More Bad Economic News ... QE3 More Realistic?

Chicago PMI survey result came in at 52.7, significantly below the Street's 57.0, and lowest since Sep. '09.  Production and new order indexes were down, but order backlogs and employment indexes did increase for the month of May.

With all of the recently released bad economic numbers, will the Fed change its mind and begin discussing a QE3?  Just last week, we heard NY Fed's Dudley, who has been very hawkish when it comes to monetary easing, say that he believes QE is no longer needed unless things get worse.  He said: "But if the economy were to slow so that we were no longer making material progress toward full employment, the downside risks to growth were to increase sharply, or if deflation risks were to climb materially, then the benefits of further accommodation would increase in my estimation and this could tilt the balance toward additional easing."  So there is still a chance of a QE3 even in an election year.

Under what circumstances would a QE3 become more likely?  We think given today's bad figures, a big disappointment tomorrow might create more 'optimism' when it comes to monetary easing.  If tomorrow's employment report is in-line or slightly better, which we think it will be, the market will not react very positively, especially after seeing this morning's Challenger job cuts and jobless claims which both indicate a not-so-good employment situation in June.

Again, long strangle positions on VIX and/or SPY could work.  SPY, the S&P 500 ETF, is approaching the 129 level which if it goes below that, the 125 level could be next.  In addition, given that the 20-day moving-average (MA) has already gone below the downward trending 50-day MA, it is also approaching the 100-day MA, which could trend downward after a down day today and tomorrow.  This appears to be a bearish technical indication building on top of an already existing bearish technical indicator.  However, as mentioned earlier, if economic news gets much worse, increasing likelihood of a QE3 could initiate a risk-on strategy in the market, which could turn around S&P 500 and SPY for the short to medium-term.  For all of these reasons, a long strangle on SPY may work.

Regarding VIX, it not only jumped nearly 21% but also dipped nearly 18% after we made a similar recommendation before March 5.  VIX is now nearing the 25.0 level again.  At this point, we think there is still potential for dramatic moves up or down, which is why a long strangle would be a good idea.  Basically, the same reasoning mentioned earlier for SPY can be applied to VIX.

The market continues to take a dump.  S&P 500 is down nearly 0.9%.  FB is down 3.3% at $27.25.  GLD is at $152.2, up 0.2%.  Lastly, VIX and VXX are up 3.2% and 5.4%, respectively.

ADP, Initial Claims, and Q1 GDP Miss Expectations

Based on another disappointing employment data, ADP, it appears that we may have been too optimistic regarding tomorrow's official US employment report.  However, we will stick with our original total NFP net change of 152K as we believe there was actually some net hiring in the government sector in May.  Initial jobless claims was disappointing again.  Q1 GDP was in-line with our estimate, but below the Street's and lower than the official advance estimate.

ADP

ADP employment report for May showed an increase of 133K in jobs within the non-farm private sectors.  This was significantly below the 150K consensus.  Hiring in small, medium, and large non-farm private businesses increased by 67K, 57K, and 9K, respectively, from the previous month. 

Initial Jobless Claims

Seasonally-adjusted initial claims came in at 383K, up 10K from another upwardly revised prior week's figure, and higher than the 370K consensus.  The upward revision trend continues and is getting stronger.  We note that this figure likely was not included in nor did it impact tomorrow's employment report.

Q1 GDP

The Q1 GDP print of 1.9% was in-line with our estimate, but below last month's official advance estimate of 2.2% and the Street's 2.0%.  On the bright side, the tiny annualized growth was driven mainly by consumption and increase in exports. 

 

Overall, this morning's economic figures were disappointing.  However, it appears that for the time being, the market is still hoping for better employment and ISM numbers tomorrow, as S&P 500 futures remain in the black.  Again, our ISM and NFP estimates for tomorrow are 54.5 and 152K, respectively. 

Disappointing May '12 Challenger Job Cuts Report

The May '12 Challenger job cuts report was disappointing. 

