Thursday, April 19, 2012

Disappointing Economic Data; QE3 to the Rescue?

After reading about this morning's economic indicators and how three of the four announced were very disappointing, we were surprised to see the equity market in the positive; more specifically, as we are writing this, S&P 500 is up approx. 2 points at 1387. We thought we should provide some type of perspective explaining this. So here it goes.

While the housing, manufacturing, initial jobless claims, and industrial production economic data were all disappointing this week, such disappointment has once again brought to the forefront the idea of Bernanke and the Fed coming to the rescue with another QE. Of course, the probability of another QE declined sharply, as we had suggested in March. However, hopes and dreams based on more Bernanke-type of equity market steroids remain alive, especially after seeing just how moderate the current economic growth rate is. We must note that the disappointing data may answer the question of whether or not Alcoa is the bellwether of the economy, at least for now.

Along with disappointing economic news, another factor that may give Bernanke the 'ok' for a QE is lower oil prices, which we have seen the last couple of weeks. Lower oil prices are driven by the not-very-impressive economic data, but also by what appears to be a prioritized strategy by the White House, which is to downplay a possible attack on Iran using various methods. We certainly suggested this to the White House in one of our previous posts.

Examples of some of the methods used include the so-called 'P5+1' negotiations that took place last weekend in Istanbul, Turkey. That will be followed by another meeting between Iran and the countries that have imposed economic sanctions and are threatening to bomb it, in Baghdad next month. The White House has continued to ignore negative comments made by Israel's Ben Netanyahu regarding the 'P5+1' as it knows that if it agrees, then the oil market will further price in an attack on Iran by US and Israel; and if it disagrees, then the market will further price in an attack on Iran by Israel.

The latest method used by the White House was President Obama's announcement of his plans to rein in oil speculation. This is very amusing to us. We see and hear both US political parties continue to voice support for Israel's objective to hit Iran, they continue to push for additional oil embargo and economic sanctions that basically reduce supply of oil for some period of time in Europe, Middle East and Asia; and then they blame the higher oil prices on traders and Iran.

With all of this said, it appears that the combination of bad economic news and various methods used to downplay a potential attack on Iran, have once again raised the possibility of the Fed and Bernanke proposing and executing yet another QE. In our opinion, if they do decide to take such action, it has to be done sooner than later because the Fed cannot and must not risk being viewed as a political factor in the upcoming Presidential election. By the way, we believe it certainly is one.

Lastly, we must note that one thing is positive about the market - earnings reports. Although some companies have missed expectations, most have not. However, these are Q1 earnings results, which ended at the end of March. Some early April economic data show that Q2 may not be off to a good start. Then again, corporate management teams and their investor relations departments can very easily play it safe and provide, as they say, 'conservative' guidance in order to keep the sell-side analysts' estimates low enough to beat, so the market can react positively. We remain cautious regarding the equity market.

Wednesday, April 11, 2012

"A Fair Market Value Update" ...

We came across this story which was published on Monday morning (4/10).  From a high-level standpoint, it basically says what we said more than a month ago.  Of course, this one provides more detail than we did, but hey, we say timing is more important.  In addition, the wide range given for S&P 500 in 2012 increases the probability of the author's projections being correct.  You could say that's a smart way to hedge projections, right?  Here's link to the article, enjoy ... A Fair Market Value Update.

Is Mainstream Media Framing & Timing Stories for a Reason?

We were just curious about mainstream media's timing of covering certain news/events.  Of course, in our opinion, coverage of stories that impact foreign policies can be questioned most of the time as even with the social/digital media at the forefront, most information regarding those stories are provided by 'anonymous' sources from within the government which are biased most of the time.  We believe intentions can always be questioned.

This brings us to the question about coverage of foreign policy and economic related stories, such as the potential economic impact of an attack on Iran by the US and/or Israel.  We just find it interesting that the mainstream media hasn't really addressed this until now that it is seeing a pullback in the equity market (of course, thanks to Alcoa (AA), the equity futures signal somewhat of a rebound this morning).  We, of course, touched on it a while back.  But suddenly we are seeing the great CNN quoting economists regarding the possibility and negative impact of an attack on Iran, with the title of: Iran-fueled oil price spike biggest threat to economy. 

To this great timing - during a market pullback, accomodated by lower oil futures, and finally a clear Republican opponent, Romney, as the President's opponent in the upcoming election - we say thanks, to CNN.  Who knows, maybe the White House did follow our suggestion and somehow convinced its media buddies to take it easy on covering the potential disaster that may come about as a result of Israel, every White House's (whether Democrat or Republican) very important election buddy, attacking Iran, to which no White House can object.

