Monday, March 26, 2012

Bernanke Juiced Up the Market Once Again

Since our March 5th post, S&P 500 has risen slightly above 1,400 to which we referred at that time as the fair value. Nothing much has changed with regards to the recovery; it remains modest at best. We believe increasing chances of implementation of QE3 by the Fed, has driven the market higher. Two things, in our opinion, have increased those chances: less talk regarding a military attack on Iran, which has put the higher gas prices and fear of inflation on the back burner (although gas prices continue to rise); and a not so strong recovery as indicated by the latest economic data. These have helped keep the QE3 option on the table. This was verified today by Bernanke's speech at the NABE (National Association for Business Economics) conference.

We remain convinced that the threat of another war waged by US/Israel, higher gasoline prices even before the summer driving season, lack of enough growth in wages or full time jobs, and the S&P 500 being fairly valued will create a market pullback.

Military attack on Iran by Israel/US?

It is interesting that we're seeing and hearing less gibberish regarding the potential attack on Iran by Israel or the United States. Although less talk about this possible military conflict was expected especially after the almighty AIPAC conference, we certainly didn't expect near-complete silence from the White House. Then again, it is understandable. We can just imagine that the 'Executive Summary' section of a White House memo would look like this:
Open discussions with the press regarding aggressive military options against Iran will impact the economy and the upcoming election negatively.
  • More Iran war talk has increased speculation regarding oil and gasoline prices.
  • Higher gasoline prices will likely dampen consumer sentiment, consumption and therefore economic growth.
  • Voters' focus will also be shifted back to the economy from a negative standpoint, allowing the opposing party to create storylines of the Administration’s economic ‘failure’ which can be pitched to voters effectively.
 The amount of war talk is recommended to be minimized. This will allow opposition to make the 'bomb, bomb, bomb Iran' pitch, which the current Administration can then label as the culprit behind higher gas prices, and pressures on the economy and Main Street's pocketbooks.

Again, the above is just our imagination and in no way does it represent any official document from the White House or any other part of the government. If we were part of the staff, that's the advice we would give.

Economic data - not so bad, but also not so great.

Below is a glimpse of economic data released since March 5th, with respect to market expectations ('Estimate'). You will see that while not all numbers were disappointing, they were also not so great. Overall, the economy is growing, but at a moderate pace. And as indicated today by the market's reaction to Bernanke's speech, the market believes the economy must remain on the life-support system provided by the Fed, or else! Well, that life support system may not remain operational for long if oil and therefore gasoline prices continue to move higher and higher.

Lastly, given the drastic movements in VIX since our March 5th post (in which we made a few suggestions) - VIX jumped approx. 20.5% by March 7th and has taken a dump since, down nearly 32% - a strangle position on VIX options would've been a good move. The same cannot be said about USO, but then again silence regarding Iran, along with Saudi Arabia’s numerous promises has slowed the upward movement in oil prices.  We note that additional potential market-moving data will be released this week.  They include Case/Shiller real estate price index, consumer confidence, final durable goods orders for Feb., PCE, Chicago PMI and the final UMich consumer sentinment for Mar. 

Friday, March 16, 2012

Feb. CPI increased 2.9% Y/Y, below our 3.02% estimate and inline with the consensus. CPI, excluding food & energy, also came in lower than our estimate; 2.2% vs 2.3%. This was also pretty much inline with the consensus. While these figures may bring a bit of relief, we note that no matter how much the US tries to tap into its oil reserves, the threat of an attack on Iran will keep oil prices and gasoline prices at high levels. In addition, yesterday's PPI results did indicate that producers are facing higher costs, which will ultimately be passed down to the consumers via higher prices. Lastly, we believe at aroun 1400, the S&P 500 is fairly valued. The further it goes above that level, the more extreme a pull-back will likely be. Of course, the futures indicate that the market will be reacting positively to the CPI numbers.

Tuesday, March 13, 2012

Upcoming CPI data ...

Friday's CPI data will be analyzed in great detail as it may force the Fed to delay QE3 even if QE3 will be the "sterilized" version.

We estimate the CPI data to come in slightly above expectations, driven by increase in the labor force as indicated in last week’s employment report. We expect overall CPI M/M change of 0.53% versus the consensus of 0.4%. This also represents a 3.02% increase over the last 12 months. Core CPI, which excludes food & energy prices, will likely show a 0.26% M/M change versus a consensus of 0.20%. Core CPI Y/Y change, we estimate, will be approx. 2.30%, ahead of the Fed's 2.00% target.

If our estimates turn out to be correct and/or if the annual change comes in above 2.00%, then we could see the market react negatively as it may hint that potential risk of too much inflation could force the Fed to re-think its overall QE policy.

