Market Update 5 26 10 _ Durable Goods

A bit of relief

The pressure in the market is easing a bit this morning after a strong Durable Goods release and higher than expected New Home Sales.  The 10 year Treasury is off almost ¾’s of a point to trade at 3.24%.  The Dow is up about 100 points to trade at 10,147. 

Durable Goods was expected to post a 1.3% increase but actually posted a 2.9% figure.  New Home Sales were expected to come in at 425,000 but posted 504,000 instead.

A matter of perspective

Many times in life people can look upon the exact same set of data and come away with very different conclusions. 

For example, yesterday my wife asked my 7 year old daughter “Is daddy’s hair more brownish or blondish?”

She replied “It’s more BALDISH.”

If I’d been there for the insult I’d have sent her to her room.

This difference in perspective reminds me of today’s Durable Goods data.  While it is certainly good news to see that Durable Goods orders are rising, I find it difficult to use that number as a basis for concluding that a recovery is imminent.  One person sees “recovery” in the number, another looks deeper and sees “baldish”. 

One of many headwinds that Durable Goods must overcome is the decline in value of the Euro.  The most recent Durable Goods figure covers the 3/31/10 to 4/30/10 time period…one month.  Durable Goods orders were up 2.9% over that 30 days (the bulk of which was comprised of aircraft orders…a typically volatile sector).  To get a better look at core activity we can use Durable Goods Ex-Transportation which posted a -1.00% figure vs. an expectation for a 0.5% gain. 

So Durable Goods Ex-Transportation was -1.00%.  Over that same time period the Euro was down only 1.6%. 

Since the start of the new Durable Goods reporting period the Euro has dropped an additional 8% in value.  That trend can only continue for so long before it begins to price our exports out of the picture…and a drop in exports will be reflected in Durable Goods orders. 

It will be interesting to see how well Durable Goods orders can hold up when the value of the Euro is dropping like a rock and austerity measures kick in across the European continent.  Time will tell but given the overall macro picture right now it seems that Durable Goods orders would have a difficult time gaining much momentum. 

 

 

Looking forward

Tomorrow we get GDP, Personal Consumption, Initial and Continuing Claims, and Core PCE (the Feds favorite measure of inflation).

There are no new stories out of Europe or the Korean peninsula to spook the markets this morning.  All in all it’s just a steady but quiet trading day.

If you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707

 

Market Update 5 20 10 _ An ugly start

 

Who remembers the Bionic Man?  Remember the intro to the show when Steve Austin is squawking over the radio saying “Flight Con! I can't hold it! She's breaking up, she's break—"…and then the plane crashes and rolls across the desert in a giant smoking flaming trail of dust and debris?  This market has that feel to it. 

The markets are taking a beating again this morning.  The Dow is off 200 points to trade at 10,240 and the 10 year Treasury is up over a point to trade at 3.23%. 

Fear over sovereign debt problems in Europe continues to reverberate through the markets.  In addition to the steady drumbeat of fear out of Europe the market is joined this morning by a chorus of higher Initial and Continuing Jobless Claims. 

Initial Jobless Claims were released at 471,000 vs. an estimate of 440,000.  Continuing Claims were released at 4.625 million vs. 4.605 million.

If you want to buy it’s not the best day…if you want to sell then now would be a good time.  There’s not much more to report…I think I might go fishing. 

If you have any questions or if there is anything I can be doing for you just let me know.

 

Market Upate 5 19 10 _ Another Fed President weighs in

The Fed continues to telegraph their preference to maintain the language in the FOMC statement regarding “exceptionally low levels of the Fed Funds rate for an extended period” and today’s  economic data only provides more support for that stance.  CPI shows no inflation. 

Last week the Minneapolis Fed President (soon to be voting member) expressed his support of the “extended period” language and this week Cleveland Fed President Pianalto (current voting member) did the same.

Pianalto’s remarks were in a speech to the Economics Club of Pittsburgh.  The bulk of her speech was directed at how the Cleveland Fed does their forecasting (yawn), but at the end she tacked on her current thinking with regard to the economy…and therefore provided a clear window to how she will be voting.