We ask again: Is Alcoa the Bellwether of the Economy?

Alcoa (AA), the aluminum manufacturer that many refer to as the bellwether of the U.S. economy, reported better than expected Q1 earnings. This will be taken as good news by the market, at least early on. We decided to do some back-of-the-envelope calculation to see if this 'bellwether' reputation has any merit. As usual, our analysis was not very complicated.

If one is talking about AA's quarterly performance being an economic indicator, then sales growth is what one must look at. The Company's 70% Y/Y decline in earnings, although it beat the very credible Street's estimates, certainly should not be considered a good economic growth indicator. For this reason, we focused on the Company's sales growth.

We first looked at the correlation of AA's top-line growth and U.S. GDP growth. Not surprisingly, the two are positively correlated. The figure, based on 13 years of quarterly data, was approx. 0.60.

We then regressed annualized GDP growth per quarter against AA's sales growth. It turns out that a 1% AA quarterly sales growth represents an increase in US GDP growth of only 20bps. We must say that the AA sales coefficient turned out to be statistically significant, explaining 33% of the variation in GDP growth. However, based on this very complicated & simple linear regression (!), AA Q1 sales growth indicates only a 1.9% Q1 GDP growth, significantly below 2.4% which is the midpoint of economists' estimates ranging between 2.2% and 2.6%.

For this reason, if AA's performance is a bellwether of the economy, then maybe we should not be overly optimistic about Q1 economic growth.  In addition, maybe the higher Feb. wholesale inventories reported on Monday were due to lack of sales rather than higher projected sales.  Or as we have been before, we can remain a bit hesitant in viewing AA quarterly results as a bellwether for the U.S. economy. Of course, after the market's (S&P 500) 4.3% decline over the last five trading days, we do expect AA's better than expected earnings to have a positive impact, but we doubt such impact will last long.

Regarding the Company’s quarterly earnings presentation, its 2012 end-market guidance calls for strong growth in North American automotive and heavy trucks markets, partially offset by weakness in the beverage can industry, and commercial building and construction. The only bright spot that AA sees in Europe is the beverage can packaging end-market, in which AA expects a 5% - 7% growth this year. For China, the Company lowered its growth projections of the automotive and trucking industries, while it slightly upped growth forecast for commercial building and construction.


After hitting levels to which we referred as fair value, S&P 500 has already broken below the two support levels that we mentioned before, 1390 and 1375; and it is not too far away from 1350. It will likely remain between 1350 and 1365 until the important PPI and CPI figures are released on Thursday and Friday, respectively (in addition to the initial jobless claims). We note that the 1350 level can be considered very important as the S&P 500 hit that level and went slightly above it multiple times in 2011 before beginning its near 19% correction phase in Aug. '11. The 1300 level, or another 4% decline, could become more probable if that 1350 support level is broken through.

Lastly, we must note that Bernanke did not mention further quantitative easing on Monday night. The market is beginning to discount any probability of further easing after June, which also explains the latest pullback.

Friday, April 6, 2012

Disappointing March Employment Report

The March employment report was basically a whiff or a strikeout.  Given the start of baseball season, we thought we might as well include some baseball lingo.  BLS threw the market a mean yakker.

The market is closed for today, but the S&P 500 futures were down 1.1%. With such a disappointing report, Bernanke may begin talking about further monetary easing again. His next public appearance will be at the Federal Reserve Bank of Atlanta's Financial markets Conference on Monday night.  We wouldn't be surprised if many politicians and/or Wall Streeters were leaving messages for Bernanke, begging him to be kind to the equity market when making his Monday night speech.  Who knows, but maybe President Obama is thanking the Lord for the Easter Holiday (Good Friday) for which the markets are closed.  He and many others are probably hoping the negative impact of such a bad report will die down a bit by the time the market opens on Monday morning.

Regarding the report, NFP went up by 120K, but significantly below the Street's 200K expectation.  In addition, it was lower than the 246K in March '11.  The private sector added 121K versus the 215K that the Street expected.  This was also lower than the 261K jobs added in March '11.

Manufacturing did well by adding 37K jobs.  This was slightly higher than the 26K manufacturing jobs added in March '11.  On the other end, 33.8K retail jobs were lost in March.  Last year, this sector had added 7.7K jobs.  The surge in temporary help services to which we pointed in the Feb. report, dipped down a bit in March, losing 7.5K jobs.

Average weekly hours declined to 34.5 hours in March from Feb.'s upwardly revised 34.6 hours.  This was in-line with expectations.  Hourly earnings change was also in-line at 0.2%.  We must note that hourly earnings change for Feb. was also revised up, to 0.3% from 0.1%.

