Weekly Markets Review 10-22-2010

October 22, 2010

“No snowflake in an avalanche ever feels responsible.” -Voltaire

Major market indices finished higher last week. The DJIA rose 0.51%, the S&P 500 added 0.95%, and the Nasdaq jumped 2.78%. Growth stocks outperformed value stocks. And the small cap index gained 1.35%. The 10-Treasury yield gained 23 basis points on the week, closing at 2.57%.
Over the last year, many investors have abandoned diversification in favor of stability. In 2009, net new purchases in bond funds were $350 billion. Equity funds? $14 billion. Bonds took in 25 times more money than stocks. All of that amidst a nice run up in global equity markets.
Now, we see a perfect storm of variables coming together to drag the weariest of investors back to the table:
- Hedge funds and institutional managers, themselves having been weary, now find themselves in a beta chase, socking cash into the market, as they seek to avoid of third-straight year of underperformance.
- Retail investors who have missed the run up are now wearily dipping their toes back into the water.
- Bonds are paying nothing and many of the formerly high yielding assets large institutions have held are now resetting—making equities look very good in comparison.
- The 10-year Treasury pays 2.50 percent. The S&P index pays 1.90%, with a chance of appreciation.
- With GOP candidates almost certain to gain ground in next month’s election, and most “reasonable” analysts reporting that the chance of a double-dip recession is slim, equities stand to benefit by the gridlock and confusion—they always do.
- And most importantly, the two economic factors that truly drive the stock market, interest rates and inflation, are in the perfect position to do so. And the Fed chairman is all but telling the public that he has no intention of raising interest rates for the foreseeable future. In fact, he is all but assured to announce a renewed program of quantitative easing later this month (also great news for the market—at least for now…).
Our analysis points towards specific areas of the market. We prefer value over growth. And we like the equities of select geographic regions ranked in the following order:
1) Southeast Asia, ex-Japan
2) Latin America
3) Canada/Australia
4) U.S.
5) Scandinavia
6) Europe
While a rising tide lifts all ships, some ships are more prone to sinking when the tide turns.
Goldman Sach’s chief economist Jan Hatzius believes that September’s loss of 95,000 jobs and lower economic expectations will lead the Fed to announce a purchase of roughly $500 billion of Treasury purchases lasting through mid-2011. This will be the second time in two years the Fed has used “quantitative easing,” leading traders to dub this phase, “QE2.”
Hatzius continues to say that the impact of QE2 will be the reason he expects the economy over the next nine months to be only “fairly bad” rather than “very bad.” And he notes that the Fed may need to hold rates at current levels until 2015 or later.
Rahm Emmanuel drew consternation when he quipped, “You don’t ever want a crisis to go to waste.” And in this case, we do. Amidst the uncertainty lay opportunity. Stay tuned…
Economically Speaking
- Americans filing first-time unemployment benefits applications increased by 13,000 last week to 462,000, reported the Labor Department. Coincidentally, the total number of people receiving benefits decreased to the lowest level since November 2008, while the number of those receiving extended benefits decreased.
- August’s trade deficit widened by 8.8% on growing U.S. demand for foreign autos and capital equipment. The gains in purchases of overseas goods underscored that American companies are investing in new equipment and inventories, and foreign sales of U.S. goods rose to the highest level in two years.
- The FOMC announced last week that it will likely launch a second round of quantitative easing, as "several" officials said the Fed would need to act soon unless inflation moves back towards a more consistent level. As expected, the committee cut its growth expectations for the rest of this year and next. Spending is mixed and hiring concerns are weighing down business investment, but a return to recession is unlikely.
- The global economy appears to be slowing, and most developed and large developing countries are already in a downturn, according to the OECD's latest composite leading indicators. It's the second month of decline for the forward-looking CLIs, which are designed to provide early signals of turning points between economic expansion and slowdown, and "the outlook given by the CLIs for Canada, France, Italy, the United Kingdom, Brazil, China and India points strongly to a downturn."
- The September consumer and producer price indices both pointed to tame inflation. The seasonally adjusted consumer price index rose by 0.1% from August, according to the U.S. Department of Labor. The core rate, which is more closely watched by the Fed, was unchanged. Underlying inflation is running below the Fed's informal target of between 1.7% and 2.0% because of the weak economy. The producer price index increased 0.4% last month. The core index increased 0.1%.
Foreign Observations
- China’s current account surplus totaled $126.5 billion in the first six months, down 6 percent year on year, and the capital and financial account surplus rose 48 percent to $90 billion, the State Administration of Foreign Exchange (SAFE) said Oct. 12, Xinhua reported. The second quarter current account surplus totaled $72.9 billion, up 35 percent year on year, and the capital and financial account dropped 68 percent to $25.8 billion. China's foreign exchange reserves grew by $178 billion, up 8 percent year on year, SAFE stated, adding that foreign exchange reserves gained $82.1 billion in the second quarter, down 17 percent year on year.