She began by reiterating the Feds dual mandate of maximum employment and stable prices.  The bit about “maximum employment” has to be a tough bit lately…but  with inflation nowhere in sight I’d give them an “A” on stable prices…for now.

I’m going to skip over much of the material she covered…it was basically a “Forecasting 101” type presentation.  Where things get interesting for you and I is toward the end where she lists her yardsticks for measuring the health of the economy, where they are, where she sees them going, and what that means for the Fed Funds rate.

Use the Force

Force 1 - Unemployment

Pianalto lists two major “forces” affecting the recovery from this recession.  The first is Unemployment, the second is a “heightened sense of caution” among Americans. 

With regard to Unemployment she points out that half of those that are unemployed have been that way for at least 6-months.  Over that time period essential job skills can erode which leads to lower productivity if/when you do get a job.  In many cases the unemployment will be structural…meaning that the job just ain’t coming back.  This leads to an even greater loss in productivity because now you have workers looking for jobs outside of their industry…jobs for which they don’t have any skills.  The longer the Unemployment rate remains elevated the bigger the negative impact from these forces.

Force 2 - Caution signs

The next force is that of the “heightened sense of caution”.  I’ve referred to this as a “change in behavior” over this cycle.  This is the type of economic event that leaves a deep and long lasting mark on those that travel through it.  If you lose your house you remember it ‘til the day you die.  If you go 6 to 12 months with no job you remember the pain and uncertainty that accompanies that status…and you will do whatever it takes to avoid being in that position again.  It’s the type of thing changes behavior going forward...by definition your behavior over the next 5 years won’t resemble that of the last 5 years.  This evolution toward more defensive behavior (one might also call it a return to more rational behavior) will in turn serve as a drag on GDP (one of several). 

Pianalto gives further evidence as to the “heightened sense of caution” among Americans:

“In a recent survey by Ohio's Xavier University, 60 percent of those polled believe attaining the American dream is harder for this generation than ones before. And nearly 70 percent think it will be even more difficult for their children. Many people are now just aiming for “financial security” as their American dream.”

Many people are just aiming for “financial security” as their American dream?  If that doesn’t signify a seismic shift in behavior then I don’t know what does.  It’s no longer that people want a house, 2.5 kids, a big screen TV and an  SUV.  Now the goal for many Americans is simply to avoid be kicked out on the street with no job.  Do you remember Maslow’s Hierarchy of Needs from Psych 101 in college?  People aiming for “financial security” as their new goal just got knocked down a few notches on that pyramid.   The need for recognition and social status has perhaps been replaced with the need for survival.    

Pianalto sums up her outlook on the “two forces” with the following: “These two factors—overall caution and the effects of labor market damage—lead me to an outlook for relatively subdued output growth through this year and next, with unemployment rates that decline only gradually.”

So here she echo’s the same sentiment as the Minneapolis Fed last week…there will be no quick recovery and expect the unemployment rate to remain high.

Moving on to the Inflation front she says that current data point to disinflation rather than inflation.  Of the two measures that the Cleveland Fed uses to track inflation they have both been on a disinflationary trend since the middle of 2008.

Her conclusion

For the next couple of years, I expect employment levels to remain well below what I would consider full employment. Similarly, I expect inflation to only gradually drift up from its currently low level but nonetheless remain subdued. In my view, this outlook warrants exceptionally low levels of the federal funds rate for an extended period of time.

Put Pianalto down in the column that lists “people voting to keep rates at zero”.  Before the month is up we’ll have more statements from Fed Vice Chairman Kohn (retiring on June 23…Yellen will replace), NY President Dudley, St. Louis President Bullard, Chairman Bernanke, Richmond’s Lacker, Philadelphia’s Plosser, and Chicago’s Evans.  The next FOMC meeting is on June 23^rd. 

Vice Chairman Kohn retires at the next FOMC meeting.  I picture his retirement party at the Fed being more of a “sheet cake and fruit punch in the lobby” type of deal where they present him with a big oil painting of his likeness that will hang in the hall at the Fed rather than the “midnight flight to Vegas” type.  If I’m wrong, and if anyone out there has an extra wristband that will get me in to the Vegas party let me know…I’d pay top dollar to see the open market committee let loose in Sin City. 