It came in at 61,887, up 52.6% from April's 40,559, and up 66.7% from May '11.  YTD job cuts of 245,540 are up 20.1%.  Top three reasons for job cuts were restructuring, closing and cost-cutting, which we think indicate not-so-great, or moderate, economic conditions at best.  Total planned job cuts in May were highest in the computer, transportation and financial industries; and highest in the Western region with CA leading the way.

On the hiring front, according to Challenger, there were 7,722 announced hiring plans in May, down 4,072 m/m, and down 2,526 Y/Y.  Hiring plans were highest in the automotive, health care/products, and industrial goods industries.

This report certainly isn't positive.  However, it does not necessarily indicate how good or bad tomorrow's official employment report will be.  A better indicator, although not accurate, is the ADP report which will be released at 8:15am.

NFP Estimate & an Update ...

After the feel-good day yesterday, the equity market is down more than 1%.  Disappointing April pending home sales released earlier this morning certainly did not help. 

April pending home sales declined 5.5% from the prior month.  This was significantly below the 0.6% increase that the market was looking for.  In addition, March's sequential growth rate was revised down by 30bps to 3.8%. 

We certainly try to estimate most of the widely followed and market moving economic indicators.  We must say that playing a guessing game is a bit risky, and for this reason, we post estimates in which we have enough confidence.  Yesterday we posted our estimates for Q1 GDP (which we had also posted during the second week of April) and manufacturing ISM, 1.9% and 54.5, respectively. 

After looking at the initial claims data, along with results of some of the Federal Reserve Bank districts' business surveys, and the current ADP consensus, we're estimating NFP of 152K for May, slightly above the 150K consensus.  If the official NFP count does represent an addition of 152K, we do not think it is significant enough to turn around the current risk-off attitude.  In addition, when analyzing responses to surveys regarding business conditions six months from now, it appeared that many are expecting to slow down hiring. 

Worries about Greece, Spain, Italy (which has taken a backseat the last few months but will likely be on the front pages again soon), the overall downturn in Europe and a slight slowdown in China's growth rate will likely overtake the possibly better than expected ISM and employment results.

S&P 500 is at 1313, down 1.4%.  FB is trading at $28.29/sh, down nearly another 2%.  Gold is up nearly $14.  Lastly, we thought to give you a clearer picture regarding how some sectors have performed YTD, this past month, and since we posted our less risky proposition in early March.  The simple table is below. 

Update ... Q1 GDP & May ISM Estimates ...

This short week will certainly be filled with some market moving economic indicators.  With the way the equity markets shot up this morning, it appears that many were expecting either significantly better than expected economic indicator results, or significantly worse, which may start more talk/rumors about QE3.  When there's some type of insurance such as the QE's, although not providing 100% coverage, most tend to take more risk.

Let's start with last week's economic numbers.  As we had guessed, they were pretty much mixed.

MBA Mortgage index went up 3.8% compared to prior week's 9.2%.  While the refi applications increased 5.6%, the home purchase applications were down for the second week in a row, -3.0%.

New home sales print for April was 343K, above the 339K expectation.  There was m/m increase in every region except the South.  All regions reported Y/Y growth in new home sales.  Month's supply, basically inventory, went down to 5.1 from 5.2 in March.

Initial jobless claims were again disappointing, 370K versus estimates of 365K.  Not surprisingly, the previous week's figure was revised higher by 2K to 372K.  It was amusing to see many headlines asserting the "decline" in initial claims.  By the way, in addition to continuing claims data for week of May 7 being about 10K more than expected, the prior week's data (week of April 30) was revised higher by 24K to 3,289K. 

Both durable orders for April were disappointing.  Overall durable orders went up 0.2% from March, lower than the 0.3% estimates.  Excluding transportation, that figure was -0.6%, significantly below the market's 1.0% expectation. 

University of Michigan/Reuters consumer confidence figure surprised to the upside, coming in at 79.3 versus the 77.5 consensus.

This week got off to a mixed start with the Case/Shiller 20-city house price index coming in about 20bps better than expected.  The index declined 2.6% in March.  However, the Conference Board's consumer confidence index was pretty disappointing, 64.9 versus the 69.4 estimate.  In addition, the Dallas Fed May manufacturing survey result of -5.1 (released this morning) was worse than last month's -3.4.  