- Beijing will inject more than 4 trillion yuan ($600 billion) into key industries and inland regions as part of the new five-year economic plan, South China Morning Post reported Oct. 15, citing two unnamed officials involved in its drafting. China will also lower the economic growth rate and focus more on structural adjustments in its blueprint for 2011 to 2015. The officials said the government would spend the money to provide financial support, including tax cuts and exemptions, to nine industries deemed strategically significant to the national economy, including new energy, new materials, information technology, biology and new medicine, energy conservation and environmental protection, aerospace, marine, advanced manufacturing, and hi-tech services industries. China is also looking at replacing its 10-year Go-West program.
- China's property prices in 70 major cities increased 9.1 percent in September, China Securities reported Oct. 15.
- Germany is confident that its deficit will reach 3 percent of its gross domestic product (GDP) and fall within European Union limits in 2011, a spokesman said Oct. 15, EU Business reported. Germany will be the first major economy in the eurozone to do so since the global recession of 2009, he said, adding the deficit is expected to be around 4.5 percent of GDP this year due to a strong economic recovery in Europe's biggest economy.
- Europe must urgently step up investment in resources in Eastern Europe and Central Asia to counterbalance an increasing Chinese interest in raw materials and minerals, German Chancellor Angela Merkel said in a speech to leaders of Germany's Committee on Eastern European Economic Relations, Bloomberg reported. Merkel said the need to secure long-term supplies goes beyond natural gas and oil to minerals, specifically citing deposits of rare earth minerals in Central Asia.
- European exports increased 1% in August as the eurozone manages to weather the global slowdown and a stronger euro. Inflation accelerated to 1.8%, the highest level since November 2008. Meanwhile industrial production in the region rose more than expected in August, a sign that the industrial sector continued to support recovery in the third quarter.
- Singapore will "steepen and widen" the currency's trading band while continuing to seek a ''modest and gradual appreciation,'' the Monetary Authority of Singapore said Oct. 14, Bloomberg reported. Singapore's economy grew 10.3 percent in the third quarter from a year earlier, compared with a revised 19.6 percent expansion in the previous quarter, the government said. Manufacturing rose 12.1 percent in the third quarter compared to a year earlier.
- According to a statement from the Russian Agriculture Ministry, the recent drought and string of forest fires destroyed 13.3 million hectares of the country's grain crop, about one-third of the expected harvest, RIA Novosti reported Oct. 12. The losses amount to roughly 41.5 billion rubles ($1.4 billion), the ministry said.
Equity Markets Review
- JPMorgan Chase reported a 23% increase in 3Q profits, beating analyst expectations. While net income rose, revenues were down for the quarter. JPM and other large banks may also face a squeeze on net interest margins as high-yielding assets pay off.
- St. Jude Medical will acquire AGA Medical Holdings for cash and shares worth $1.3B, or $20.80/share, vs. Friday's close of $14.71. AGA Medical, with sales of $200M, develops and manufactures devices used to treat structural heart defects and vascular abnormalities using transcatheter treatments.
- Pension fund managers say they continue to shave their exposure to equities, fleeing stocks for bonds as they try to achieve stable returns that more-or-less keep pace with their obligations. Earlier this decade, corporate pension plans had almost 70% of their money in stocks; by July, they had cut their exposure to just 45%. Their caution, coupled with that of self-directed investors, is shifting market influence to hedge funds that often trade rapidly, contributing to volatility, and could be one reason markets have become so choppy.
- General Motors said yesterday that the Treasury's 12.4% stake in Citigroup, in conjunction with the Treasury's 61% stake in GM, poses a conflict of interest in GM's upcoming IPO according to Finra rules. As a result, Citigroup Global Markets won't be allowed to sell shares to discretionary accounts without prior consent from clients. The IPO is expected to take place in November; no formal price range has been specified yet, though GM Chairman Ed Whitacre has said he expects a share price "somewhere in the $20 range... $20, $25, something like that would be my guess," based on a 4-to-1 split.
- Google handily beat earnings expectations yesterday (see details below), posting a 32% jump in profit and 23% increase in revenue as online ad spending experienced a broad recovery. The company said that its "core business grew very well, and our newer businesses - particularly display and mobile - continued to show significant momentum."
- Intel beat earnings estimates yesterday and pointed to "solid [global] demand" for computers, allaying concerns that businesses are reducing tech spending. Its gross profit margin rose to 65.9% from 57.6%, and the company expects it to rise to 67% for Q4. Intel is seeing strong demand for an overhauled line of microprocessors, and expects the Apple-led resurgence in tablets to eventually "be additive to our bottom line and not take away from it."
- General Electric earnings fell 18% in the third quarter as it added $1.1 billion to reserves for a charge related to the 2008 sale of its Japanese consumer-finance business. Revenue slipped 5% from the year-earlier period. GE cited lower equipment sales as the reason for the decline.
- Winnebago Industries reported profit for the fiscal fourth quarter as revenues more than doubled and cost cutting continued to pay off. The recreational vehicle market returned to profitability in the recent quarters after recovering from an industry crisis that caused competitors to file for bankruptcy and leave the business.
- LVMH Moët Hennessy Louis Vuitton, the French luxury goods maker, reported a 24% increase in third-quarter sales with all divisions posting double-digit growth. The sales report confirms the strong rebound of luxury products.
