Archive - Dec 16, 2010

RanSquawk is reporting that according to "sources", PIMCO's total return fund may buy up to 10% in equity securities. We have not seen another confirmation yet on this very material development which, if true, will confirm that Bill Gross is starting to sound the retreat on rates (his deceptive de minimis purchase of $17 worth of closed-end mutual funds notwithstanding), and that PIMCO may soon become the most unique experiment in a fund transitioning from pure bonds to hybrid (or all out) equity.

Sometime we wonder if we are the only ones who are stunned by the ridiculousness coming out of the stock market on what seems a daily basis. Luckily, there is at least one other person out there who, like us, take a bemused approach to the endless insanity. As Albert Edwards says in his latest note: "I’ve been doing this job long enough to recognise when the markets are entering a new phase of madness that leaves me scratching my head with  bemusement. The notion that we are in a sustainable economic recovery is as ludicrous as it was in 2005-2007. But investors are back on the dance floor, waltzing their way towards the next, inevitable implosion – yet another they will no doubt claim in retrospect was totally unpredictable!"

Today's Philly Fed current activity index came at what at first glance appears to be a healthy 24.3 in December from 22.5 in November on expectations of 15.0. Great right? Nope. Reading between the lines shows that the critical Employment index dropped from 13.3 to 5.1, and further confirming the weakness in employment was the plunge in number of employees which dropped from 13.3 to 5.1: all other indicators merely confirmed yet another inventory driven short-term boost (pre-liquidation). Just as important, shipments plunged from 16.8 to 7.3 in one month. Yet what was most notable is the absolute explosion in the Prices Paid index which followed mortgage yields in going parabolic. From 34 in November, the Price Paid index surged to 51.2! Recall David Rosenberg discussing the mother of all margin squeezes yesterday... It's here. From the index: "Price increases for inputs as well as firms’ own manufactured goods are more widespread this month. Fifty?two percent of the firms reported higher prices for inputs, compared with 38 percent in the previous month. The prices paid index, which increased 17 points this month, has increased 41 points over the past three months. On balance,  firms also reported a rise in prices for manufactured goods: More firms reported increases in prices (21 percent) than reported decreases (10 percent), and the prices received index increased 13 points, its first positive reading in eight months." Add to this the earlier comments from Fedex that the main reason for the EPS miss (not so much revenue) was due to a spike in labor costs, and one wonders: Quo Vadis Deflation?

"How can a 5% positive forecast coexist with calls for a recession, including our own?...Market oriented analysts point to the fact that positive wealth effect is more associated with house values not equities and that QE2 will not have the impact Bernanke expects – certainly the past 6 weeks lean that way. History shows that corporations will not spend their cash with capacity utilization this low. Because the Buy America Bonds were not included in the compromise, state finances should further deteriorate, by at least as much as the fiscal stimulus implied by the tax deal. Net-net, there is a strong argument that all four components of GDP will disappoint and that US growth will be negative or minimal for 2011. With equity markets and credit spreads priced for Goldilocks growth – cheap money is also key – the probabilities of disappointment are high. As any further fiscal push is unlikely in the US, and Europe is focused on austerity despite the collapsing euro-debt markets, asset prices cannot climb from here." - John Taylor, FX Concepts

Though the foreclosure crisis may have faded from the Mainstream Media's coverage, Foreclosure Crisis Monthly continues its lonely battle to keep the banking/mortgage fiasco front and center in the national consciousness.

The negative convexity loop in mortgages is starting to see casualties left and right. The most recent read on the 30 Year Cash Fannie Mortgage rose by 11 bps overnight, and by a stunning 1% in the last month. At 4.703% the prevailing wholesale mortgage rate is back to the highest it has been since May 2010. And while some have speculated that this inflection in rates would have been sufficient to get Americans to jump on refinancing their mortgages, attempting to catch low rates while they can, the jump has been so powerful that to many the now incremental 10% loss in purchasing power does not make a purchase equitable any more. As a result, ceteris paribus, home prices will have to decline by about 10% to compensate for the pick up in rates in just the last month. And since the jump in rates on a duration adjusted basis is even more painful, there will be increase selling of comparable securities as managers look to shed a sudden surge in duration, leading to a further spike in yields, and so forth.

Spain takes one step closer to a bailout, then eventual restructuring (aka, default), thus far exactly as forecast by BoomBustBlog. For those not keeping track, it is currently the financing premium leader among the non-bailed out PIIGS group.

