@ the open 2-2-12

Equity Markets & General Comments – European market are lower this morning following auctions by Spain and France which frankly went pretty well…the success of the LTRO is not being lost on the markets and it is little coincidence that Germany leads the way in Europe as their macro data has been at worst decent and the additional liquidity of the LTRO has at least delayed the realization of bailing out all of Southern Europe for the time being. France has benefitted from this last point as well but their economic performance has come up short and the downgrade didn’t help. The majority of Asia markets were up in overnight trading on the heels of yesterday’s performance here in the states as the S&P was up 89 basis points yesterday and we hit a new 52-week high on the NASDAQ 100…

We’ve got a heavy slate of macro data out today and we’ll see what the weekly claims numbers look like after the ADP job change report disappointed yesterday and last month was revised lower…remember the jobs report for January is out tomorrow and that could impact trading today. The market will also pay close attention to productivity and unit labor costs as Q4 EPS continue to disappoint on an aggregate basis…higher unit labor costs doesn’t exactly say “higher profit margins” and the next question is “can we raise prices?” None of this is good for growth outlook or Fed policy since the Fed is clearly not prepared to deal with a situation involving higher inflation and lower profits for companies implies lower capital spending…the upside, to the extent that there is one, could be that demand is finally outstripping the labor/capital mix at the macro level which means that an addition to the labor component is needed…the only potential problem could be that the appropriately skilled labor component can’t be located and that is likely more a function of the housing market than anything else (lousy home sales keep labor stationary when it could otherwise move to fill open positions elsewhere in the country). We’ll see what happens, all economic problems ultimately have a way of coalescing at around key issues after the “easy fixes” to the latest downturn have been put in place (print more money, lower short term rates)…just another way of saying that the law of unintended consequences becomes a binding constraint at some point.

Macro, News & Events

Economic releases

• January Challenger Job Cuts (YoY)…last was 30.6%
• February RBC Consumer outlook index…last was 45.8
• Q4 Nonfarm productivity…+0.8% v. +2.3%
• Q4 Unit labor costs…+0.8% v. -2.5%
• Weekly Initial jobless claims…371k v. 377k
• Weekly continuing claims…3,535k v. 3,554k

Revisions to prior numbers
• January New York ISM…last was 51.1
• January ICSC Chain store sales YoY…last was +3.5%

Events

• Federal Reserve Chairman Bernanke will testify before the House Budget Committee on the state of the US economy this morning @ 1000

Earnings – large slate of companies announcing earnings results today (38)…to date, 220 of the S&P 500 have announced with the average year over year change in EPS coming in at +2.88%...once again, this compares to +19.5% (Q1), +16.3% (Q2) and +14.8% (Q3)…in other words an inauspicious roughly first half of the earnings season. Interesting cyclical names to watch today: International Paper (looking for $0.61/share); Snap-on (looking for $1.18); Dow Chemical (looking for $0.31); Cummins Engine (looking for $2.24/share); Mastercard (looking for $3.91/share)

