Archive for July, 2006

  • The Midday Market
    , July 31st, 2006 at 11:28 am

    The markets are mixed so far. Energy stocks are up a bit, and financials have pulled back. The yield on the 90-day T-Bill has crossed over the 5-year yield which I don’t think had happened before.
    Expeditors International (EXPD) is set to report earnings tomorrow. After having a great first half, the stock has been very volatile recently.

  • Economy Grew By 2.5% in Q2
    , July 28th, 2006 at 9:15 am

    The govenment just reported that GDP grew by 2.5% for the second quarter, which is less than half the rate of the first quarter:

    The second-quarter’s performance — which reflected the bite of high energy prices and rising interest rates on people and businesses as well as a cooling in the once red-hot housing market — was weaker than the 3 percent pace analysts were forecasting.
    The 2.5 percent pace was the slowest since a 1.8 percent growth rate in final quarter of 2005, when the economy was suffering fallout from the devastating Gulf Coast hurricanes.
    Even though the economy cooled in the second quarter, inflation heated up.
    An inflation gauge closely watched by the Federal Reserve showed that core prices — excluding food and energy — jumped by 2.9 percent in the second quarter — far outside the Fed’s comfort zone. That was up from a 2.1 percent increase in the first quarter and marked the highest inflation reading since the third quarter of 1994, when core inflation rose by 3.2 percent.
    The inflation reading was taken before the latest run-up in energy prices. Oil prices hit a record closing high of $77.03 a barrel on July 14. Gasoline prices also have marched higher, topping $3 a gallon in many areas.

  • Your Soft Landing Survival Guide
    , July 27th, 2006 at 6:03 am

    Talk of a soft landing is very in right now. It’s the new gay. No wait…I think it might be the new black. Actually, I’m not really sure. Either way, it’s here, get used to it. Even Jeremy Seigel has jumped on the Soft Landing Bandwagon.
    This got us to thinking, how has the market behaved during previous soft landings? The problem is, true soft landings have been quite rare. Many landings start out soft, and become hard very fast (my apologies for the wording of that sentence).
    By my count, there have been three successful soft landings of the past 40 years. The first was in 1966, then again in 1986, and again in 1995. Here’s a graph of the 10-year Treasury yield along with the 90-day yield going back to the early 1960s:
    As always, I pass the graphics savings on to you the customer.
    The 1966 case is probably the most relevant to us today. The country was at war. It was a mid-term election year. Short-term interest rates had been climbing for some time, and the yield curve flattened out in January in 1966. Short-term rates continued to head higher and didn’t peak until September.
    Remarkably, the economy wobbled but didn’t go under. Real GDP grew by 4.3% in 1966, 2.5% in 1967 (including a flat second quarter) and ramped up to 4.9% in 1968. It wasn’t until late-1969 that the economy finally started to break.
    The stock market, however, had a painful time in 1966. Stocks peaked on February 9, shortly after the 90-day yield first caught up with the 10-year yield. At its high point, the Dow came within 5 points of 1,000, although it wouldn’t close above the millennium mark for another six years. By the low point on October 9, the Dow lost 25% and the S&P 500 dropped 22%.
    This was a classic bear market. I think the outlook for stocks is far better today than it was 40 years ago. P/E ratios have been coming down, and the Fed is already talking about calling off its rate increases.
    Starting from January 10, 1966 (roughly when the yield curve first became flat) and measuring one year out, the best industry groups were Hardware (18.9%), Books (17.3%), Gold (15.2%) and Insurance (7.85). The worst were Health (-66.2%), Software (-39.3%), Textiles (28.8%) and Chemicals (23.4%).
    In 1986, it was still Morning in America, although real GDP growth had been dropping from its blistering levels. The economy grew by 5.6% in 1984 and 4.3% in 1985. By 1986, the economy grew by just 2.8% (1.4% in the second quarter) and a recession seemed possible. Once again, it was a mid-term election year. Just like 1966, the party controlling the White House was rebuked at the polls.
    The slowdown, however, was temporary and the economy accelerated again. In 1987, the economy expanded by 4.5%. Despite the market crash, the economy grew by another 3.7% in 1988.
    The major difference between now and then is that the yield curve never got anywhere close to inverting. Long-term bond holders were still not convinced that Paul Volcker had won the war against inflation. The top-performing groups of 1986 had a definite defensive bias; Tobacco (50.5%), Drugs (35.7%) and Boxes (35.4%–really, that’s what it says “Boxes”). The worst groups were Health (-15.1%), Hardware (-8.6%) and Aerospace/Defense (-7%). It’s interesting to see that Hardware went from best to worst, but Health is still at the bottom.
    In 1994, the Federal Reserve had raised interest rate very aggressively. By 1995, the economy began to feel the squeeze. Real GDP growth was just 2%, less than half the rate of the year before. The economy was particularly weak in the first half of 1995 when it by 1.1% in the first quarter, and 0.7% in the second quarter. Since long-term yields climbed with short-term rates, the yield curve never formally inverted.
    All ten S&P 500 sectors had a good year in 1995:
    I think history shows that defensive stocks are a good place to ride out a soft landing. You’re protecting yourself against the most severe losses, and there’s a good chance for decent capital gains.