Other data to be released this week includes pending home sales (tomorrow), MBA mortgage index (tomorrow), Challenger job cuts (Thursday), initial jobless claims (Thursday), ADP Employment Change (Thursday), Q1 GDP (Thursday), Chicago PMI (Thursday), state of employment (Friday), ISM manufacturing (Friday) and PCE prices (Friday). 

We have not yet come up with a projection for non-farm payrolls (basically the state of employment report due out on Friday), but will likely do so at some point tomorrow, and it may be followed up by minor adjustments on Thursday morning after the ADP release. 

Regarding the Q1 GDP, we stated a while back (in a post discussing Alcoa) that Q1 GDP will likely be around 1.9%.  Initially, the median estimate on the Street was around 2.25%.  The first estimate came in at 2.2%.  For Thursday's GDP data release, the Street expects 2.0%. 

The May ISM manufacturing consensus is 54.0, which basically means the Street is expecting a decline from April's 54.8.  We also expect a decline, but a slightly lesser one.  We think ISM manufacturing will come in at around 54.5.  Of course the market's reaction will depend on the job numbers which are also released on Friday.  Again, we will post our initial non-farm payrolls estimate tomorrow morning. 

The S&P 500 is still up, although not nearly as high as it was earlier this morning.  After almost hitting 1335, it has come down a bit to 1325, but is still up around 0.6% for the day.  NASDAQ was up over 1.5% earlier but now it is up only around 0.45%.  FB is down 8%, below $30/sh.  Gold is down another $11 today at $1557.6. 

The FB IPO Debacle

We're probably beating a dead horse here, but thought to give one more update on FB.  As everyone already knows, FB's big four underwriters' analysts involved in the deal lowered their estimates after FB filed an amended S-1 which discussed the risk of minimal growth in revenues generated from the mobile platform.  In addition, some are saying that those analysts were provided with more 'color' regarding Q1 and FY '12 revenues, and FY '13 EPS by someone from FB.  What makes this even better is that the analysts lowered their estimates asindicated by Reuters earlier tonight (5/22).  And to top it off, some are saying that those underwriters only informed select clients (which we will safely assume means only institutional clients) of the downward revision of their estimates.  Retail investors were left in the dark, as usual.  To all of this, we say ... wow!  Then again, none of this is very surprising.

Based on this new info that strengthens our initial argument that FB remains overvalued, we lowered our own estimates (which we must note were pretty comparable to what Reuters says were Goldman Sachs' initial estimates).  The new projections are provided below.  We also lowered our terminal growth assumption for the DCF model, which along with lower top & bottom-line estimates, resulted in a $23.00/sh valuation.



But let us try to examine how all of this may impact the big four underwriters, the ‘muppets’ (or in this case the retail investors), and most importantly, the employees at FB.

The big four - Morgan Stanley, JP Morgan, Goldman Sachs, and Bank of America - will likely have to deal with a so-called investigation.  As usual, we know that they will likely get just a slap on the wrist, if the accusations are proven to be correct.

The retail investors lost more money, unfortunately.  This had added, and will continue to add, to the mistrust of Wall Street among individual investors, which is a negative for the market.

And what about those 'poor' FB employees?  We think that after hearing about accusations that some member(s) of the FB management team shared valuable information with underwriters and not with its employees, and that the information led to what appears to be a disappointing IPO, the employees will hold a possibly costly grudge.  Yes, many that were given shares early on will remain millionaires (or billionaires), but their worth has already declined 26% from where FB opened on May 18.  We fear that a lot of employees that were planning to leave the Company will do so even more quickly.  In addition, it may no longer be too easy for FB to find qualified employees to join its 'team', as such display of mismanagement may have reduced the number of 'likes' clicked on the statement (a virtual one) - FB is the best place to work at.  

Better Housing ... Worse Manufacturing

Existing home sales for April were released this morning.  The figure came in at 4.62MM, slightly below estimates of 4.65MM, an increase of 3.4% from the prior month, and 10.0% Y/Y.  We note that the March figure was revised down by 100K.  The month's supply increased to 6.6, that's up 6.5% from March.  The good news is that it is down 27.5% from last year.