I’ll provide more color as we hear from the other Fed members over the remainder of the month.  If you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707

 

Market Update 5 14 10 _ The Fed speaks

In the beginning

Today is May 14^th, 2010.  Three years ago the 10 year Treasury was trading around a 5.20% level.  Then the Bear Stearns hedge funds collapsed and kicked off the Armageddon World Tour.  Today the 10-year is trading at a 3.45%.  It’s been three years since the Big Bang and I’m still writing updates discussing why yields are low or going lower.  Three years.  Somewhere in Japan there has to be a fixed income analyst/economist/second rate comedian that understands exactly how I feel. 

Along the way we heard Fed Chairmen say that the Sub-Prime problem was contained, that it wouldn’t spread to the general economy. We heard that housing prices had some “frothy pockets” but that they weren’t in danger of a general decline.  We heard some real doozies. 

Today

Now it looks like the Armageddon World Tour has some dates scheduled in Europe.  If European soccer fans get angry enough to burn down their home stadium over a loss to a rival team I can’t WAIT to see their collective reactions once they figure out what’s coming their way over this sovereign debt deal.  Gas prices could rise on Molotov Cocktail activity alone.

Perhaps the most interesting news of the day comes from the Fed.  The Fed is sending out messengers again this morning and the Minneapolis Federal Reserve President is speaking in tones that sound terribly candid.  It almost sounds like he never took the class on “fed speak”.  Fed Speak is a bit like the Jedi Mind Trick…it’s the thing where you speak but nobody listening really gets the true meaning of what you just said.  Greenspan was a master of this technique.  Fed President Kocherlakota didn’t get the memo.  He spoke in a straight-forward manner today and much of it lines up with what we’ve been saying for quite a while.

His outlook

Kocherlakota says he is mildly optimistic at this point.  He believes the recovery is firmly underway but that it will not be a “V” shaped recovery.  For those interested in the different “shapes” of a recovery you can pull up the Market Update from 5/7/09…it goes over the various types of recoveries.  It’s a bit disconcerting that a year after I wrote that piece we are still discussing what the shape of this recovery might be.  Threats to the recovery include higher future taxes that will be necessary to repay the amount of money we’ve borrowed.  Higher future taxes reduce the amount of capital that is available to be invested by the private sector, which leads to lower growth and slower rates of job creation.

It’s important to note that next year Kocherlakota will be a voting member…so here we’re getting a nice glimpse into the way a future voting member views the world.  In his statements he leaves no questions about his views on the language “likely to warrant exceptionally low levels of Fed Funds rate for an extended period of time.”  He states categorically that he would have voted for that language at the last meeting.

Why would he have voted for the language?  Because he sees the economy struggling with the Unemployment Rate remaining high and expected inflation remaining low.  Specifically he states that it wouldn’t surprise him to see the Unemployment Rate remain above 9.00% through the end of this year, nor if it remained above 8.00% by the end of next year.  Regarding inflation he states that he sees 5-year inflation expectations running at about 2.00%.

In summary he sees a weak economy, very high unemployment for at least two years, no inflation for 5 years, he agrees with the majority of voting members that a zero level on the Fed Funds is appropriate and that he’d vote for keeping it that way for an extended period.

We’re three years into the Armageddon World Tour/quagmire and this soon-to-be voting member of the Fed is laying out language that hints at another two years of exceptionally low rates. 

After stating all of this, Kocherlakota goes on to state that it’s all data dependent and the Fed stands ready to raise rates quickly whenever they need to whether it be “3 weeks, 3 months, or 3 years”.  This statement reminds me of the old playground threat… “don’t make me”.  I hear it occasionally when a big group of kids is outside playing.  Invariably there will be a disagreement of some sort and someone will always invoke this vague threat in an attempt to get what they want.  It’s always a hollow threat, nobody ever actually DOES anything.  It’s just a convenient way to appear like you have some control over the situation when in reality things are very close to uncontrollable. 

