“Fear is the strongest driving-force in competition. Not fear of one's opponent, but of the skill and high standard which he represents; fear, too, of not acquitting oneself well. In the achievement of greater performances, of beating formidable rivals, the athlete defeats fear and conquers himself.” -Frank Stampfl
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Hindsight
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%.
Nearly one-third of the S&P 500 companies has reported 3Q earnings, and so far so good. Earnings have risen 48% year over year. As has revenue growth (excluding financials), growing 10%. Nearly 80% of companies have beat estimates so far, and profits are up 11.5%, better than the 9.1% increase last quarter.
Some of the analysts we respect figure that 2010 S&P 500 earnings will clock in at $84 per share, and estimates for 2011 are looking like $95 per share. If that holds true, then break out the hats and streamers. If you multiply the $95 per share by a price-to-earnings multiple of 15, that places the S&P at 1,425 in 2011—a 20% jump from today.
The industrial production index fell 0.2% in September, its first decline since June 2009, defying expectations of a 0.2% rise. Year over year, industrial production has fallen to 5.4% from 6.4%, still fairly strong—but approaching a level economists would consider neutral, as opposed to positive. While this does not qualify as terrible news, it does make one wonder where the $1 trillion in monetary and fiscal stimulus ended up? To what ends did that $1 trillion go? Anyone?
The G20 nations met over the weekend and—once again—it seems that little was accomplished. The meeting ended with proposed IMF reform. Also, there was an agreement to not use currency devaluation to gain a competitive advantage, but how this agreement is to be enforced?
U.S. Treasury Secretary Tim Geithner is heading to China to discuss the matter of the yuan. This move will likely increase Chinese anger at the United States and the rest of the G-20, as it is interpreted as anti-Chinese. The bottom line: every nation is contending with its internal economic issues, while attempting to maintain and assert influence worldwide. No single nation will unilaterally hamstring itself to mollify its trading partners—regardless of how loud the catcalls become. For anyone to expect an overnight solution is naïve, if not a little dangerous. We must look out for our interests while also understanding those of our trading partners, and learn to operate within the realities of that construct.
And as the Chinese are apt to say: our problems begin and end at home. Stay tuned…
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Economically Speaking
- The Philadelphia Manufacturing Index expanded less than forecast in October, rising from 0.7 to 1.
- Initial jobless claims declined by 23,000 to 452,000 last week, a level consistent with improvement in the labor market.
- The Conference Board’s index of leading economic indicators increased 0.3% in September, signaling that the recovery will extend into 2011.
- There were some glimmers of light in the Fed's Beige Book, including an assessment that economic activity "continued to rise, albeit at a modest pace" through early October. Manufacturing continued to expand, retail spending was flat to moderately positive, and there were reports of increasing demand for loans. However, there was little positive to be said about the nation's two weak spots: housing and jobs. Housing "remained weak," commercial real estate conditions were "subdued," and inventories were "elevated or rising." In the job market, hiring "remained limited" and firms are "reluctant" to add to permanent payrolls.
- U.S. multinational firms, such as GE and Cisco, are pushing for a tax holiday in order to repatriate billions of dollars “trapped” overseas but have been rebuffed by the White House. Research suggests that 30-40% of the nearly $1T in cash held by non-financial S&P 500 companies is being held abroad; for some companies, the trapped cash accounts for more than 75% of their cash balances, but bringing the money back to the U.S. for domestic use would force the firms to pay tax on the money, usually of 25-35%. Corporations say bringing the money back would be good for the U.S. economy, but the White House feels it would raise expectations of future tax holidays, that the repatriated money might be paid to shareholders instead of used for job creation and that a lack of investment is not the most pressing economic problem.
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Foreign Observations
- The People's Bank of China on Oct. 19 raised interest rates for the first time in nearly three years, The Wall Street Journal reported. The one-year yuan lending rate will increase from 5.31 percent to 5.56 percent, with the one-year yuan deposit rate increasing from 2.25 percent to 2.5 percent.
- China's gross domestic product grew 9.6 percent in the third quarter compared to the same period in 2009, the National Bureau of Statistics said Oct. 21, Xinhua reported. Growth slowed from 11.9 percent in the first quarter and 10.3 percent in the second quarter. Fiscal revenue was 628.72 billion yuan ($94.66 billion) in September, up 12.1 percent from a year earlier. Foreign direct investment rose 6.14 percent year on year to $8.384 billion, rising 16.6 percent in the first nine months. China's yuan-denominated lending rose to 595.5 billion yuan ($89.28 billion), an increase of 9.2 percent from August, according to China's central bank.