Regarding the market's performance today, S&P 500's near 1% move up is driven by slightly better than expected retail sales data. We note that those figures were positively impacted by higher gasoline prices. We are getting closer and closer to the CY '12 1.0 PEG that we discussed last week, which basically indicates where S&P 500 would be at fair value plus a QE premium.

Monday, March 12, 2012

High Gas Prices Threaten Stock Market Gains: Report (Morgan Stanley/CNBC)

Appears that Morgan Stanley is thinking basically the same thing we mentioned early last week  - a more cautious/conservative view of the stock market for the time being.  Below is the link to the story provided by CNBC.  We must note that there are also many others that disagree.

Link: High Gas Prices Threaten Stock Market Gains: Report

Friday, March 9, 2012

Thoughts on the Employment Report ...

The Feb. NFP and private payrolls print was more in-line with our estimates than the consensus. NFP came in at 227K versus our 217K and the 210K consensus. Private sector added 233K jobs versus our 235K estimate and the 225K consensus.

A few things stood out in the report. Within the private sector, while professional and business services added 82K jobs in Feb., more than half of those, or 45K, were temporary positions. We touched on this in our March 5th post. What makes this figure even more interesting is that in Feb. '11 only 28% jobs added in this sector were temporary. Historically, increase in temps has been a leading indicator of recoveries or downturns. Whether or not they are indicating an upcoming downturn during the next 6-12 months remains to be seen. They certainly do indicate employers' hesitancy in making that 'commitment' and adding more full-time employees.

The less Y/Y decline in government jobs wasn't surprising, given what we had noticed in the Challenger report, however, we had expected more than a 6K decline. Then again, it is an election year.

Hiring in construction actually declined by 13K, which was surprising to us given the warm winter that we've had this year. The same thing can be said of the 7.4K jobs lost in the retail trade sector.

With these good jobs numbers, the unemployment rate remained at 8.3%, in-line with the consensus. We don't pay much attention to this figure as it depends on the labor force and participation rate, which do change. Basically the base used to come up with the official unemployment rate is questionable. This rate remained unchanged because the participation rate increased by 20bps from Jan., after having decreased steadily from 64.2% in Feb. '11 to 63.7% in Jan., which of course helped make the decline in unemployment rate look so attractive. The U-6 unemployment rate, in our opinion, is a better measure to look at. It declined by 20bps to 14.9%. This level is still very high.

In addition, the average time that people have been unemployed remained very high, 40 weeks. Although this figure has declined from 40.9 weeks in Nov. of last year, it is still well above the Feb. '11 36.7 weeks. Here's another figure that remains alarming: 42.6% of the unemployed have been without jobs for more than 27 weeks, or approx. 6 months. These numbers aren't very impressive given that we are in the third year of recovery from the 'Great Recession'.

Lastly, average weekly hours remained at 34.5 hours, unchanged from Jan. And the hourly earnings change of a mere 0.1% was only half of the 0.2% that the market expected. Average weekly earnings went up by only 0.13%. With lack of much wage growth and latest surge in energy prices, next week's CPI and PPI numbers become even more important, as we mentioned in our last post.

Friday's Employment Report ...

Regarding Friday's employment numbers, we think the warm winter likely had a positive impact, which will be diminished during the next few months. In addition, the impact of higher energy costs hasn't yet been realized by many companies and therefore is likely not yet visible in the Feb. figures. All of this, combined with a slight uptick in hiring within the public sector, we believe will result in NFP in-line or better than the 210K estimate. We think the number will be around 217K.

As usual, the private figure will be higher. Wednesday's ADP provided some color regarding that. Historically of course, ADP and BLS private payroll numbers have been very highly correlated. Although they both move in the same direction more than 95% of the time, the m/m changes can vary significantly. For example, during the last 12 months, m/m change in BLS private NFP has ranged from being 168K less to 96K more than m/m change in ADP. The BLS m/m change has come in less than the change in ADP in 5 of the last 6 months. But again, given what we discussed earlier, we think growth in BLS private payrolls will be in-line with or slightly better than the ADP growth released Wednesday. We estimate private job growth of around 235K.

If the employment numbers do beat the consensus, of course the market will react positively, but such reaction will be short lived. Even with what appears to be another successful round of kicking the Greek default-can down the road, we could see some profit taking at the end of Friday, limiting the upside for the day. While after the not-so impressive manufacturing data, the Fed and the press may have been hinting that QE3 will be launched soon, we believe the better than expected employment figures could put QE3 back on the shelf again, which would be another reason why many would do some profit taking.

In addition, given the latest rise in energy prices, next week's CPI and PPI reports will be very important, and until they are released, uncertainty in the market will likely increase. Lastly, capacity utilization, which is also scheduled to be released next week, will provide more color on how to interpret Friday's employment numbers.