Of the unemployed, 42.5% have been without jobs for more than 27 weeks (or approx. 6 months).  This is only slightly lower than Feb.'s 42.6% and remains a concern.  As we have said before, these figures are not impressive given that we are in the third year of recovery.

Unemployment rate dipped 10bps to 8.2% mainly because the labor force participation rate also declined. Participation rate went down to 63.8% from 63.9% in Feb.  This figure was also lower than the 64.0% in March '11.  As usual, we think U-6 unemployment rate is a better measure to look at.  It dipped by 40bps to 14.5%.  Although the decline is positive, this level is still very high.

Again, the futures indicate a negative reaction to the disappointing report.  When the market opens on Monday, this will likely be very true.  However, some of the losses will likely be pared by the time the market closes on Monday, mainly due to Bernanke’s upcoming speech on Monday night.  Many may decide to wait to hear what Bernanke says before making a move.  We’ll see.  Happy Easter to everyone!

Wednesday, April 4, 2012

Equity Market to Fed & Bernanke: "I Wanna Get High, So High!"

S&P 500 is down 15.03, or 1.10% today.  Simply put, the stay of that Fed 'insurance', the QE3 or 4 or infinity, is now less certain, based on the FOMC minutes released yesterday.  We touched on this in early March and in our last post , even after Bernanke juiced up the market.  In addition, it appears that Spain is now slowly taking Greece's role in this entire Eurozone fiasco that's been going on for a long time.  And no matter how low (comparatively speaking) Italy's 10-year yield is, don't count out Italy; its time may come due shortly.  The ECB President, Draghi, also hinted this morning of the increasing risk of inflation in the EZ.

All of this, basically hides the not-bad ADP employment report for March, which was pretty much in-line with estimates.  ISM Services was a slight miss, but not too bad.  So, what does all of this tell us?  For one thing, it demonstrates just how much the market has become dependent on the Fed's helping hand.  The addiction to QE policies will be tough to let go, as we're seeing today.  Such addiction has also brought about the non-rational market, where bad news is actually good news.  The more bad news, the more likely it is that the Fed will continue to supply the Street with the 'product' to which institutional and retail investors are addicted.  If the last couple of months' economic data had been worse, the Fed would've likely stated that more than "a couple" of its members are in favor of implementing more monetary easing policies.  As a reminder, Operation Twist ends this June, so we will see if the Fed begins to hint to expect more QE after June.  As many have stated, it will be tough to implement a QE post-June, mainly due to the upcoming Presidential election.  The Fed does not want to do anything that favors either side.   So the ones that did not begin to transition towards the risk-off strategy, better hope that this Friday's employment figures come in way worse than expected so that the Fed can start distributing more gibberish about the increasing likelihood of another QE. 

Let's not forget about oil.  As talks about invading Iran have died down, WTI front month has dipped to below $103.  However, this does not necessarily mean that gasoline prices will follow.  On the downside, gasoline prices do not adjust as quickly as they do on the upside, and we believe it will be even slower this year given the increasing volatility in oil futures.  The volatility is of course driven by lack of certainty regarding a strong-enough economic recovery, another QE by the Fed, and an invasion of Iran by Israel, the US, or both. 

Regarding the potential war with Iran, it appears that things are getting pretty heated between Israel and the US.  The White House may have listened to our suggestion that we included in our last post (of course we're only dreaming about that possibility!).  But it may have taken it a bit too far as there are reports (by Israel of course) that the US has leaked some strategic information regarding Israel to the media with the intention to either delay or change Israel's plan to attack Iran.  As an example, Israel's objective of using Azerbaijan as a base on which to station and fuel its aircrafts, and from which to attack Iran, was leaked to the Foreign Policy publication; at least that's what the pro-Israelis say.  No matter what though, for the time being, the tension between the US and Israel has increased; but we all know that the so-called 'tension' will die down as soon as some pro-Israel lobby groups dangle the re-election carrot in front of the Obama team. The risk of a war with Iran still remains, no matter if Obama wants it or not. 

From a technical standpoint, if S&P 500 closes below 1,400, and assuming that Friday's employment report won't be too good or too bad, then we could see S&P 500 dip down to around 1,390.  The next two support levels below that are 1,375 and 1,350.  The reason we chose to assume a no surprise in the March employment report is that we haven't yet had a chance to come up with our own estimate, mainly due to time constraints.  If we do, and if our estimates change anything we mentioned in this post, we will make sure to post an update before Friday morning.