Weekly Sector Review
The sectors of the U.S. economy, as well as the S&P 500, have performed as follows:
Last Week’s Returns:
Information Technology... 3.91%
Materials... 1.23
Consumer Staples... 1.42
Utilities... 0.21
Consumer Discretionary... 1.00
Financials... (2.38)
S&P 500... 0.95
Industrials... (0.13)
Healthcare... 1.19
Telecommunications... 0.05
Energy... 1.34
Sports, Culture & Politics
- U.S. District Judge Roger Vinson announced that 20 plaintiff states, suing to prevent new healthcare reform laws from taking effect, have shown “plausible claim that the line has been crossed” in reference to the government having acted in ways that might be “extra-constitutional.” The 20 states bringing healthcare suits will be permitted to move forward.
- The Afghan government is talking “countryman to countryman” to the Taliban in ongoing, unofficial personal contacts, Afghan President Hamid Karzai told CNN’s Larry King in an interview scheduled to air Oct. 11, AFP reported. With the peace council in existence, the talks will officially continue with rigor, Karzai stated, adding those groups working against Afghanistan cannot be accepted. The United States and other allies should reassure the Afghan people that the partnership is staying and that Afghanistan will emerge and transition into a better country, a better economy and a stronger, effective state, Karzai said. U.S. special envoy for Afghanistan and Pakistan Richard Holbrooke has said an increasing number of Afghan Taliban associates have been reaching out for negotiations about ending the war, but the move has not led to formal talks, AP reported Oct. 15. He attributed Taliban interest in talks to stepped-up military pressure on the militant group.
- A bag of C-4 explosives found at a Manhattan cemetery had been there since May or June 2009 after a caretaker dug it up while planting bushes, New York Police Department (NYPD) Commissioner Raymond Kelly said Oct. 11, New York's WABC-TV reported. A man working in the cemetery found the bag on Oct. 10 and threw it into a garbage container. After talking to acquaintances about the discovery, the man called police because of the possible danger.
- Recent intelligence reports raise concerns that the Pakistani Taliban, which orchestrated the failed Times Square bombing, may have successfully placed another operative inside the United States to launch a second attack, according to U.S. sources, Fox News reported Oct. 15. A senior counterterrorism official was not aware of any "imminent threats" against the United States. Another source said the identity and whereabouts of the suspected operative are unknown, but said “the guy is here.”
- Chilean minders trapped underground for more than two months were rescued using a four-meter “Phoenix” capsule which acted as an elevator, hoisting miners up through a 26-inch hole. More than one billion people worldwide watched the live, televised rescue.
- The United States lifted the moratorium on deepwater oil drilling that was installed after the BP oil spill in April, U.S. Interior Department Secretary Ken Salazar said, DPA reported Oct. 12. Companies must apply for a permit and undergo inspection before drilling can begin, Salazar said, adding that the oil and natural gas industry will operate under "tighter rules, stronger oversight" and a more dynamic regulatory environment.
- The U.S. Defense Department said Oct. 15 that it was preparing for WikiLeaks to release around 400,000 secret military reports on the Iraq War, AFP reported. The leaked reports were pulled from an Iraq-based "tactical reports database" that contained tactical reports and unit-level reporting, a Pentagon spokesman said, adding that the department does not know how many or which documents will be released. He said a 120-person taskforce was set up several weeks ago to peruse the database of reports and determine the possible impact of their release, saying the department is concerned that the leaked reports compile "significant activities," such as attacks against coalition troops, or Iraqi security forces, civilians and infrastructure.
- Iran has joined senior Afghan, U.N. and NATO officials in high-level talks on Afghanistan, unnamed officials said Oct. 18, AP reported. U.S. special envoy to Afghanistan and Pakistan Richard Holbrooke said Washington has no problem with Iranian participation in the talks as Iran and Afghanistan share a long and porous border. Iran's participation in the discussions will be limited to Afghanistan; anything discussed will neither affect nor be affected by other bilateral issues, Holbrooke said.
- Iran sent Abu Mustafa al Sheibani, the Shia commander of the Sheibani Network who takes orders from Tehran, back to Iraq to reorganize militants, U.S. military and intelligence officials said, The Long War Journal reported Oct. 18. He is believed to have returned to Iraq sometime in late summer. Sheibani’s return shows that Iran is attempting to exert political pressure on Iraq and increase pressure on the reduced U.S. forces operating in the south and Baghdad, officials said. Sheibani and others promoted by Qods (Force) serve a purpose to kill people and sow chaos, a U.S. military intelligence officer stated.
- The Ohio State Buckeyes lost to Wisconsin Saturday night, 31-18, and fall to number 10 in the first BCS rankings. The top three are: 1) Oklahoma, 2) Oregon, 3) Boise State
The weekend’s top-five box office performers as reported by The New York Times were:
1) Jackass 3D, Paramount Pictures & MTV Films, $50,000,000
2) Red, Summit Entertainment, $22,500,000
3) The Social Network, Columbia TriStar, $11,000,000
4) Secretariat, Walt Disney, $9,503,000
5) Life As We Know It, Warner Bros., $9,200,000

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