I find the “don’t make me” phrase to be a nice parallel to Kocheralakota’s statement that he stands ready to tighten in “3 weeks, 3 months, or 3 years” right after he lays out a scenario where he doesn’t see the need to raise rates for at least two years.  The Fed can talk all the trash they want about raising rates but it looks like they have no room to do so anytime soon.  A Marine buddy of mine used to describe people making these types of statements as having “an alligator mouth and a hummingbirds backside” because they lack the muscle to back up their talk.  My friends statement regarding the backside of the hummingbird is a bit more colorful than how I relayed it here…but in the interest of keeping this a family friendly piece I toned it down a bit.

Reducing the Fed balance sheet?

Kocherlakota next addressed the size of the Feds balance sheet and an exit timeline.  He sets the bar exceptionally low when it comes to an exit.  With regard to the pace and size of MBS sales “we want to be careful not to cause large jumps in long-term interest rates, and especially not in mortgage rates. But I believe that we can do so, as long as we commit to a sufficiently slow pace of sales. I’m optimistic that we can get MBSs off our balance sheet by 2020 at the very latest.”

There you have it…a 10 year exit deadline…way to go out on a limb.  I find that strategy terribly amusing.  Base case cash flow projections on new issue 30 year 6% MBS show that for every $1 million in principal you buy today, you will have $5,157 in outstanding principal remaining in 2020.  That is a 99.48% reduction based on pay-downs alone.  I guess I wonder why you’d even bother to issue a deadline…why not just say we’re going to hold them until they have factored down so far that they are insignificant?  In a world where words matter I guess his way is better than saying “we’re stuck and we can’t get out.” 

Reading between the lines

There is an interesting and important wrinkle in his statement this morning.  He states that “Over 2 trillion dollars of those assets are in Treasuries or in mortgage-backed securities issued by Fannie Mae and Freddie Mac. These MBSs are backed by the U.S. government—the Fed faces no credit risk in holding them. However, the MBSs do expose us to interest rate risk and prepayment risk.”

We occasionally get some questions about the safety of debt issued by Fannie and Freddie.  There is a mountain of reasons why this debt will never be allowed to go unpaid.  The multitude of reasons can effectively be summed up by stating that any failure to pay on behalf of the GSE’s would effectively destroy what remains of the global financial system, and that congress would rather not go down in history as the entity that both created and nurtured the institutions behind such an event. 

Today’s statement by Kocherlakota adds just a few more boulders to the top of the mountain of reasons that you shouldn’t be worried about the credit worthiness of the GSE’s.  Fed Presidents openly speak about Fannie and Freddie being backed by the US Government and that they have “NO CREDIT RISK”. 

Kocherlakota is no idiot.  He understands the power of words and he understands the structure of Fannie and Freddie.  He understands that the prospectus on Fannie and Freddie debt contains no explicit guaranty by the US Government…but he also understands the reality that there is no other alternative than for the US Government to make sure that the GSE’s make good on that debt…period.  He’s not the first official to state it…he’s just the most recent. 

If you occasionally field questions from board members on the safety and soundness of GSE debt just add this statement to the file as another piece of evidence that there is nothing to worry about with regard to the credit quality of Fannie and Freddie.  I wouldn’t touch their stock but I’d sleep well at night owning their bonds. 

In closing

That’s it from Memphis folks.  This weekend is the grand finale of the World Championship BBQ competition along the banks of the might Mississippi River.  Many bond trading desks send their traders down to mingle with their Memphis cohorts each year during this event so business tends to get lighter as the afternoon approaches.  This translates to “if you have any business to do then try to do it early because by 2PM the traders will be down on the river, elbow deep in beer and BBQ.”

As always if you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707

 

Market Update - A humorous example from todays market

 

I have a gift (some call it an affliction) that enables me to see the humor in even the most chaotic of circumstances.  When I look at today’s train wreck in the market something jumps out at me.  Below is a graph of today’s trading price of Proctor and Gamble, trading symbol PG.  PG is one of the 30 stocks that make up the Dow Jones Industrial Average…”the Dow” as we call it...the index that was off 1,000 points today.

