@ the open 3-29-12

Equity Markets – Asian indices were down across the board in overnight trading after yesterday’s modest sell-off here and in Europe and on continuing concerns about the impact of slowing growth in China on corporate earnings there, the Shanghai Composite and the Hang Seng were the underperforming indices in Asia overnight. Europe is in modest sell-off mode this morning as well, near the lows for the session as investors assess the situation surrounding the EFSF/ESM, the general strikes in Spain (now) and Italy (tomorrow), the conflicting statements that have been issued by various political figures over the last week (Monti claims Greece is fixed, S&P says that another restructuring is coming), the Rajoy 2012 budget release tomorrow…you get the picture. After a big Q1 rally and many questions left unanswered it doesn’t surprise me to see a little profit taking at a minimum. Futures here have worsened throughout the morning as Europe has sold off and we look to have a down opening.

Volatility – we saw a spike in the VIX yesterday only to have it fall back as the market recovered some of its losses late in the day…we’ll see what today holds but again, buying some volatility along and along makes sense to me here given the situational outlook and nagging questions about global growth…perhaps last August still haunts me too much…

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Macro, News & Events

Economic Releases –macro data released this morning was for the most part disappointing as durable goods missed estimates by a wide margin (+2.2% v. +3.0% expectation)…this combined with the growing concern about an industrial slowdown in China sent the US equity markets lower.

• Q4 GDP (QoQ)…+3.0% v. +3.0% (updated number)
• Q4 Personal Consumption…+2.1% v. +2.1% (updated)
• Q4 GDP Price Index…+0.9% v. +0.9% (updated)
• Q4 Core PCE (QoQ)…+1.3% v. +1.3% (updated)
• Weekly Initial Jobless claims…+350k v. +348k
• Weekly Continuing jobless claims…3.350k v. 3,352k
• March Kansas City Federal Reserve Mfg. Activity Index…13 v. 13

Events

1030 – Richmond Fed President Lacker will give the introductory remarks at the Richmond Fed’s 2012 credit markets symposium in Charlotte
1215 – Atlanta Fed President Lockhart will speak on the European economic crisis as part of a panel discussion at Emory University
1245 – Chairman Bernanke will give his 4th and final lecture at George Washington University

Earnings

• Best Buy (BBY) will announce earnings before the market opens…the street is looking for $2.15 / share

Asia, Europe & USA

• Earnings shortfalls continue in China as the slowing economy has caught analysts flat-footed with earnings expectations that are too high
• Japanese retail sales surprised to the upside in February as reconstruction driven demand aids the economy…sales were up 3.5% year over year that’s the biggest advance since August 2010 and more than double the average estimate of +1.4%
• EMU finance ministers meet to discuss the ESM and EFSF as it appears that the EMU leadership (read that as Germany) will push for the ESM and EFSF to run in parallel at least for the time being which would provide a temporary boost to the appearance of the debt crisis fund in the EMU. The big question remains however regarding if the leadership will go along with raising the total bailout loan ceiling beyond the current €500 billion limit. One potential problem is that any EMU country leader could veto any utilization of additional EFSF funds to augment the ESM.
• Political risk meets Monti on his return to Rome as leaders of the Democratic Party have said that they will try to reverse the changes proposed to Italian labor laws in parliament…the labor reforms are the 4th and by far most ambitious reforms from the Monti-led cabinet. The PM argues that the changes are necessary for Italy to reach a sustainable growth path that will enable the country to support its debt load and social welfare promises going forward. Italian GDP growth has lagged behind that of the EMU as a whole for the last decade…
• Spain will see its first general strike since the Rajoy government came to power in December…the strike is a protest of the austerity measures currently in place in Spain. On the other side the country has already drawn criticism from other EMU countries for doing too little to remedy the fiscal situation after Rajoy announced earlier this month that the deficit for 2012 would exceed the target set earlier in the year. Rajoy will present his 2012 budget tomorrow.
• Unemployment in Germany declined more than the forecast in March and the jobless rate declined to a 20 year low of 6.7%..
• Bayerische Landesbank, the 2nd largest state-owned bank in Germany (taken over during the credit crisis) said that net income fell 84% in 2011 due to losses at its Hungarian subsidiary…
• The German cabinet introduced draft legislation to the Bundestag today that would allow the country to contribute to the latest plan for an enhanced permanent rescue fund for the EMU in an attempt to end the debt crisis there. The package follows the existing line of thinking for a €500 billion permanent rescue fund (ESM). The legislation also seeks to implement the “fiscal compact” treaty to enforce budgetary discipline in the EMU. So far 25 of 27 leaders have agreed to the pact.
• Economic confidence measures in the EMU declined in March…the index which samples executive and consumer confidence declined to 94.4 from 94.5 in February…economists had forecast 94.5 for the March numbers.
• Class 8 truck manufacturers in the US are benefitting from a revival in demand as US freight haulers replace aging fleets…shipments of Class 8 trucks could rise as much as 12% this year following gains of +65% and +29% over the last two years. The average replacement demand per year in the US is 250,000 units and production topped that last year, the first time since 2006. The driver here is utilization rates and maintenance…below 500,000 miles the rule of thumb is $0.02 to $0.04 per mile in maintenance…above 500,000 the rule of thumb is $0.15 to $0.20 per mile