Asia, Europe & USA

• Deutsche Bank AG profit declined 76% in Q4 amid the sovereign debt crisis and a poor investment banking as well as poor sales and trading results…net income missed by a wide margin as the estimate average on net income for the quarter was €556 million and the bank did €147 million… Q4 2010 net income was €601 million.
• Spain auctioned €4.56 billion of 3, 4 and 5 yr paper (target was 4.5 billion) at yields of 2.86%, 3.46% and 3.57% respectively as the LTRO continues to impact demand for bonds along the curve for the “periphery”.
• Spain’s jobless claims rose by the most in three years in January, leaving the unemployment rate at 22.9%, as the economy entered into “double dip” territory…Spanish GDP may decline 1.5% in 2012
• Sources say that the Spanish government may have banks take up to 34% of their losses on real estate as charges against capital and that any bank without sufficient capital will have access to loans from the country’s bank rescue fund.
• The decline of the Collateralized Loan Obligation (CLO) funds which once accounted for up to 74% of demand for leverage loan paper has put more of the supply from the bank loan market into hedge funds and historically high yield bond investors as pricing cheapens. Without the cheap sources of funding for structured securities after that market collapsed in 2008/2009 this has increased the pricing to companies using this type of financing and increased the volatility in secondary trading as CLO’s were typically “buy and die” holders of the paper given their structure.
• Royal Dutch Shell will raise their dividend for the first time since 2009 as new projects generate more cash…the company plans to spend $30 billion over the next 3 years on up to 60 new projects.
• The Saudis may increase their commitment to the IMF in exchange for an increased voting share…Legarde has been trying to raise an additional $500 billion for the fund and will visit Riyadh on the 4th.
• France auctioned €5.7 billion of 10-yr paper at an average yield of 3.13% (down 16 bps from the offering in January)…they also sold 1.25 billion of 8 years at 2.91% and 1 billion of 6 years at 2.44%
• Proctor & Gamble, the world’s largest consumer products company, took advantage of 50 year lows in the 10 year and the latest rally in corporate spreads to print $1 billion of 10 year notes at 2.3% or roughly 83 basis points thru France. PG is rated Aa3/AA- by Moody’s and S&P…France is rated Aaa/AA+…vive le Proctor
• 74 fans (these truly were fanatics) were killed yesterday when a riot broke out following a soccer game at Port Said, Egypt…the violence further points out the loss of control by civil authorities post the Mubarak regime.
• The unofficial leader of the bondholder group on the Greek debt exchange is calling for public institutions to share the pain along with other investors to help get the Greek deal done…the ECB, the primary target of the call, has so far refused to take a haircut on their holdings which has led some to speculate that perhaps the ECB will exchange some or all of their holdings after the private market investors have taken their beating…the longer we talk about a deal on this Greek exchange, the less likely a deal becomes…remember, even after a “deal” is announced by this creditors committee you still have to get holders to tender in 2/3 of the paper that’s outstanding…that’s a tall order to get done before the middle of March.

Credit Markets –

Sovereign CDS – we’ve got a mixed bag on the sovereign spread front this morning but ultimately very little is changed from yesterday when we saw a big rally in spreads even though there is no resolution on the Greek debt exchange…we keep hearing that a deal is imminent throughout the day only to hear at the end of the day that it will likely be next week…ultimately this will frustrate the markets but today appears to not be that day. French and Spanish bond auctions we pretty well as they pushed farther out the curve and began to test the limits of the LTRO and so far its holding which is a very good sign for the markets. The bigger question will come at the end of this month when the banks return to the ECB for the next round of LTRO funding as well as what happens in the “real economy” in the EMU…reportedly most banks continue to hoard cash which will ultimately weigh heavily on the economic recovery but this will take some more time to see how it will play out.

US Corporate Credit – leveraged loans outperformed yesterday as the LCDX index rallied by 11 basis points…the high yield index was in by 6 basis points and the investment grade index was better by 1 basis point. At some point in the not too distant future we begin to hit a minimum spread compression point for the investment grade market because companies will act as Proctor & Gamble did yesterday and test the market with new deals which will force holders to sell existing paper in some instances which will push down prices in the secondary market and widen out spreads which will loop back on the new issue market. With the 10 year around 1.8% and generic 10 year spreads on high quality industrials around 1.2% or so…who wouldn’t think that 3% 10 year debt is a good idea…we’ll test the markets true appetite for these yields at some point this year. As an example, how much demand is there for 5 year IBM at 1.25%? or 3 year IBM at 0.55% when the company pays a 1.5% dividend rate annually! This is the ultimate nexus of the conflict being waged in the capital markets. Or you get the PG 10 year deal at 2.3%...seriously…PG pays an astounding 3.3% dividend…and someone would buy their 2.3% bonds (well of course its institutions and likely life insurance companies that basically have to buy this stuff)…but no self respecting individual investor should buy PG bonds when they can own PG stock returning over 100 bps more in yield and (for the time being) tax advantaged.

Energy Markets – WTI is selling off this morning as we trend back toward the mid 90’s following the Department of Energy’s crude oil inventory release yesterday that showed actual inventory levels 60% higher than projected for the week ended 1/27…the bottleneck in Cushing continues as inventory levels there were up 4x over the previous week…the bleed off in distillate inventories was also much lower than anticipated (about 1/10th the amount used as projected to be used) this is more about the weather pattern than anything else and RBOB inventories spiked to 6x what had been projected…none of this was taken as good news by the energy markets yesterday and the trend lower continues today.

Futures – the natural gas strip remains below $3/mcf but the decline in crude as brought the equivalence differential down to 5.6x…we get the EIA natural gas storage change this morning at 1030…expectations are for a draw of 129 bcf but I wouldn’t be surprised to see an add to this number given what’s been going on with the weather.

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.