 

We began laughing the moment we pulled this up.  When I see it I realize that somebody woke up this morning holding PG at $60…and he felt pretty good about it all the way through lunch time. When he comes back from lunch he answers a few e-mails, completes a few reports, then he pulls up the internet to check the value of his portfolio and dream of the day he can retire from the drudgery which currently ensnares him.  When he pulls up his stock account he sees the Dow melting down, he checks the price of PG and he thinks “OMG…SELL!”  So he puts in a market order to sell and he takes a nitro-glycerin pill to keep his heart in check.  His fill order comes back at $40…he wants to cry over a big loss like that but he’s just glad he’s off the train.  A few minutes later he pulls up a quote on PG to see just how big a bullet he dodged and he sees that the price is back up at $60.  He then pukes his cheeseburger onto his desk and he goes home sick.

 

Across town someone else just got back from lunch and was answering e-mails, completing reports, and dreaming of the day when he too can escape the drudgery which currently ensnares him.  He was watching the market as well.  This guy watched as PG started to drop…from $60 down to $55 per share and he jumped in with a market order to buy a bunch of it.  His fill order comes back in less than a minute at $40.  He thinks “OMG…SWEET! I got it at $40!”  Ten minutes later he’s still in disbelief at his great execution and he checks the quote on PG and it comes back at $60.  “OMG!  I’m rich! I just made 20 bucks a share in less than a minute…I’m gonna be famous…I’ll probably be on Oprah!”  He now dreams of how much closer he just got to escaping the drudgery which ensnares him.

 

So that’s where I see the humor today.  It’ll be even better if these guys know each other and meet up for happy hour after work.  Imagine the scene where they each talk about their day in the market.

 

Steve Scaramastro, SVP

800-311-0707

 

PS – we were concerned that someone on this distribution list might own Proctor and Gamble and be upset by this example…but then we figured you probably won’t get this e-mail because you went home early after puking your cheeseburger .

 

 

 

 

 

Market update 5 6 10 _ post panic

 

Good news…we’re only off 500 on the Dow

The sell-off in stocks had been picking up a little steam as we headed into the afternoon but it didn’t look like anything worrisome.  When we dropped from down 100 to down 225 it was news…but the drop from down 225 to down 300 then 500 was a train wreck.  At roughly down 500 the office was filled with the staccato chatter of people working, watching a disaster, and trying to relay the news at the same time.  The trading desk was then coming over the speakers announcing that liquidity was leaving the market.  By the time the Dow was posting close to down 1,000 points it was the type of selloff that stops an entire office of seasoned capital markets folks in their tracks.  Everyone was watching the machines to see how far this would go, to see what was fueling this.  It happened so quickly that by the time you could call out the update on the new level it was stale and the market was down another huge chunk. 

The fever pitch came at 1:42 Eastern time when the Dow Jones was trading at 10,458.  It dropped 547 points over the next 5 minutes to post trades at 9,885.  That was a very alarming 5 minutes.

What the heck was THAT?

Right now it’s clear that something started a panic and the herd all went for the door at the same time.  I imagine that sometime later today or tomorrow we’ll have some news on what started it.  Regardless of the cause it serves as a pretty good window into how “certain” everyone is of this recovery.  At the first sign of trouble the market fell into panic selling that took us back to lows we haven’t seen since November 2009.  That doesn’t tell me that the market is sold on this recovery. 

I hope we get some news on this quickly because phones are ringing and rumors are starting about who did what and when.

The market has “recovered” nicely to be only down 410 points with the Dow trading at 10,462.  I feel like I need to go outside for a cigarette…and I don’t smoke. 

Below is a graph of the Dow’s activity this afternoon. 

If you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707

 

FW: Market Update - Meltdown

Whoa Nelly…volatility is BACK!

Ah…just when many people thought that all was well and that the few dribs and drabs of good economic news we were receiving were the harbingers of better times on the horizon…we get a reality check. 