  • Earnings from Varian and Fair Isaac
    , July 26th, 2006 at 9:31 pm

    After today’s close, Varian Medical (VAR) reported earnings of 41 cents a share, which was above the Street’s forecast of 38 cents a share. The company also raised its outlook for this year’s growth to 18%-19%.
    Fair Isaac’s (FIC) earnings fell from 53 cents a share to 40 cents a share. That included charges of 15 cents a share, but it was still below expectations of 42 cents a share. This was a very disappointing quarter for FIC.
    Respironics (RESP) will report its earnings tomorrow.

  • Jeffrey Saut on War and Stocks
    , July 26th, 2006 at 3:30 pm

    Whatever the outcome, our sense remains that the various markets will revert to a focus on the issues evident prior to the recent hostilities. Those issues remain a softening real estate market, rising interest rates, high energy prices, inflation, a weakening dollar, P/E multiple compressions, waning earnings momentum, weakening consumer spending, flat wage growth, and declining GDP momentum. And to that GDP point, it is worth nothing that while we have a healthy distrust of the government’s measuring metrics, the one thing you can trust is tax receipts. And surprisingly, tax receipts are growing at around 10%. Ladies and gentlemen, 10% growth in tax receipts just does not “foot” with 2.5% GDP growth. “Somebody” is lying! Either tax receipts are getting ready to collapse, or the economy is going to continue to surprise on the upside. If economic strength is the “call,” then while the Fed may pause at its August meeting, it is certainly not done with its parade of rate ratchets. If, on the other hand, the economic slowing is about to accelerate, the concurrent loss of earnings momentum is not a particularly pleasant environment for stocks.
    As for the ubiquitous argument that stock P/E multiples are cheap based on forward-looking earnings estimates, hereto we are skeptical. Indeed, P/E ratios on forward-looking earnings are almost always lower, making stocks look undervalued. That was the case in 2000, 2001, 2002, etc. It is just the nature of Wall Street to overestimate earnings. Yet, the real driver of stock prices is what investors are willing to pay for those earnings, and as we have suggested for the past few years, P/E multiples are compressing due to rising inflation and rising interest rates. And that is why, despite double-digit earnings growth as measured by the S&P 500, stocks have gone nowhere for the past few years. That said, there is always a bull market somewhere and for the past few years we have suggested it was in small/mid-capitalization stocks, “stuff stocks,” Japan, Canada, emerging markets, etc.

    Here’s a table on how the market has reacted during different wars (FactSet provided the data).

  • Chart of the Day
    , July 26th, 2006 at 3:13 pm

    The market has been shifting out of consumer discretionary stocks and into consumer staples stocks. Here’s a chart of the Staples ETF (XLP) against the Discretionary ETF (XLY):

  • Executive Pay Disclosure
    , July 26th, 2006 at 2:54 pm

    The SEC voted today to require companies to provide more detail about executive pay, including perks. As you may know, I yield to no one is bashing the SEC and tedious regulations, but I honestly can’t get too worked up about this one.
    If anything, it will show shareholders that executive pay at most large corporations is a very tiny amount of overall expenses. It sure gets people upset, but it’s not what’s hurting most businesses. Actually, I wouldn’t mind seeing companies go a step further and provide their executive pay in per-share terms. For example, Stanley O’Neal, the CEO of Merrill Lynch, received a very generous stock options grant of $14 million just a few days after 9/11. To be sure, that’s a huge amount of money. But in per-share terms, it works about to roughly 1.5 cents. Since the time of the options grant, Merill’s stock is up $34 a share, which could also be called 3,400 pennies. Are Merrill’s shareholders demanding that 1.5 cent back?
    The SEC did not adopt a rule which would require disclosing the income and perks of a company’s highest-paid employees. This became known as the “Katie Couric” rule. Companies complained that revealing the income of celebrities could damage competitiveness. Also, just think of the catfights that would ensue if one actress knew she was being paid less than another. We just can’t have that happening.