- In a New York Times report, industry officials said China has quietly halted shipments of key rare earth minerals to the U.S., following a similar embargo on Japan which has been going on for the last month and China's previously announced intentions to reduce mineral exports next year. U.S. trade officials said they're looking into the report. China mines 95% of the world's rare earth minerals, which have broad commercial and military applications, and its embargo decision is likely to be particularly damaging to Western companies which are believed to keep much smaller stockpiles of rare earths than Japanese companies.
- Japan's government cut its economic outlook for the first time since February 2009, saying "economic movements appear to be pausing recently" and reiterating that the economy is in a mild deflationary phase. A rising yen and slowing exports are threatening Japan's economic recovery, and the government warned a further slowdown is possible if the global economy loses steam or if there are swings in share prices and foreign exchange rates.
- Approximately 500 French workers from the I'Etang de Beurre refinery as well as airline and postal workers blocked access to the Marseille airport protesting the planned pension reform, Reuters reported Oct. 21. Vehicles were prevented from accessing the car park, said Medhi Rachid of the General Confederation of Labor union chapter at a nearby refinery in Bouches du Rhone.
- Russia plans to privatize around 900 enterprises owned or controlled by the Russian Federation or its regions by 2015, and a report on the plan will be submitted to Russian President Dmitri Medvedev immediately, Itar-Tass reported Oct. 20, citing Russian First Deputy Prime Minister Igor Shuvalov. Shuvalov said the majority of enterprises are in strategic sectors, and would bring the state 1.8 trillion rubles (about $58 billion) in revenue, according to preliminary estimates. He added that regions must prepare for the privatization plan, which will bring as much revenue to the regions as the federal level, and said the Kremlin is working with the regions to determine a list of assets for privatization.
- Afghan President Hamid Karzai on Oct. 25 acknowledged his office has received cash payments from Iran, but insists the process was transparent, BBC News reported. According to a New York Times report, the money was intended to promote Iranian interests in Kabul. Karzai said the money was not for individual use; rather, it was intended for the president's office.
- Russia is planning to launch a large privatization program in the coming months. The plan is meant to attract foreign capital and technology; the Kremlin expects to raise $50 billion from the privatization effort. However, the plan depends on many variables and could fall apart before Moscow realizes its goal of securing strength for the state and economy for years to come. (Stratfor)
- Brazil has declined to send its finance minister and central bank chief to an Oct. 22-23 Group of Twenty (G-20) finance meeting, opting instead to send the finance ministry's secretary of international affairs. With the apparent snub, Brasilia is avoiding an uncomfortable situation at the meeting: The government is looking for ways to devalue the rapidly appreciating real at the same time as the United States is attempting to lead a multilateral effort to encourage states not to engage in economic policies that forcibly weaken one's currency strength. Downgrading its presence also holds a domestic benefit, keeping Brazil's top economic officials at home amid a presidential run-off campaign where economic issues are at the forefront. (Stratfor)
- G-20 finance chiefs meeting in South Korea called the global economic recovery “fragile and uneven” and agreed to move toward more market-determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies, Bloomberg reported Oct. 23.
- The G-20 agreed to reform the International Monetary Fund giving developing economies like China more influence, IMF Managing Director Dominique Strauss-Kahn said Oct. 23, Reuters reported. More than 6 percent of IMF voting power will shift to dynamic developing countries, which will become the third-biggest member of the 187-strong Washington-based lender, IMF officials said. Europe will give up two of the eight or nine seats it controls on the 24-member IMF Executive Board. The United States, which has a 17.67 percent share of IMF membership subscriptions, will retain its veto on important decisions that require an 85 percent super-majority vote.
- Following U.S. Federal Reserve Chairman Ben Bernanke’s strategy speech pushing for easier monetary policy, German Economy Minister Rainer Bruederle said it is the “wrong way” to stimulate growth and may amount to a manipulation of the dollar, Bloomberg reported Oct. 23. Emerging-market officials at the G-20 meeting in South Korea were among the critics of Bernanke’s policy, Bruederle stated, adding that more liquidity is the wrong way to prevent or solve problems.
- Germany revised higher its estimate for 2010 economic growth, forecasting the country's GDP will expand 3.4% this year but slow to +1.8% in 2011. It's a very large revision from April's forecast of 1.4% growth this year, but was widely expected as Q2's 2.2% growth was the strongest in two decades.