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Credit Markets –

• Italy auctioned €3.25 billion of 10-yr paper at 5.24% (5.5% last) and €4.76 billion of 5-yr paper (2.5 bb fixed and 2.26bb floating) at 4.18% on the fixed (4.19% last) and 4.6% on the floating. The targeted amount was €8.5 billion…they fell short slightly. Italian bond prices fell following the auction.
• The head of sovereign ratings at S&P said that Greece will probably have to restructure again…although Moritz Kraemer wouldn’t give an estimated date he did say that the next restructuring would have to involve the “official creditors” meaning the current bailout providers.
• Corporate bond sales around the globe are challenging the record issuance set in 2009 as record low yields spur issuance…Q1 issuance this year is approaching $1.14 trillion…the record is $1.16 trillion in Q1 2009.
• Below investment grade bond issuance in the US has recorded a record quarter with $91. 6 billion of issuance.
• The general strike in Spain is having an impact as Iberia cancelled 65% of flights and power demand was down 16% from normal utilization across the country…workers are protesting labor law reforms under consideration…the Rajoy government has little choice but to attempt to implement these reforms as Spain struggles to revive growth and implement fiscal austerity simultaneously.

Sovereign CDS – spreads are mixed but overall relatively little changed in morning trading as the market digests comments from S&P, the Spanish general strikes, general strikes to come tomorrow in Italy and the Rajoy 2012 budget announcement. Cash bond yields are modestly wider this morning following new issuance out of Italy.

US Corporate Credit – The leveraged loan CDS index led the way yesterday as spreads narrowed by 2 basis points to +281 basis points…both the 5-year high yield index and investment grade indices were wider by 9 and 1 basis points respectively (+565 and +91). With Q1 coming to a close this week we can look back at year end and see that even with record debt issuance this quarter, spreads have narrowed substantially:

• Leverage Loan Index - began the year at +433 bps…currently +281
• High Yield Index – began the year at +679 bps…currently +565
• Investment Grade Index (5-yr) – began the year at +121….now +91

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Energy Markets –

• Total’s runaway gas well in the North Sea is jeopardizing plans to reverse a production slump at France’s largest E&P company. The 5-day old leak at the Elgin platform in the North Sea has helped wipe 6 billion euro of market value from the company. A plan to drill an emergency well to stop the lead could take 6 months to complete. Workers were taken off the platform as a flare is burning and there’s a large cloud of natural gas that if ignited could potentially create another Deepwater Horizon incident.
• The Enbridge pipeline expansion may help generate as much as $15 billion in additional revenue for Canadian crude producers if prices rise as a result of the alleviation of infrastructure bottlenecks which allow the crude to bypass Cushing, OK and head to the Gulf of Mexico refineries. The Seaway pipeline expansion would add as much as 500,000 barrels per day in flow rate to the gulf from Canada and the US Bakken Shale areas.

Crude is lower in morning trading with the market trading spot WTI under $105 / barrel….the WTI / Brent spread remains at $19 / barrel.

Futures – spot natural gas at the Henry Hub (this is the NYMEX traded hub product) finished yesterday at $2.03 / mcf…that’s the lowest price since September 2009 when prices were under $2 /mcf and economists were arguing over the status of the economy in terms of the recession (turns out it ended in June). Natural gas futures have held up better than crude oil over the last day of trading as the energy equivalence ratio has dropped to 6.15x.

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.