Economy Expands by 2.8% in QII

U.S. economic growth advanced by a revised 2.8% pace during the second quarter – the strongest quarterly gain since QII07 (4.8%), and slightly more than three times the first quarter increase of 0.9%. We seriously doubt that a similar posting will be seen for a few quarters. We expect third-quarter growth to be in the vicinity of 1.0%-1.5%, and fourth-quarter activity to advance by a lowly 1.0%. To date, the credit crisis has had little economic effect, except for the dampening of consumer spirits and the curtailment of business lending. Unless there is some plan implemented to help the situation, a recession seems to be a certainty. However, we suspect that some solution will help ease the crisis, and unclog the lending channel. If our assumptions are correct, we then believe a recovery will commence sooner rather than later. We also anticipate economic growth of 2.4% in 2009.

source: Argus Research, Market Watch, September 30, 2008

Commodity Prices Sink

The pace of commodity price deceleration has intensified in recent weeks amid a drop in the pace of global economic demand and the somewhat stronger level of the U.S. dollar. Economists like to observe the trends in the Economist’s Commodity Price Indices since these trends don’t have the volatile influence of crude oil prices. The Economists All Items Index has fallen 7.7% over the last month, but remains 4.9% higher than year-ago levels. Similarly, the Food Index has fallen by 8.4% in the past month and remains 15.3% higher year-over-year. The big drop has been in Industrial commodity prices, which are down 6.8% over the last month and 6.5% over the last 52 weeks. We expect a general continuation in this downward trend, but caution against complacency. There are still a number of emerging economies in need of commodities and we suspect demand will rebound once the crisis and the economic slump has dissipated.

source: Argus Research, Market Watch, September 25, 2008

Tobin’s ‘q’ at 0.68 in QII

The Federal Reserve recently released its quarterly Flow of Funds data for the second quarter of 2008, which permits us to estimate a back-of-the-envelope value of Tobin’s ‘q’ – a measure of market valuation. The ‘q’ is defined as the ratio of the market value of a firm to the replacement cost of its assets – in this case we are estimating those figures for the entire industry. According to Nobel Laureate James Tobin, the ratio of total stock market value to the stock market’s net worth (corporate net worth) is a reliable indicator of market valuation. When the stock market trades at a ‘discount’ to the replacement cost of its assets, the market is inexpensive, or cheaper to buy than build. This discount possesses ‘q’ ratios that are less than 1.0. Conversely, when “q” exceeds 1.0, the market trades at a premium. The run-up from 1996-2000 had ‘q’ approaching the unthinkable value of 2.0. Encouragingly, the most recent (2Q08) level of 0.68 implies a reasonable valuation of market conditions. The long-term average (since 1952) for Tobin’s ‘q’ is 0.75.

Argus Research, Market Watch, September 24, 2008

Rereading Warren Buffett

"Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell."

...

"We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful."

- Warren E. Buffett

Home Prices Driving Loan Defaults

Housing inventory sits at nearly 12-months, or more than twice the average level. Foreclosures are adding to supply. As a result, more downside in home prices seems assured. Home prices are already down about 15% from the 2006 peak, according to S&P Case Schiller. Many of the major banks are forecasting additional price declines of that same magnitude. Less well publicized is that home prices doubled nationally from 1998 through mid-2006, and ballooned by far larger amounts in the markets now seeing the biggest declines. Still, for those that signed up for highly leveraged mortgages late in the boom, delinquency rates continue to skyrocket. The percentage of home loans more than 30 days past due is already at its highest level since the early 1990’s. On September 5, the Mortgage Bankers Association reported that as of June 30 more than 9% of mortgage loans were either at least one payment past due (6.4%) or in foreclosure (2.75%), both records.


Source: Argus Research Market Watch, September 18, 2008

Financial Headlines

Bernanke deals with dissent by giving hawks a voice
Federal Reserve Chairman Ben Bernanke is coping with a financial crisis, possible recession and also inflation, while dealing with an unusual level of dissent among his team of policymakers. To make the Fed more democratic and transparent, Bernanke incorporates the views of his colleagues in official announcements. The strategy may sometimes muddle the Fed's position, but it gives the hawks a voice and likely means that the Federal Open Market Committee is running properly. The Economist (11 Sep.)

