that occurred this week were the vote of confidence for Greece’s Prime Minister, the Federal Open Market Committee (FOMC) meeting minutes and the surprise plan by the International Energy Agency (IEA), of which the United States is a founding member, to release additional oil from strategic reserves.

Following days of anxiety due to concerns over a possible Greek default, investors have been calmed for the time being by the confidence vote early Wednesday in Greek Prime Minister George Papandreou’s government.  Investors are hoping this paves the way to the passage of another batch of austerity measures in a vote next Tuesday. Greece’s partners in Europe and the IMF have made the $17 billion bailout (#2) contingent on a positive Parliamentary vote on the austerity package.

So why is Greece important?  The Washington Post laid out a very plausible scenario describing how a Greek default could ripple across the financial world.  According to them, this is how the dominoes might fall:

  • Without an emergency loan from the IMF and European countries, Greece may default on $18 billion in debt it owes between July 15 and August 20.
  • Greek banks hold nearly $200 billion of Greek debt, and a default could cause a collapse of the Greek banking system.  Germany, France and Britain own another $265 billion and would suffer significant losses as well.
  • Because of the Federal Reserve’s zero-interest rate policy, many U.S. money market funds lend money to European banks at favorable rates.  The top ten U.S. money market funds collectively have approximately $380 billion in short-term investments with European Banks.  If European banks suddenly suffer huge losses due to Greece, U.S. money market funds would shy away from Europe and cause a liquidity crisis much like what happened in the days following the collapse of Lehman Brothers in the United States.
  • Lastly, remember AIG?  They sold insurance called “credit default swaps” on debt holdings.  They went bankrupt when they couldn’t pay out on the claims.  There are over $5 billion in credit default swaps on Greek debt.  However, since the industry remains unregulated no one knows who holds the contracts or what impact a default might have on their financial health.

The Federal Reserve, the International Monetary Fund and the European Union are all acutely aware of the potential ramifications.  Because of recent history, we are confident that Greece will not be allowed to default (at least not in the near term).   The stakes are too high.

In other news, the Federal Reserve released the minutes from their latest meeting.  It turns out the economy is weaker than they had anticipated with Chairman Bernanke admitting, “We don’t have a precise read on why this slower pace of growth is persisting.”  The minutes of the FOMC meeting assigned blame outside of the U.S., pointing at Japan along with rising food and oil prices.  With the end of QE 2 next week, we anticipate the Fed will stay on the sidelines for the next couple of months while determining the size and scope of the current slowdown.  The earliest we might hear new policy coming from the Fed would be at the Jackson Hole Summit in late August (the event during which QE 2 was announced last year).

For the story of the week we turn to the U.S. Postal Service (USPS).  On the same day that FedEx announced a 33% jump in profits, the USPS declared an emergency end to its contributions to the federal pension fund for its workers.  This move by USPS, effective today, will save it $800 million by the end of the fiscal year on September 30.  The Postal Service reported a loss of $8.5 billion in its 2010 fiscal year.  It also reported a widening second-quarter loss, to $2.6 billion, on declining volumes.  Here’s the part you probably didn’t hear.  The Postal Service claims they overpaid the employee retirement account by some $6.9 billion and has asked Congress to pass legislation to return the money.  With several bills in Congress, it is unclear what potential remedies lie ahead.  “Right now we don’t believe this decision will have any impact on current employees and it will not have any impact on current retirees” said the USPS this week.  The real question is what impact this will have on taxpayers in the years ahead.  Now you know.

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