The region that experienced biggest increase in seasonally adjusted sales versus last month was the Northeast, 5.1%.  The weakest region based on a monthly comparison was the Midwest.  The Northeast also saw the biggest Y/Y increase at 19.2%.

On the pricing front, there was a 10.1% Y/Y increase in prices, with the West leading the way at 15.9%.  There was not a decline in prices in any of the regions.

Now, let's move to the not-so-good news.  The Federal Reserve Bank of Richmond released its May manufacturing survey results, and they came in significantly below expectations.  Current conditions were 4.0 versus the 11.0 estimate.  In addition, that figure was a significant decline from April's 14.0.  This was more in line with the Philly Fed rather than the Empire State survey results.

The bright side was that the number of employees and the average workweek increased, according to the businesses surveyed.  However, the wages indicator declined.  Other components of the survey that we believe can be viewed as indicators for future hiring were down.  They include backlog of orders coming in at -18.0, and much lower m/m volume of new orders and capacity utilization.

Results of survey about the businesses' expectations support what we just said.  Expectations regarding order backlogs, capacity utilization, number of employees and capex were all lower than the prior month.  Expectations regarding volume of new orders came in only slightly above April's figure.  Wages were also a bit higher, but that is not surprising, given the increase in number of employees cited in the current conditions survey.  Prices paid declined at a lower rate than prices received, which is usually not very good news.  Prices paid declined 14.4% versus a decline of 17.6% in prices received.

Regarding the overall market, after the S&P 500 came close to the 1290 level that we have been suggesting for a while, more specifically, 1291.98 on Friday, we are seeing a dead-cat bounce.  Right now, it is at 1327.19, up 2.7% from the Friday lows.  As things had gotten worse, increasing hopes and chances of further monetary easing, along with today's better than expected housing numbers, are driving the markets higher.  We think the market will likely settle a bit later this week as various economic indicators (new home sales, FHFA housing price index, initial jobless claims, durable orders, and consumer confidence) are scheduled to be released.  We think they'll provide mixed signals regarding the economy.  Let's not forget about the EZ crisis, of which another 'kicking the can down the road' step was taken (as it was revealed that Greece and other PIIGS members received some 'emergency' and 'secret' loans), which is also driving US equity markets higher.  We remain cautious as Greece's election is not far away, and as we get closer, the market will likely again demonstrate a risk-off.

And regarding FB, as we know most readers probably have their Facebook page open right now, it is trading down about 3%.  We note that it has pared its losses a bit as it was down more than 8% earlier this morning. 

An Attempt at Valuing Facebook (FB) ... Remains Overvalued

Facebook (FB) is not a bad company, but we must say that it is overvalued, as we assumed it would be prior to it going public last week.

The Company’s revenues are driven by industry growth, more specifically growth in the social network advertising market, which we see growing at a 15% CAGR over the next five years.  Although the mobile advertising market is estimated to grow at a 40%+ 5-yr CAGR, it will remain a small portion of the overall online advertising market.

In addition to these markets, FB’s topline growth is driven by user growth, or as FB puts it, monthly average users (MAU).  However, mobile MAUs are growing faster, and as we mentioned early last week, this could be a negative for the Company as it isn’t yet generating significant ad or other types of revenues from its mobile platform.  Again, the mobile ad market does appear attractive, but we don’t think FB users are yet ready to embrace ads, etc. on their smartphones or tablets.  FB is trying various ways to monetize the users on the mobile platform.  For example, it is using sponsored stories, but the results of such a strategy remain to be seen.  Given such uncertainty, we discounted growth driven by the mobile ad market.

The payments & other fees revenue growth potential is pretty attractive.  FB may be successful in including ecommerce which then can enhance return on ads placed on FB, making them more attractive to advertisers and companies.  We have that segment going from a mere $557.0MM in FY ’11 to $3.2bil in FY ’16.  Overall, we’re seeing a 5-year 26.5% CAGR for payments & other fees revenues. 

FB is in a growth stage. While expanding and attempting to further monetize its 1bil-and-growing users, we will likely see margins decline during the next 12 – 18 months.  A summary of our top and bottom-line estimates is provided below, followed by our MAU and avg. quarterly ARPU (avg. revenue per user) projections. 