U.S. trade deficit soared to $62.2 billion in July
A record-high oil price propelled the U.S. trade deficit to $62.2 billion in July, the highest in 16 months. This month, the price of oil is down more than 25% from that peak price. There is reason to believe that inflation is either stagnant or slowing, as import prices exclusive of oil fell slightly this month. The New York Times (11 Sep.)

Market participants debate best way to deal with crises
The rally in markets after the U.S. government's rescue of Fannie Mae and Freddie Mac ended quickly as investors appeared concerned about the health of other financial institutions. Some market participants are pushing for a systemic solution. Others are suggesting different fixes. Former Federal Reserve Chairman Alan Greenspan said a formal framework should be established to deal with financial institutions on the verge of collapse. Financial Times (11 Sep.)

Fed's Kohn says house prices still have room to fall
Although the rate at which house prices are falling has slowed, Federal Reserve Vice Chairman Donald Kohn does not see the decline as having hit bottom. Mortgage conditions have tightened since the spring, and that impact has yet to play out. Kohn recommended that banks and other lenders build up buffers during prosperous times to guard against economic downturns. Reuters (11 Sep.)

The market opened down more than 1.5% Thursday morning, but was able to recover. The S&P 500 managed to rally and finish the day in the black more than 1% higher. While this volatility may appear normal, reversals like this aren't. From a historical perspective there have been 26 other days where the S&P 500 was down more than 1% at one point, and able to finish the day up 1%+ higher. It has happened three times this year. The only other years where there have been three or more of these type of reversals were 1987-3x, 1990-3x, 1998-5x and 2002-6x.

Financial News Headlines

Report: U.S. reliance on foreign capital leaves it vulnerable
America's reliance on foreign central banks and sovereign-wealth funds for funding may restrict Washington's policy options, according to a report from the Council of Foreign Relations. "This does not mean foreign creditors are certain or even likely to use their financial assets as a weapon. It does mean that they could do so if they want," said Brad Setser, fellow for geoeconomics at the council. Reuters (09 Sep.)

Buffett's Berkshire caps insurance level of bank deposits
Kansas Bankers Surety, a subsidiary of Berkshire Hathaway, will quit insuring bank deposits for more than the amount guaranteed by the U.S. government, according to the Wall Street Journal. Reuters (10 Sep.) A significant indication of just how worried Buffett, and likely others, are about future bank failures.

Greenspan applauds government takeover of Fannie, Freddie
Former Federal Reserve Chairman Alan Greenspan applauded the U.S. government's bailout of Fannie Mae and Freddie Mac. Greenspan had urged Congress to empower the government with authority to manage large companies in crises to protect taxpayers, although he proposed that the Fed should not be relied on for handling bailouts and that the process needs to be transparent. CNBC (09 Sep.)

Stunted shopping means difficult Q3. Consumer spending will take a decided turn for the worse in Q3, economists say. "The seemingly resilient U.S. consumer is finally buckling." The slump will slow GDP growth to 1.2% - less than half of the prior quarter's 3.3%. Factors: Eight months of falling employment; weakening consumer confidence; and falling property values. seekingalpha.com

Pending Home Sales fell 3.2% in July vs. June, and 6.8% vs. a year ago - worse than the -2.1% M/M consensus. The drop indicates that the U.S. housing market may continue to weaken over the coming months. "Pending home sales are oscillating month-to-month, with the long-term trend essentially flat," NAR's Lawrence Yun said. "Overly stringent lending criteria imposed by Fannie Mae and Freddie Mac in the past month no doubt held back contract signings," implying the recent Treasury move to free up mortgage funds may be a net positive for the industry. seekingalpha.com

V-Shaped Recovery for Earnings in 2009?

