@ the open 1-3-11

“once more unto the breach, dear friends, once more” (Henry V, Act III) – Santa Claus is coming late to the holiday season but few seem to be complaining…yet little has changed beyond current evidence of a slowing in economic activity globally as a result of the debt crisis in the EMU…but it’s it like this every year? Holiday demand and follow on sales to clear out inventory drives order books late and early in the year only to be followed by flagging demand in Q1. Hopes remain that the housing market could turn around in the US and thus drive additional durable goods demand via household formation but even if there is additional housing demand it may only provide a hit to the storage REIT industry as former homeowners who’ve moved into apartments or in with relatives take their existing excess belongings out of storage and into their new digs…then again perhaps I’m too pessimistic. It does appear that vehicle demand is starting to come back as the pattern currently underway is eerily similar to that from the early 80’s double dip while we have a significantly higher population of adult drivers in the US of course we’re prime to test the theory that vehicle quality has improved dramatically over the last 10 years which could prolong our time spent below the average demand level of the last 30 years of 14.44 mm autos. Risks to the year remain those that we’ve discussed ad nauseum over the last several months (EMU debt crisis, Greek exit from the EMU, Iranian provocation, Chinese bank crisis, US double dip)…pick it. Of this I’m certain, there will be an event that we haven’t discussed that crops up at some point…”once more unto the breach…”

Equity markets – so far this year we’re seeing some decent rallies in equity markets that have opened for trading…the debate is over what’s driving the gains. Manufacturing data out of Asia has been better than expected and the outlook for the ISM numbers coming out in the US this morning are also fairly bullish. News from Germany and UK has also been better but saber rattling from Iran over the Straits of Hormuz hangs over the market and is helping to drive WTI higher by 2.5% in early trading. European indices remain mixed this morning and off of their earlier highs as the realization remains that nothing has been done so far to end the debt crisis but the hope in the rest of the world appears to be that it won’t matter in the end…don’t bet on this.

Macro, News & Events

Economic Releases –

• November Construction spending (MoM)…+0.4% v. +0.8%
• December ISM Mfg Index…53.4 v. 52.7 (above 50.0 is growing)
• December ISM Prices Paid Index…48.0 v. 45.0

Events

• Minutes from the 12/13 FOMC meeting to be released @ 1400
• No earnings from the S&P 500 companies

Asia, Europe & USA

• Japan and the US face a cumulative $5.8 billion in debt maturities this year and will likely face higher interest rates which will only exacerbate their budgetary issues
• Australian factory output levels grew for the first time in 6 months which follows reports indicating pickup in manufacturing activity in both China and India which have economists hopeful that the EMU debt crisis may not create a global economic slowdown
• Unemployment in Germany fell more than forecast in December (-22,000)…the forecast decline had been -10,000. The jobless rate fell to 6.8%. The key stat going forward will the orders for German industrial production if the rest of the EMU is truly slowing and headed for recession. Current forecasts for 2012 growth from the IFO and Budesbank are +0.4% and +0.6% respectively (down from 2.3% and 1.8% previously). Current estimates for 2011 growth from the German government are +2.9%.
• Manufacturing in the UK fell less than projected in December amidst increasing demand from Germany and China….the Chartered Institute of Purchasing and Supply Economics rose to 49.6 from 47.7 in November
• Belgium auctioned €2.44 billion of 3-mo & 6-mo bills exceeding the 2.2 billion target…the 3-mo bill yield was 0.26% down from the 0.78% yield on the last print in December. The bid-to-cover dropped from 8.6x to 2.1x as a result. The push out of the “final solution” to March has investors more comfortable with short dated paper
• GE has $78.7 billion of debt maturing in 2012 (the most of any US corporate issuer)…Ally Financial (fka GMAC) has $11.7 bb, the largest of any below investment grade issuer. Total US corporate maturities this year aggregate to $620 billion as yields rise.
• UBS and ING Groep are preparing to auction “covered bonds” (secured by mortgages or municipal loans) to reduce borrowing costs and sate demand for more secure paper…Financial institutions in Europe sold €367.2 billion of the paper in 2011
• Sears Holdings (SHLD) plan to cut costs and close money losing Sears and K-Mart locations are failing to convince investors that the retail concept can survive as bonds continue to fall as spreads move to over 1,000 basis points (10%) usually considered indicative of financial distress.
• Regulators ratings choice may be going from bad to worse as they consider using OECD “ratings” of sovereign debt as opposed to the ratings agencies…2/3 of OECD membership is made up of EU member countries and they have an inherent conflict of interest in “over-rating” EU sovereign paper…the same argument used in Dodd-Frank to stop using S&P and Moody’s as they are paid by the rated entities thus creating the inherent conflict of interest. So you’re going from entities that can at least be somewhat disciplined by the capital markets (sold or shorted if they perform miserably) to government bureaucrats…anyone who thinks that this is a good idea should have their head examined.
• Cablevision (CVC) is now the “cheapest” US cable company following the resignation of their COO last month…of course the Dolan’s aren’t likely to sell
• BP is trying to get Halliburton (HAL) to cover all of its expenses and costs incurred as a result of the spill disaster at the Macondo well in 2010…BP has paid more than $21 billion to date
• The Iranians are warning the US against sending the Stennis back through the Straits of Hormuz after the carrier transited the straits on the 27th headed eastward…this follows 10 days of maneuvers by the Iranian navy on the east side of the strait in the Gulf of Oman. The Iranians are threatening to block the flow of oil through the strait saying that it would be “easy” while the US Navy said on the 28th that there will be zero tolerance for blockage of the strait. In other words, it looks like we have a standoff or potentially a feigned “right hook” from the Navy while the Israelis come through with an “upper cut” right and bomb the existing nuke sights inside of Iran…they’ve been asking for this for some time.

Credit markets –

Sovereign CDS – nice rally this morning in spreads as the Belgian bill auction goes well bringing out buyers…there’s plenty of liquidity but there’s also a good deal of supply coming in the cash markets which is only one headline away from sending spreads spiraling back toward all time highs…

Short term markets – the euro / dollar OIS spread differential continues to come in as dollar spreads are now over 50 bps…with the ECB now lending out dollars at 50 bps this implies that we’re back to the 100 bps of lending costs that were at the ECB prior to the announced lending rate cut back in early December…at that rate there was very little borrowing going on so you could make the argument that this could be the new equilibrium level…we’ll see if this spread peaks out here or if it continues to creep higher.

Oil markets – WTI is posting a strong rally on better than expected monthly mfg data from Australia to Germany and the UK with a positive outlook for the ISM data here in the US as well…also adding to the rally is the renewed saber rattling by the Iranians as they threaten to shut down the Straits of Hormuz if the US sends the Stennis back through the strait…typical Iranian strategy is the push to see just how far they can push…there’s a smack down coming and the oil markets are reflecting this, the only question is what’s the probability that being put on the event. WTI is currently headed toward $102 and the WTI / Brent spread has collapsed back under -$9.

Phillip Pennell, CFA
Turnberry Capital Management
(203) 861-2708 (Direct)
(203) 861-2700 (Trading)
(203) 917-2255 (Mobile)

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.