    Although the final rule dropped the “Katie Couric” requirement, the SEC will seek comment on a less-sweeping approach that would target pay to policymakers at larger companies and their subsidiaries, excluding most professional athletes, television and film personalities, salesmen, traders and investment bankers. As in the original plan, the revised approach calls for identifying highly-paid non-executives by job title, rather than name.

    Two things. First, I’m sure that many investment bankers are the highest-paid employees at many conglomerates and financial services firm (talk about catfights). Also, no matter what job title they use, don’t you think we’ll be able to identify which one is Katie?

    To combat “backdating” and other abuses in awarding stock options, the SEC will require option grants to be disclosed clearly in tables showing the fair value of the option grant. The closing market price of the stock on the grant date must be shown if it is higher than the option’s exercise price, along with the date the company’s directors awarded the options if it is different than the grant date of the options. If the exercise price of options is different from the closing market price on the grant date, the company must describe its method for determining the exercise price.
    In addition, companies must provide more details about option grants to executives in a new compensation discussion and analysis report, explaining methods used in granting stock options, including why a particular grant date was chosen. Other timing questions, such as whether options are granted to executives before the firm issues important information or whether the company times the release of market-moving information to affect the value of executive stock options, also must be addressed in the report.

    Again, I really don’t have a problem with this; the more info the better. But I hardly see how this “combats backdating.” Unless the boards has specified it, back-dating is already illegal.

  • Daniel Gross on the HCA Deal
    , July 26th, 2006 at 11:24 am

    From Slate:

    Big business deals usually aren’t ironic, but this one surely is. HCA, a firm founded by the family of the Republican Senate majority leader, Bain, a firm whose founders include Massachusetts governor and GOP presidential aspirant Mitt Romney, and KKR, a firm run by Henry Kravis, a major Republican donor, are betting on the continued expansion of government. HCA’s sale is essentially a $33 billion investment in the idea that government will take an even bigger role in health care. As Les Funtleyder, health-care strategist at Wall Street firm Miller Tabak + Co., put it this morning, “[T]he buyout firms are making a leveraged bet on an improving economy and the prospect of universal health care.”

    There’s also the role of Sarbanes-Oxley and nuisance shareholder lawsuits.

  • Greenspan Was Right
    , July 26th, 2006 at 11:09 am

    Here’s a headline you don’t see often: “Greenspan Was Right.” Bloomberg is coming to the defense of Greenspan’s support for derivatives.

    The former chairman of the Federal Reserve has been saying since 2002 that derivatives — financial agreements used to bet on everything from bond prices to weather patterns — actually reduce risks by making financial markets resilient to shocks. He told a Bond Market Association gathering in New York in May that derivatives are the most significant change on Wall Street “in decades.”
    At a time when oil prices are above $70 a barrel, the Mideast is exploding and more than two dozen central banks have raised interest rates since May, derivatives are allowing companies to borrow a record $607 billion and obtain relatively cheap financing.
    By bundling more than 10 percent of that into so-called collateralized debt obligations, bankers are able to provide more cash to companies, especially those that need it the most. Defaults fell to the lowest since 1997 as sales of CDOs rose 63 percent to $177 billion in the first half, according to the Bond Market Association, a New York-based trade group of dealers and underwriters.

  • Bernanke’s Financial Disclosure
    , July 25th, 2006 at 11:40 pm

    Just as I suspected, he’s rich:

    The chairman’s financial disclosure form, released Tuesday, showed that he’s a millionaire, with holdings last year in no-frills U.S. Treasury securities, Canadian Treasury bonds (???), stock and bond mutual funds and two annuities.
    Bernanke, 52, took the Fed helm in February succeeding longtime chairman Alan Greenspan, who also played it safe when it came to his own investments while at the central bank.
    An economist who spent most of his career in academia, including teaching at Princeton, Bernanke also is receiving royalties on two textbooks he wrote. Royalty income was listed at between $50,001 and $100,000 for each textbook, the document showed.
    Bernanke’s biggest assets last year were two annuities – TIAA Traditional and CREF Stock Large Cap Blend, which were each valued at between $500,001 to $1,000,000. He sold some of his holdings in those two investments last year.