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Equity Markets Review
-Citigroup reported that 3Q revenues fell 10%.
- Hasbro reported solid 3Q earnings.
- Apple’s 3Q earnings were exemplary, as better than expected earnings were announced. Still, shares sank over 5% in after-hours trading because iPad sales came in below target and the company provided Q1 EPS guidance of $4.80, significantly lower than consensus of $5.07.
- McDonald’s Corp. posted a 10% gain in 3Q profit thanks to new products like frappes and smoothies available in the U.S. and Europe.
- New stress tests by the Federal Housing Finance Agency show that Fannie Mae and Freddie Mac may end up drawing $363B from the government to absorb mortgage losses. In that worst-case scenario, the cost to taxpayers would be $259B, because almost 30% of the funds would come back to the Treasury in the form of dividend payments. A best-case scenario would see the two mortgage giants take a total of $221B, costing taxpayers $142B after dividends. So far, Fannie and Freddie have drawn $148B, which means that even if the economy sees a strong near-term recovery, regulators expect to pay out at least another $70B.
- KKR took another step away from its roots as a leveraged buyout firm, announcing it was hiring a group of nine traders from Goldman Sachs who had worked on Goldman's proprietary trading desk. The financial reform law which has brought an end to major prop trading desks at firms like Goldman is presenting a new opportunity for hedge funds and money managers, and KKR's move will help it better compete against rival BlackRock.
- Yahoo posted a slight earnings beat yesterday evening (details below) but revenue growth was sluggish and the company has pared back expectations for Q4.
- Goldman Sachs is said to be considering paying back the $5B investment that Warren Buffett's Berkshire Hathaway made during the height of the financial crisis. At the time, Berkshire's investment was seen as a critical vote of confidence in the firm and helped Goldman raise an additional $5B the following day. However, it came with tough conditions, including hefty dividend payments of 10% a year on Berkshire's "perpetual" preferred shares and curbs on insider selling. If approved by the Fed, Goldman can redeem Berkshire's preferred shares for $5.5B (plus a charge of $1.6B) and replace the capital with cheaper funding now available in the debt markets.
- Goldman Sachs’ 3Q net income fell 40% and net revenue declined 28%, mostly on the downturn in trading.
- Morgan Stanley’s 3Q earnings fell 67% as the loss of trading volume weighed in heavily.
- Wells Fargo reported record 3Q profits that beat estimates as credit conditions improved.
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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... 0.20%
Materials... (0.63)
Consumer Staples... 0.46
Utilities... (0.04)
Consumer Discretionary... 0.76
Financials... 1.91
S&P 500... 0.51
Industrials... 0.69
Healthcare... 0.29
Telecommunications... 0.02
Energy... 0.36
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Sports, Culture & Politics
- More than 105 tons of marijuana contained in 10,000 packages were seized by Mexican authorities in the border town of Tijuana, according to the Mexican military, AFP reported. Eleven people were arrested in the operation, officials stated.
- Cuts in international aid as well as drought and floods in various areas of North Korea may result in a "chronic" new food crisis, according to U.N. Secretary General Ban Ki Moon, AFP reported Oct. 22. The “acute humanitarian needs" of at least 3.5 million North Korean women and children would worsen because of food shortages, he stated.
- The FBI is investigating the death of a 21-year-old man in Mexico who according to his father was a member of the U.S. National Guard, an FBI spokesman said Oct. 21, CNN reported. Jose Gil Hernandez Ramirez was killed in an Oct. 20 drive-by shooting in Ciudad Juarez, according to the Chihuahua state attorney general's office. The FBI is working alongside the U.S. Army Criminal Investigation Command.
- U.S. Private Bowe Bergdahl is alive and being held in a remote area of Pakistan by al Qaeda, according to a senior Taliban source involved in efforts to release the soldier, Sky News reported Oct. 21. Bergdahl was seized after he wandered off his base in Paktika province in eastern Afghanistan, in June 2009. The source said Bergdahl escaped his captors for 10 days but was recaptured and is reportedly in good health.
The weekend’s top-five box office performers as reported by The New York Times were:
1) Paranormal Activity 2, Paramount Pictures, $41,500,000
2) Jackass 3D, Paramount Pictures & MTV Films, $21,600,000
3) Red, Summit Entertainment, $22,500,000
4) Hereafter, Warner Bros., $12,005,000
5) The Social Network, Columbia TriStar, $7,300,000