Equity markets are extending their losses this afternoon and US Treasuries continue to rally as the global flight to safety continues.  The Dow is off 800 points at the moment to trade at 9,982 and the 10-year Treasury is up over two points to trade at 3.26%.  The 10-year Treasury is trading at its May 2009 lows. 

The 30 year bond is up over 3.5 points to trade at a 4.17%.  The last 15 minutes of trading have taken on a very spooky feel…it’s eerily familiar to some of the activity we saw during the big crisis.  These times were characterized by markets falling so fast that by the time you call someone to tell them about it it’s all worse.  Everything is worse before I can get don’t typing. 

This write up was going to be a much longer piece but this market is too fast…I wanted to get the word out to everyone as fast as I could.

If any questions call.

 

 

 

Market update 5 4 10

 

Looking for a safe harbor

 

The markets are seeing a flight to safety today.  There is a great deal of concern that the problems in Greece will spread to other areas of the Euro zone and it is spooking the markets in a material way.  The Dow Jones Industrials are off 242 points to trade at 10,909.  They’ve traded below 11,000 for the better part of the day.  Every stock index in Europe is in negative territory for the day, Treasuries have been in full rally mode from the open, and the 10 year Treasury is currently up 19/32’s to trade with a 3.60% yield. 

 

Stocks

 

Below is a list of the major equity indices around the world and how they’ve performed today.  There is only one major stock index on the planet that is up today…the Nikkei 225…maybe they didn’t watch the news…or maybe they are a bunch of contrarians, who knows.  At any rate, the entire world seems to be concerned over the problems in Europe.  Money is leaving risky assets and moving toward safer harbors.

 

When I see every stock index on the planet down at the same time it makes me wonder if diversification is worth the effort.  It seems like it would just be easier to lose money in one language rather than a bunch of different ones. 

 

Oh the irony

 

Everyone has a passing familiarity with Credit Default Swaps at this point in history.  As a quick and dirty refresher you just need to know that the CDS spread is the amount (in basis points) that you have to pay to get insurance against default on a bond.  With that bit of housekeeping aside let’s look at some real world example.

 

These spreads are all relative so let’s look at the cost of insuring a good bond first.  If you want to buy default insurance against a AA rated bond issued by Japan you’d be looking at a cost of 12 basis points.  Have concerns over the debt of Great Britain then you need to pony up 39 basis points up front for insurance.  Worried about Texas debt?  41 basis points.

 

If you own Greek government debt and you want to buy insurance against loss for a year it will cost you 999.57 basis points up front.  What you get for this is your entire principal amount back if Greece defaults on the issue.  So you pay up front, and if it all goes south you put a bond worth maybe 15 cents to the insurer and they give you par.  Without even looking at the actual numbers for settlement date we can clearly see that Greek debt is considered more risky than debt from the State of Texas.  After all it costs almost 1,000 bps to insure against default on Greek debt vs. only 41 bps on Texas debt.  So far so good.

 

This next bit I find alarming.  Credit Default Swap spreads on debt from the Islamic Republic of Pakistan are priced at 744 basis points.  Insurance on Pakistani bonds is 247 bps CHEAPER than that on the debt of Greece.

 

As I ponder this arrangement I envision Pakistan in my mind.  The image that comes to mind is a dirty, third world, desperately poor country with a serious terrorist problem, an unstable government, angry neighbors, and a very loose hold on its nuclear arsenal.  We are CURRENTLY BOMBING places in this country, the most wanted terrorist in the entire world is rumored to live there, and the latest news suggests that people in Pakistan are involved in the recent attempt to car bomb Times Square in New York City.  The country can’t control vast swaths of its own country (this one is a push since we can’t either), instead they simply call those areas “lawless tribal lands” and let the terrorists have a de facto home country.  The market currently considers this country as being in better shape to repay its debt than is Greece.  I find that remarkable. 

 

I’m gonna go buy a Gyro sandwich and some baklava tonight…while I still can. 

 

That’s all the news to report this afternoon.

 

If you have any questions or if there is anything I can be doing for you just let me know.

 

Steve Scaramastro, SVP

800-311-0707