Thursday, March 8, 2012

Thoughts on Challenger & Initial Claims Reports ...

Challenger Job Cuts Report

While the Challenger Feb. job cuts report appeared to be slightly better than the previous month's, a couple of things stood out which supported what we mentioned earlier this week.

First, the YTD pace of job cuts is running at 18% more than last year’s. 105,214 jobs have been cut this year compared to 89,221 same time last year. Another 25.6K job cuts in March, which is only 62% of job cuts announced in March '11, and this year's Q1 job cuts will be higher than last year's, keeping this recovery a modest one at best.

Second, unlike last year, most of this year's cuts have been in the consumer products and transportation sectors, indicating the negative impact of higher oil prices which also drive gasoline prices higher. According to the report, "Both sectors are undoubtedly feeling the impact of rising fuel prices as heavy users of fuel, but also from their dependency on consumers, who are being forced to spend more on gasoline and less on the products and services provided by these firms.” And believe it or not, Feb. figures would have looked worse were it not for the 'recovery' in government jobs (most states and local). Again, this recovery is a modest one at best.

Initial Jobless Claims (3/3/12)

Seasonally adjusted figure came in above expectations, 362K vs. 351K, which is not good news. It was also higher than the previous week's figure, which itself was revised higher by 3K to 354K. Although seasonally adjusted initial claims have been below 400K in 8 out of the last 9 weeks, they have not gone below 350K in 4 years!  In addition, we note that the seasonal factor applied to the raw figure was the highest for the first week of March since 1995!

For this reason, we believe it is also important to look at the raw, or non-seasonally adjusted number, which was approx. 365.8K, up 31K+ from the previous week.

The, what we believe to be bad news, is partially offset by yesterday's inline ADP private payroll number of 216K. Then again, those ADP figures get revised more than even the government employment-related numbers.

We will provide more thoughts on tomorrow's expected BLS employment figures later today.

Tuesday, March 6, 2012

Market Update ...

The Dow, NASDAQ and S&P 500 are all more than 1.0% lower today.  At least for the time being, it appears that our more risk-off strategy was the right call. Then again, let’s see if it lasts longer than two days. VIX is up 21% this week.

With Greece’s sovereign debt issues driving the market lower, oil and gold are following along. With oil lower, GDP may not be that negatively impacted and gas prices could spike up only close to $5 this summer. But we note that this appears to be a no-win situation, at least for this year. Oil below $105 may be good for the economy, but the lower it goes the more likely it will increase chances of a military conflict with Iran. Morality of wars isn’t usually questioned among the ‘decision makers’. However, potential economic impacts of wars are always taken seriously. Lower oil prices may reduce short-term economic impact of such a conflict, allowing war hawks to roll out the ground and/or air attacks on Iran. But of course the significant long-term costs associated with such an attack, which mostly the US servicemen and taxpayers will be bearing, are basically swept under the rug, possibly one of those expensive and classic Persian rugs.

Regarding stocks, from a technical standpoint, we note that if the S&P 500 closes below 1342, another 1.0% - 1.5% downside, or 1325, could come within the next few weeks. Of course, any positive jobs data later this week could change all of that.

Lastly, if the market does go through a lengthy correction phase, the Fed could activate its ‘insurance’ policy, QE3, sooner than later, but unfortunately at a higher premium – higher inflation in the long-run.

Monday, March 5, 2012

Equity Market, War, Oil, and the Economy

Well, given the equity market's excellent performance during the last five months, we thought we should provide some thoughts regarding our past and future strategies. We'll first review performance of our recommendations and then we'll provide some thoughts regarding oil and the state of the economy. We will also touch on why we think it may be time to move towards a slightly less risky strategy.

S&P 500 went below the 1,120 level which allowed us to implement our more risk-on and aggressive strategy, as we mentioned in late Sept. '11. It actually closed at its year low of 1,099.23 on 10/3/11. The index has increased approx. 22% from the 1,120 level. XLY, consumer cyclical ETF, increased by nearly 29%.

GLD has increased by only 4% since our last post, but then again we all know that it has outperformed the equity market over the long-term.

Looking ahead, S&P 500 is at 13.7x and 12.6x CY '12 and CY '13 EPS estimates, respectively. It may be surprising, but we think the '12 multiple is more attractive as it assumes a 15% EPS growth, which translates to a mere 0.9 one-year PEG. A PEG of 1.0 would mean that there is another 10% upside to the S&P 500 for this year. The 2013 estimates represent a PEG of 1.5. Excluding the 'Great Recession', S&P 500 has been trading at average one-year PEG of only 0.9 during the last 23 years. In addition, recent increase in oil prices could impact not only economic growth but also company margins which may result in lower than expected EPS.

