Gleacher Market Commentary

Market Commentary from Gleacher's Russ Certo

Good morning.  Last week the S&P 500 experienced its first weekly decline in eight weeks.  On January 19th the index fell by more than 1%, something it hasn’t done in 37 trading days.  The technology heavy Nasdaq was down 2.4% as AAPL was a big drag, falling 6% on the week.  Smaller stocks, captured by Russell 2000, underperformed large caps in their second weekly decline since mid-November, down 4.26%. 

Further, transportation index diverged from the Dow, sometimes a harbinger of less than optimistic technicals of sorts.  Earnings per share reports that beat estimates are coming in at 68%, below the past four quarter average of 74% and risk premiums are too low as VIX indicates complacency which can be seen by the routing in financial stocks last week.  In each of the past three years, the stock market has weathered serious January selloff and has never experienced four down Januaries in a row.  Pending on the outcome for this week, we will learn if this precedent upheld.

The highlight of the week was on Friday when GE posted its first revenue increase in two years and its highest level of new orders since 2007.  The revenue increase was slim, just 1%.  This boosted the headline indexes as the stock rallied 7% on Friday.  Jeff Immelt, CEO of GE, was elevated on Friday as an economic adviser to the president and is a precursor to Tuesday’s billed business friendly State of the Union Address. 

Retail investors put $3.8 billion into U.S. stock mutual funds on the week.  “Your starting to see retail investors pile into stocks now that the market has doubled,” said David Rosenberg, chief economist at Gluskin Sheff and Associates.  While the $3.8 billion is the biggest weekly inflow since May, it added just .09% to the total assets of stock funds.  Last year investors yanked out roughly $35 billion.  The January effect?      

According to Trimtabs, in 2006, 72% of all the new money that come into U.S. stock funds came in January.  In both 2009 and 2010 more than $6.8 billion flowed into U.S. stock funds in January.  Still, a total of $109 billion gushed back out during the two years.  Accordingly, asset allocation flows are important to the valuation of sister markets and we’ll be watching the tenor of these flows, particularly for the impact on bond markets.

European and Asian markets were mixed overnight with equity bourses were merely ebbing lower.  Commodities made gains again overnight and these gains were despite a stronger USD which is .5% stronger versus the Euro.  This is on the heels of Irish political leaders suggesting they’ll press to pass a budget before elections as the collapse of the Prime Minister Brian Cowen’s coalition threw the government into disarray over the weekend.

The fanfare here in the states this week will be a trickling of earnings, Treasury supply of 2s. 5s, and 7s, Fed intent on further asset purchases revealed Wednesday, Q4 GDP on Friday and the delivery of the State of the Union Address on Tuesday. 

The headlines in weekend press leaked “Obama to Push New Spending.”  A video released apparently called for new government spending on infrastructure, education and research and to boost U.S. competitiveness around the world.  This is all linked to Chinese premier Hu visit last week and GE Immelt anointed as adviser.  Congressional Democrats and Republicans have threatened to sit next to each other during the speech to illustrate their bipartisanship but I’ll be looking for the wild applause of half the Congress while the others sit beside.   Note: fist thought after seeing the explicit headline is net bearish for fixed income and may be why domestic markets are shrugging off Ireland government collapse.

Even more eye-catching or popping was the piece in the NYT this weekend which illustrated less buying of U.S. debt by China.  China USED to finance the U.S. budget deficit and the article details nicely an important history and levels of participation.  For instance, in 2006, China financed more than half the U.S. deficit and even in the financial crises China spent more than $100 billion on Treasuries over a two month period in September and October of 2008. 

But over the last year China has been a net seller of Treasuries, which is staggering given the size of the bilateral trade deficit at the moment.  In November alone, they sold $11 billion.  Remember how liquid the Treasury market was at the end of the year and the magnitude of the sell-off despite the critical proclamations in strategy community of 1% 10 year not yields coming on the back of QE2?

For the twelve months ending November, China reduced Treasury holdings by $36 billion.  This is an important article to preview the is other data that is relevant to demand equation in Treasury arena.  And one should think the alternative question, where are the proceeds going or the increased reserves which are fast approaching $3 trillion?

Speaking of sovereign debt, Barron’s has been expressing investment views of the roundtable as of late and in this week’s piece, revealed some interesting notes from Felix Zulauf, roundtable member.  Other than owning VIX and shorting Sovereign Europe and European bank shares, he details some sovereign imbalances.  Some eye opening snippets like in 2009, the banks in Europe bought 90% of all the government paper issued, an exposure. 

With the deposit base falling now, medium size banks in these countries can’t get cheap financing from the ECB.  They have to compete in the interbank funding market and are finding their cost of financing to by North of 4%, or prohibitive??%@$%  Since when is 4% funding prohibitive? 

Some anomalies are that Italy is possibly fundamentally sounder than Spain because 60% of Italy’s debt is in domestic hands and only 40% of Spanish government paper is owned locally.  And yet there is a ratings discrepancy between the two credits as Spain is AA by Moodys and Italy gets an A-plus.  However, he believes there will be a financing crises as Italy itself needs for refinance about $300 billion this year.

In fact Euro-zone bonds face more tests in February as the cushion of money reinvested from maturing bonds will shrink considerably and new financings will be mostly new money.  Governments will need to borrow a NET of $66 billion in February after accounting for redemptions and interest payments, compared to just 8 billion Euro borrowings in January.  Moreover, in the coming week Italy is spotlight with 6 month bill auction, two year zeros, 3 billion Euro inflation bonds and other auction tenors.  Germany auctions 2 billion ultra long July 42 bunds too.  That should be fun.…;

Domestically, January’s $51 billion of issuance makes history as the song remains the same, more debt and rolling over of debt.  One could almost figure that bank bonds have accounted for nearly 60% of all U.S. high grade bonds this year.

What is a discussion of debt issuance without considering the GSEs?  It was revealed this weekend that the Obama administration is likely to miss a deadline for issuing a long-awaited report about the future of Fannie and Freddie and what might replace them.  The delay is supposedly due to recent focus on preparing for the State of the Union address tomorrow, turnover of recent staff, and differences of opinions between Treasury and White House officials.  Priorities?

In this piece, heavily regulated bank owned cooperatives are discussed as new prospective model for the GSEs and the concept of administration worry over not charging enough fees from originators to cover the true cost of any prospective guarantees.  This was leaked last week and is further detailed below.

Barron’s has an editorial focus piece on the GSEs which exposes the notion that the four largest U.S. banks have acquired or wrote more than $5 trillion in mortgages from 2005 to 2007 and have reserved only $10 billion for possible repurchases from and faulty underwriting claims.  The article cites the recent BofA settlement and actually really nicely conveys the moral hazard across the entire stakeholder spectrum, including consumers.  It is the liars club and I think of financial earnings last week and in the future as well as the behavior of consumers with the likes of jingle mail going forward.

Also, regulators closed banks on Friday bringing the total for 2001 to seven.  The largest this weekend was United Western Bank of Denver with $2.05 billion in assets.  .  Others in North Carolina, South Carolina, and Georgia. 

Think houses are a slow sale?  Try a yacht.

Russ Certo