Now, let’s move on to valuation.  We currently value it at $27.69, which is 18.7% below its Monday closing price.  It is tough to value a company such as FB.  We tried to stay with the basics and used DCF.  We must note that we did make some pretty optimistic assumptions.  Our valuation, FB’s current market value, along with a comparison of some val multiples of other companies are provided below.  We note that our target makes FB’s val multiples pretty comparable to where the others are trading at.

In summary, as we mentioned a couple of times before the IPO last week, FB appears to have been overhyped.  Even after an 11.0% decline today, which puts it 10.5% below the $38.00/sh IPO price, FB remains overvalued.  If anyone needs additional detail regarding our estimates and the val model, let us know.

Philly Fed, Initial Claims, Overall Market ... and FB

In this lengthy post, we discuss the Philly Fed business survey results, initial jobless claims, our thoughts on the overall market, and we also digress a bit and touch on Facebook (FB).

Philly Fed Business Survey

The Philly Fed business survey came in at -5.8 for May, significantly below estimates of 8.8.  It appears that the Empire State manufacturing data which came out earlier this week may have been an outlier.

Drivers for such disappointing Philly Fed survey results included the much faster delivery time which was impacted by much lower unfilled orders.  In addition, decline in number of employees and average workweek was not encouraging at all.

A couple of other things stood out in the report.  One was that the index for future capex (the next six months) in that region declined significantly to 5.3 from 21.7.  This basically indicates that businesses surveyed do not expect as much capex in the future as they did the previous month.  The other data that caught our attention was response to the question of what factors are forcing businesses not to hire aggressively.  In the current stormy political environment (which is expected given the upcoming elections) politicians usually say taxes, health care legislation, other regulations or policies, and lack of skilled workers are the biggest reasons why businesses are not hiring more.  Well, at least in the third Federal Reserve District, the biggest factor restraining hiring is the businesses' pessimism regarding topline growth in the future.  The next biggest factor was that companies wanted to keep costs low, which is expected given lack of sales growth.  Clearly, such data is not very encouraging.

Initial Jobless Claims

Seasonally adjusted initial jobless claims were again above expectations, and as we suggested before, the prior week's data was revised up.  In fact, YTD, every single week's jobless claims data has been revised up; 20 weeks in a row!

Overall Market

The equity market took another dump Thursday with the S&P 500 declining another 1.5% to 1304.86.  Since end of April, it has declined approx. 6.7%; and it is down 8.3% from its YTD high of 1422.38.  It is down 4.7% since we posted recommending transitioning to less risky equity sectors on 3/5/12.  That 1325 support level we touched on earlier this week was broken through on Wednesday.  Thursday's further decline was an indication that it could be well on its way to the 1290 level we suggested.  However, again, as mentioned earlier this week, the Facebook (FB) IPO could help create a dead-cat bounce Friday.

We haven't yet had a chance to go through FB's S-1 in much detail as we knew we wouldn't be able to get in on the action early enough.  However, we do have some hesitations regarding sustainability of FB's revenue model in the long-run.  The Company generates revenues from ads (based on number of impressions or click-throughs) and from fees that its payment platform charges businesses per transaction.  Consistent growth in ad revenues is in question.  We have already seen one major business, GM, pull its ads saying they do not pay off.  In addition, more and more FB users are on the mobile platform which creates some limitations for generating ad revenues.  Lack of screen space certainly further restrains FB to place ads on its mobile platform.  Also, we believe it is less likely for users to conduct click-throughs on ads they see on their mobile devices as compared to the ones they see on their laptops, PCs or Macs.

Although FB's user base continues to grow (for good reasons as the users love their experience on the FB platform), we could see the average revenue per user, ARPU, level off and possibly decline for the reasons mentioned above, which is not good news for the Company's topline growth.  We also note that FB's revenues from transactions, which in the March quarter made up 17.6% of total revenues, are heavily concentrated.  In other words, most of those revenues come from purchases of apps by users from one company, Zynga (ZNGA).  We are not saying that other developers won't contribute to FB's revenues, but right now the risk of client concentration is clear and present.  Also, surprisingly, we did notice seasonality in this young Company's revenues.  It appears that the March quarter is usually its lightest when it comes to topline, which could explain why they chose to go IPO after the March quarter.