As we speculated earlier in the week, the ECB just confirmed it is doubling its reserve capital from a token €5.8 billion to €10.8 billion. The bank cited increased volatility in FX rates, interest rates, gold prices and higher credit risks as the cause for the increase. Of course, even with this hike, the capitalization of the European central bank is still woefully insufficient. As we noted previously: "the ECB has €5.8 billion of capital [now €10.8 billion] on €1.924 trillion of assets: roughly 331x leverage. As a reminder the Fed has $57 billion capital on $2,385 billion in assets, or a 42x leverage ratio. On the other hand, the ECB only holds €72 billion in directly purchased bonds as part of its "assets", whereas the bulk of the Fed's assets are rate-sensitive instruments: roughly $2.1 trillion in "securities held outright."" In other words, the only global hedge fund that has a greater leverage than the Fed, has just cut its gross leverage from a stunning 331 to only 178x.

• Must read - Reuters special report: Is America the sick man of the globe? (Reuters)
• Banks Push Fed to Curb Borrowers' Right to Rescind Mortgages (Bloomberg)
• EU Struggles for Unity Ahead of Debt Crisis Summit (Reuters)
• Spain Pays High Yield to Sell Bonds (WSJ)
• Investors' Doubts Buffet Spain (WSJ)
• If we keep taxes low on America's high earners, the terrorists win (WaPo)
• Mort Zuckerman: Only business can put Obama back on top (FT)

A barrage of economic data this morning. Initial jobless claims came at 420K, a slight decline from the prior number of 423K, and as always woefully insufficient to actually start helping the unemployment rate. The prior was naturally revised higher, as we expected last week. On the other hand, continuing claims jumped from 4.086MM to 4.135MM on expectations of 4.115MM. NSA claims continued to be a notably higher than seasonal, and was at 486,284 this week. Most notably, people claiming benefits across all Unemployment Insurance Programs rose by a huge 893,959 in the week ended November 27 (of which 142K was in EUC and 182K was in extended claims) Elsewhere, housing starts came at 555K on expectations of 550K, up slightly from a previous 519K. And while this number was a slight improvement, it was offset by the building permits, which dropped from 552K to 530K, on expectations of 560K. Lastly, the current account deficit came in worse than expected at ($127.2 billion) on expectations of ($126) billion, and down from (123.3) billion previously. All in all another day of if not broad economic weakness, then complete lack of improvement.

The key events shaping today's markets in the US, Europe and Asia.

Following yesterday's threat to the country's Aa1 rating by Moody's, Spain was put in the unpleasant position of having to raise €3 billion in 10 and 15 year bonds. Not surprisingly, the auction was as close to a disaster as it could be, considering it had the ECB's backing. In its final bond auction the country managed to raise just €2.4 billion (€1.782 billion in 10 years and €619 million in 15 years), with the 10 Year yielding 5.446% and the 15 Year 5.932. These rates compare to 4.615% and 4.541% previously: obviously many are concerned by this massive jumpin rates. The Bid To Covers came at 1.67 and 2.5, compared to 1.84 and 1.44 previously. Obviously, at these rates, ongoing funding for the country is unsustainable considering the internal cost of capital. Luckily, this is the last bond auction for the year for Spain.

After reporting Q2 results that missed substantially on both the top and the bottom line, FedEx is now down over 3%, and is pushing the broader futures lower. The company which was expected to make $9.77 billion in revenue and $1.32 in EPS, made only $9.63 billion and $1.16 in adjusted EPS. And just like every other institution in the US, the firm hopes to make up for its current loss in the future: FedEx actually boosted its adjusted year end EPS projections from $4.80 to $5.25 to $5.00 to $5.30, on consensus of $5.20. Yet while everyone is happy for the company's optimism, having such a substantially subpar quarter at a time when the firm should have been benefiting materially from a restocking and/or liquidating economy and an expected "surge" in logistical expenditures, will make quite a few people scratch their heads. The only question is whether, just like Cisco and Best Buy previously, this surprising miss will be attributed to company specific factors, or the sell-side analysts finally realize there are systemic factors which are actually impacting companies broadly in a downward fashion.

• Asian stocks, Copper decline before European debt talks; Treasuries gain.
• EU faces `gridlock' on debt crisis; agrees on a crisis- management mechanism in 2013.
• India’s central bank kept benchmark interest rates unchanged after 6 increases this year.
• Oil falls to near $88 in Asia despite plunge in US crude inventory.
• Qatar makes $65B bet it can remake economy in World Cup preparation.
• US foreclosure filings plunge to two-year low as lenders probe practices.
• AAR Corp beats by $0.07, posts Q2 EPS of $0.42. Revs rose 36.0% to $447M.

Today we have claims, housing starts, current account, Philly Fed index, and the Fed’s balance sheet. There is also a $6-8 billion POMO of 6/30/2013 – 11/30/2014 maturities.