Equity Markets – US markets are poised to open higher as futures have turned around following decent macro news out of Germany (see below) and indices across the continent are opening over 1% higher…later closing Asian markets went out at their highs for the session with the Hang Seng going parabolic at the end of trading (up roughly 200 points in the last 45 minutes of trading). The S&P wants to move higher going into month end and barring horrific numbers from the ADP report and NAPM surveys my guess is that we’re heading back toward 1250 on the S&P (I don’t think that we’ll get there today but that’s the general direction). With the FOMC minutes signaling that there is support for expanded monetary intervention and a growing expectation that the EU leadership has to do something after the August holidays the equity markets appear poised to rebound from the August lows as we move toward the 4th quarter.
I frankly see the S&P in the 1155 to 1370 “channel” to year end (the flatter channel shown below in the chart) as opposed to the 1190 to 1500 “channel” which would date back to the March ’09 lows and was at least in part manipulated by QE2…of course if there is a QE3 then all bets are off and my guess would be somewhere in the middle of these two . Bottom line, we’ll have to retest 1120 once again to confirm that it’s a real bottom but I think we may be clear to 1300 before retesting that low.
Macro, News & Events –
• Another big macro release day in what is a week of big macro releases…remember, Friday we get the August jobs report
• we get a first glimpse of employment data from the ADP survey (expecting 100k in job creation vs. 114k in July)
• The Chicago purchasing managers survey for August is due out and expected to be 53.3 v. 58.8 in July
• July factory orders are expected to come in +2% vs. -0.8% in June
• The August Milwaukee NAPM is expected to come in at 52.7 v. 57.6 in July
• Hiring in August rose for the 26th consecutive month in Germany as those out of work declined by 8,000 (a decline of 10,000 had been expected) and the unemployment rate held steady at 7%...this is the lowest rate recorded since reunification 20 years ago. The decline is modestly surprising given the 20% drop in the DAX index in August but is likely more indicative of the fact that hiring is a process that once begun is difficult to stop, the point being that this month’s equity market decline is more likely to negatively impact hiring in September.
• German retail sales grew at a 0% rate in July after surging 4.5% in June, a three year high. The consensus estimate was for a 1.5% decline in sales in July.
• Spain and Italy join the growing list of countries pledging balanced budget amendments as the price of support from the Northern EU states…of course this guarantees nothing as EU countries have been notorious for skirting the intent of fiscal treaties since the formation of the currency union back in ’98…not only that but the austerity measures could backfire as future growth slows forcing additional austerity which further slows growth…you get the picture. So while it sounds great initially (Balance the budget)…it’s highly problematic for countries where the government is the largest contributor to the economy which is to say that taxes are ridiculous and you have idiots allocating resources to their most likely worst outcomes. Sound familiar…the moral of the story is that the only good government is a SMALL government.
• Japanese demand for thermal coal is rising as the economy recovers from the devastation wrought by the March quake/tsunami…the spread between European thermal coal per ton and that at the port of Newcastle, Australia has declined from $11.25 in June to $6.75 on 8/26…Japan already the world’s largest importer of thermal coal and LNG is poised to ramp imports even more as the country moves away from nuclear electric generation in the wake of the Fukushima Dai-Ichi meltdown.
• The EU debt crisis is taking a heavy toll on the container shipping industry as an excess supply of containers and falling European demand…container traffic between Asia and continental Europe rose 4.2% in Q2, the smallest increase since 2009 and shipping rates excluding fuel surcharges were practically zero in July and little changed through August. The most worrisome aspect is that this slowdown comes during what is usually a peak shipping season as inventories build for the holidays and is likely indicative of concern of overstocking by retailers given the turmoil on the continent.
• The market rallied yesterday afternoon following the release of the FOMC minutes which indicated that there remains support on the committee for additional monetary policy moves in an effort to boost economic growth. However, with three dissenting votes the compromise solution was to announce a hold on short term rates at zero for what could be the next two years. Most analysts appear to expect the next action by the FOMC to focus on the long end of the curve in an effort to reduce longer term rates…what they don’t appear to understand is that just because you can temporarily influence rates doesn’t mean that you can force loans out the door or that you can dictate credit spreads. This very thing is what has created turmoil in the bank loan market since it was announced that short term rates would be held near zero for the next two years which clearly impacts floating rate expectations going forward (and consequently LIBOR) which in turn results in banks raising spreads to compensate for the artificially low short term rates over what could amount to 40% of the loan’s time outstanding as most are 5 year loans. Unintended consequences…you’d think that these guys would get it as they’re all economists…
Currencies – the US dollar index (DXY) continues to track below 75 even in the face of growing trouble in Europe…the bouyency of the euro continues to surprise me as the combination of Chinese buying and ECB immunization are working to keep the currency high…of course this in turn has the unintended consequence of crushing the ability of the southern European countries to attract hard currency via sales of the their goods and services and removes one of the reasons that fiat money exists…the ability of politicians to manipulate it to serve their purposes when it suits them. Austerity is bad enough but austerity in the face of potential deflation is a death spiral waiting to happen. Once again, I’m not sure that I understand what these people are thinking other than simple aquiesence to the Germans and other northern European states that are most afraid of inflation but at some point you have to ask yourself, do you want an EU that is worth less in “real terms” or do you want an EU that is going to blow sky high and potentially be worth nothing in “real terms”.
Credit Markets – sovereign spreads in Europe and Asia have improved over the course of the last several days as slightly better economic news and the general view that we’ve taken August’s best shot and survived along with belief that the FOMC will not allow things to slide further without action and expectations that something rational has to come out of the EU leadership soon, given that the southern countries are attempting to enact balanced budget amendments which gives the northern leaders a rationale behind which to act. Add to this some signs of modest improvement in Japan and you can piece together a mosaic that’s not completely given over to doom and gloom. Having said that, illiquidity remains the word for the day in the credit markets as concerns over the health of the EU banks continues to weigh on credit availability and the ever lingering fears of recession in the US hangs over the more risky parts of the high yield market thus caution remains the sensible solution and I continue to believe that higher dividend yield large cap stocks make the most sense given their recent relative outperformance…my two favorites for the time being remain T and VZ, both with yields in the high 5% range…vs. a 10 year treasury note at 1.51% yield VZ at 5.4% and T at 5.8% look very attractive given their virtual duopoly status in wireless communications (as data service demand explodes higher), stabilizing wireline declines, growing triple play footprint and copious free cash flow generation. Frankly, I’ll take make the wager on smart phones, ipads and “hot spots” driving demand well into the future for these utilities with the triple play and “Isis” as potential huge upsides to cash flow generation and wireline / business accounts as the ever shrinking base of free cash flow.
Oil Markets – long time readers know how I feel about the oil markets (generally bullish in the 80’s on WTI) and hints of support from the FOMC along with some better macro data at the margin continues to support oil prices here with WTI continuing to look ridiculously cheap relative to Dated Brent. I’m working on completion of a comparison sheet for a large number of pure play E&P companies (not inclusive of the larger integrated oils) and so far, based upon my metrics (which perhaps we’ll discuss this weekend) Quicksilver Resources (KWK : closed yesterday @ $9.68) looks like the cheapest play on domestic energy by far…note that this is a natural gas heavy and relatively small operation but at some point I think that the compelling nature of the valuation metrics makes it an interesting take over play.
Phillip Pennell, CFA
Turnberry Capital Management
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The information included in the above discussion is not intended to be used as a basis for making investment decisions nor should it be construed as a recommendation by the author to buy or sell any specific security. Individuals should consult their investment advisor prior to making any investment decisions.