Regarding FB, we are not saying that this Company will be a bust and no growth remains.  In fact, there is a lot of growth potential for FB, as many others will agree.  However, sustainability of such growth and some steps that may be necessary for this may backfire in the long-run.  Of course, the Company won't face such risk until a few more years down the road.  FB users have stayed on FB because of fewer ads and because it is free.  We just hope that with declining ARPUs in the long-run, FB won't have to consider creating a 'premium subscription' plan.  Once users get something for free or for a low price, the worst thing is to raise the price; something that NFLX has realized during the last 12 months.  We note there is significant growth potential in FB's transaction based revenues.  Then again, that space is pretty competitive with companies such as Amazon (AMZN) doing pretty well.   Unfortunately, we digressed a bit from our discussion of the overall market.  We’ll likely discuss FB in more detail once we have a chance to go through the S-1 filing and conduct some good ‘ol due diligence.

We did see some signs of a potential break of the positive correlation between gold and the equity market.  While the stocks went down further, gold spiked up a bit on Thursday.  This could be due to either that many believe commodities will still have value in bad times and/or that the macro environment is deteriorating so much that chances of further quantitative easing just may be increasing, which of course help commodities and metals such as gold.  Whether the divergence demonstrated on Thursday will last or not remains to be seen.  The gold ETF, GLD was up 2.2% on Thursday.  We must note that YTD GLD is up only .5% while S&P 500 is up 3.8%.  It’s a bit different Y/Y, with GLD up 5.6% and S&P 500 down 1.8%.

Overall, the economy is not growing as strongly as many expected and the Euro crisis continues to get worse.  For these reasons we still believe a little bounce off the lows might be short lived and 1290 for the S&P 500 is within reach.

Update on Economic Data ...

Both industrial production and capacity utilization for April came in higher than the market expected, which also means higher than our estimates.  We actually had expected a slight disappointment.  Although, we must note that the 1.1% growth in industrial production, as stated in many headlines, was misleading as growth in March was revised down from flat to -0.6%.  The actual figure of 97.4% was still above the 97.1% consensus.  Capacity utilization came in at 79.2% versus the market's 79.0% estimate and certainly above our 78.6%. We note that the March capacity utilization was also revised down.

Although the data came in above expectations, we must emphasize two things.  One is that the March figures were revised down, which could mean that Q1 GDP may actually come in below the 2.2% initial estimate.  We have stated before that based on certain indicators we believe the final Q1 GDP growth figure will be around 1.9%.  The second point of emphasis is that the higher industrial production and certainly capacity utilization go, the less likely it is for the Fed to continue its aggressive monetary easing policy, which is not necessarily good news for the equity market.

Regarding the housing numbers, as expected, permits were disappointing, but housing starts came in much higher than the estimates.  In addition, March's housing starts were revised up.

Permits for April were 715K, above the 730K expectation.  March's figure was revised to 769K from 747K.  Permits for single-unit homes grew 2% from the previous month, while permits for MDUs declined 21% m/m.  We note that the Y/Y growth rate for MDUs remained significantly above single-unit homes, 36% versus 17%, respectively.  Regionally, only the northeast did not experience negative m/m growth in total building permits (single-units and MDUs).  West had the biggest m/m decline, 14%.  However, Y/Y growth was positive for all regions with the northeast ahead of others at 33%.

Housing starts for April were at 717K, above the 680K estimates.  Starts in MDUs grew faster than single-units m/m and Y/Y.  MDUs were up 4% from March and 75% from April '11.  Single-units grew 2% m/m and 19% Y/Y.  Housing starts (for both single-units and MDUs) in the northeast region were down 21% from the prior month.  The west region was down 8%.  All regions experienced double-digit Y/Y growth in April.