The economy appears to have stabilized a bit, given the latest employment, consumer confidence and manufacturing data.

However, we note that the recovery remains very moderate at its best. Companies have basically cut to the bone and can no longer reduce HR. In addition, a big chunk of the hiring has been of temps.

In terms of economic growth, consensus for '12 GDP growth is a mere 2% followed by 2.2% in '13. We note that these estimates may be negatively impacted by recent rise in oil prices.

The housing market remains at the bottom, although existing and new home sales have been improving. Such improvement in sales and decline in inventories have been driven by short sales, foreclosures and bulk buying by institutions. Given lack of enough wage growth and continuing deleveraging by consumers, it may be tough to see a strong rebound this year.

We must point out that even though the latest economic data has been positive, it could have a negative impact on the market as it may reduce the chances of implementation of the Fed's QE3. Without such 'insurance' provided by the Fed, overall risk associated with the equity market could increase.

In addition, the sovereign debt crisis in EU remains. Greece may have kicked the can down the road, but there will come a time when it will have to clean up its mess. The same can be said of the other PIIGS. And debt crisis is not the only thing EU has to worry about these days. Given the current economic downturn in that region, the US lawmakers have actually begun to put mainly Greece, Italy, Spain and Belgium in literally a choke hold. None of these countries can say no to the US oil embargo on Iran which will begin in July. Such embargo will not only increase oil prices (as we have already seen), but it will also negatively impact those countries' potential economic growth as they will have to spend millions on their refineries to handle oil coming from other providers, which by the way have not yet been determined.

And this takes us to our so-called oil analysis. Since the end of Q3 '11, WTI oil spot price has increased 35%. Front month futures crossed $110 last week. And as a result, gasoline prices are expected to hit record highs even before the big driving summer season begins.

Oil has risen due to some economic stability in the US, some very modest growth, possibility of a QE3 by the Fed, and of course the war gibberish spewed out by Israel and the US, to which Iran has reacted with more gibberish. The last factor, the geopolitical one, we believe, is the biggest driver of higher oil prices.

How will higher oil prices impact economic growth? Given what we believe to be a quadratic relationship between oil prices (inflation adjusted) and real GDP, our analysis of historical data showed that oil prices likely impact GDP negatively if they reach levels above $105, which they have. Given the non-linear relationship between the two, we cannot say how much each $5 increase in oil price will impact GDP. We can say that at $110, GDP growth is likely impacted by approx. -12bps; at $115 by -30bps; and at $120 by nearly -50bps or -0.5%. Some believe WTI could go as high as $130 this year, potentially knocking off 1.0% from GDP growth, based on our analysis.

While President Obama, when speaking to AIPAC today, sounded as though he may not want to hit Iran, we must admit that history has proven over and over that it is not the President of the US that makes decisions regarding policies in the Middle East! And the President understands that the more talk there is, the higher oil prices will go which may hurt his chances of remaining in office. In addition, if Israel does strike Iran, given US' commitment to the state of Israel, it is very likely that the US will get involved one way or another. We will likely get more color on this, at least for the short term, tomorrow during Bibi's and Obama's press conference.

In our opinion, July is the key month. We don't think any military action will be taken between now and July. We think this is due to the US at least giving some EU countries (mainly Greece, Italy and Belgium) some time to adapt to the embargo which they are forced to ... force upon Iran. As we mentioned earlier, the oil embargo could be costly for those countries to abide by.

Chances of an attack on Iran, assuming nothing else changes, will likely increase after July. Some so-called "market indicators" indicate that there is nearly a 40% chance that either the US or Israel or both will execute an overt air strike on Iran before the end of this year. Although this figure is below 50%, it is considerably higher than the 23% and 30% representing possible strike before end of June and Sept., respectively.

Given possible chances of attacks on Iran and its negative impact on the economy and the equity market, a couple of simple strategies might help reduce such potential impact. If there is an attack, oil prices will jump further. It’s not only Iranian oil but also oil from Saudi Arabia and Kuwait that may be at risk given the possibility that Iran can create havoc at its Strait of Hormuz. If there is no attack, then the premium currently in oil prices will likely be reduced. Given all of this, a less costly strangle position on USO could help. We recommend the out-of-the-money positions for calls and puts that expire after July, or in Oct. The same reasoning could be applied to holding a strangle position on VIX.

In terms of equity positions, the market is getting closer and closer to being fairly valued, assuming no unusual events take place. Given this, we would probably begin moving some of our positions into safer sectors such as staples and utilities, both of which may benefit from possible upturn in oil prices and/or an economic slowdown.