As we have said repeatedly over the past year or so, earnings expectations are too high among both stock analysts and market strategists — but especially among analysts. Analysts in general are notoriously slow to adjust expectations at inflection points in the business cycle. Since stocks are valued based in part on earnings forecasts, we have turned our attention to analyst expectations for 2009. What we found is that double-digit earnings growth is expected in every sector. What jumps out most is the 130% rebound expected in Financial earnings. Granted, Financial earnings are expected to drop by more than 50% in 2008. Still, we believe that forecasts for the group remain too optimistic. Earnings from Consumer Discretionary stocks are expected to jump 30% next year. Expected growth rates for 2009 have grown as estimates for 2008 have been slashed. But in our view, stocks will struggle to rally meaningfully until expectations for 2009 come down as well.

Source: Argus Research Market Watch, September 4, 2008

Financial News Headlines

Bank loans from Fed set new high. U.S. banks hit a new record this week in the amount of funds borrowed from the Fed. The daily average of $18.98B beats last week's record of $18.47B. The increase in how much banks borrow from the Fed signals that banks are increasingly reluctant to lend to each other, making it more difficult for private and commercial consumers to obtain financing for home purchases and business operations.

More jobless claims. Initial jobless claims reached 444,000 vs. consensus of 420,000, up 15,000 from last week's 429,000 (revised from 425K). The Four-week average dropped 3,250 to 438,000. Economist Michael Gregory said, "we're continuing to get sort of a grinding slackening in the labor markets... Businesses are becoming more cautious about hiring and layoffs continue. At some point this begins to weigh increasingly heavily on the consumer."

Productivity rises. Q2 Productivity rose 4.3% vs. +3.5% consensus, revised up from 2.2%. Unit labor costs were -0.5% vs. 0%, revised down from +1.3%. Hourly compensation increased 3.7%, but declined 1.3% after accounting for consumer price inflation. Says economist Peter Morici: "Rapidly rising productivity growth coupled with easing oil prices will bring down headline inflation, as well as the closely watched core index."

Non-Mfg Survey shows signs of expansion. The ISM Non-Manufacturing Survey showed economic activity in the non-manufacturing sector grew in August, following two months of contraction. Its service sector index reading of 50.6 (50+ = expansion) exceeded estimates of 49.5.

BoE leave rate unchanged... Bank of England kept its benchmark rate at 5%, as expected. Policy makers judged the fastest inflation in more than a decade outweighed the possibilty the U.K. economy is wading into recession.

and ECB follows suit. Following in the footsteps of BoE, the ECB left its benchmark rate at 4.25%. President Jean-Claude Trichet weighed inflation of 3.8% against recent evidence that some eurozone nations are on the brink of recession.

Source: Seekingalpha.com/wallstreetbreakfastmustknownew

Financial News Headlines

Fed minutes show inflation disagreement. Three of 12 Federal Reserve regional banks would have liked the discount rate increased to 2.5% from 2.25% on June 26, according to FOMC minutes. Officials from Chicago, Kansas City and Dallas were worried that inflation risks were greater than downside risks to growth.

Consumers feel better- but not by much. ABC's weekly Consumer Comfort Index, released yesterday, showed American consumer confidence rose slightly on improved perceptions about the consumer spending climate. The index was up to -47 in the week to Aug. 31, but still dangerously close to its all-time low of 51, reached in May.

Quote:
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Inflation Trends Higher

The government said that the pace of consumer inflation advanced by 0.6% during July, bringing the 12-month pace to 4.5% — the fastest rate since February 1991. Meanwhile, prices (excluding the volatile food and energy component) increased by 0.3% or 2.4% from year-ago levels. This increase in core inflation exceeds the Fed’s desired 1.0%-2.0% comfort zone. In fact, the core PCED hasn’t resided safely in that comfort zone since late 2003. The real Fed Funds rate is a super-stimulative -2.33%, the lowest in several decades. With inflation climbing at this pace, it should come as no surprise that the Fed is considering a rate hike as its next move. Unfortunately, given the instability in the credit markets and the slumping housing and auto industries, we don’t see the hike taking place in the near term.


Source: Argus Research Market Watch, September 2, 2008