While the latest figures are a bit encouraging, we note that sudden growth in permits and starts will increase inventories which could push prices further down.  In addition, due to lack of strong enough wage growth rental units remain in higher demand, even with rental rates hitting new highs in certain regions.  Lastly, the latest consumer credit figure does indicate that consumers may be abandoning deleveraging a bit too soon, which combined with only modest wage growth, may lower their chances of getting a mortgage for a new home.  It may also force them to again turn to deleveraging later this year. 

Update ...

We thought it might be time to discuss some upcoming economic indicators.

Tomorrow, Wed. 5/16/12, the US Census Bureau will release April housing starts and building permits figures.  In addition, the Fed will release industrial production and capacity utilization. 

The housing figures are a bit difficult to get a handle on, mainly due to the mixed signals brought forth by the warmer weather this winter.  For example, in March, housing starts were surprisingly disappointing as many expected construction to begin much earlier due to the warmer weather.  However, building permits and housing completions were encouraging.  Similar to many economists, we believe to see an uptick in housing starts combined with a slight decline in permits.  Housing starts and permits estimates for April are 680K and 730K, respectively.

Regarding April's industrial production, the market expects a 0.5% increase from March.  After running through some numbers, we think this might be a bit too optimistic.  We are looking for an increase, but slightly less than the consensus; approx. 0.2%.  We expect capacity utilization to also come in below the 79.0% expectation.  Given the disappointing employment figures the last two months, we believe we may see a slight decline in capacity utilization and look for that figure to come in at approx. 78.56%, .04% lower than March. 

Of course, the US economic indicators have once again taken a backseat to the crisis in Europe.  Combined with the 6%+ decline in the S&P500 that we have seen since the beginning of May, slightly disappointing economic data may not have much of an impact on the equity market tomorrow (Wed.).  In addition, the market will be waiting for the release of FOMC minutes in the afternoon.  We note that Thursday's initial claims, of which the previously reported week keeps getting revised upward, along with the Philadelphia Fed's manufacturing report, are potential market movers. 

Initial claims will likely come in slightly below the 365K consensus, but we are confident that the previous week's figure will be revised up to approx. 369K.  We think by now, given the Department of Labor's consistent upward revisions, the market has taken notice. 

Expectations for the Philadelphia Fed manufacturing figure have risen after the surprisingly high Empire State manufacturing data released this morning.  For this reason, a mere in-line Philadelphia Fed manufacturing number could be seen as disappointing.  We must also note that while the Empire State survey results were better than expected, most of it was due to the current indicators within that survey.  Significant increases in current shipments and average employee workweek, along with a slight uptick in number of employees, were encouraging.  However, the forward looking indicators were not as encouraging.  The overall forward looking index declined significantly driven by lower expectations of number of employees hired, along with declines in average employee workweek, new orders and shipments.  Again, the much better than expected headline Empire State manufacturing number could have raised expectations for the Philadelphia Fed figure just a bit too much.

Lastly, we note that since our post on 3/5/12 before the open (it was approx. 1:45AM (ET)!), the market has declined 2.9%.  It did peak at 1422.38, as we had assumed it would get above 1400, but we also suggested that it was time to rotate equity holdings into more defensive types of sectors.  In addition, our suggestion of strangle positions on VIX and USO have also worked out ok.  Unfortunately, given the weaker Euro and no further indication of Bernanke becoming more aggressive regarding QE, gold has declined.  It may go down further, but that just may be necessary in order for it to break the positive correlation it has had with the equity market since the start of the monetary easing policies.  From a technical standpoint, S&P500's next support level is 1325.  If it goes below that, then there isn't much support until around 1290.  However, the Facebook (FB) IPO (which we are still trying to figure out how it will grow its revenues consistently), along with a potential dead-cat bounce, might just help the market create a base at the 1335 - 1345 level, at least for the short term.  By the way, we note that there are reports stating GM has withdrawn its ads from FB saying those ads do not pay off. 

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.

"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. 



http://mogharabi.blogspot.com/

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. 


http://mogharabi.blogspot.com/

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.

http://mogharabi.blogspot.com

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!

http://mogharabi.blogspot.com/

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.  

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. 

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.

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.

http://mogharabi.blogspot.com/

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

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.