In the era of celebrity economists and analysts, real news of good earnings numbers from Google (GOOG) and the big blue IBM yesterday were swamped by the big “story” and controversy over what the fifth man of the economic apocalypse did or didn’t say. At first I thought, what's the world coming to? On Monday, the Queen of Darkness, Meredith Whitney gets bulled up on banks & now Dr Doom, Prof Nouriel Roubini says the recession could be over by the end of this year propelling stocks higher.
But as ever, the tabloid byline writers who are the plague of financial “journalism”, missed Roubini's less sensational, clearly expressed view that the US economy remains weak and fragile and that the recovery will be tepid. Indeed CNBC twisted and misrepresented his remarks in such a way that Dr Doom felt compelled to post this on his webpage setting the record straight.
Today’s Market Moving Stories
- In the US so far, about 75% of the corporates that have disclosed earnings have reported better-than-forecast results. Better profitability is likely a result of lower input and labour costs, as well as an inventory liquidation by retailers.
- Technical analysts had been noting the potential “Head & Shoulders” topping patterns forming on the major global indices including the S&P 500. This pattern is now void after the close above 930 i.e the technical picture is now looking more positive.
- Whilst US housing data will be watched today the focus essentially remains on the flows of corporate earnings. US banks stay in the limelight. The market has saluted the performance of Goldman Sachs (GS) and JPM Chase (JPM) (the latter yesterday). The stories there may not be as good as they first look.
GS has taken more risk (VaR i.e. value at risk on the rise) and has now USD 54bn of assets classified as Level 3. JPM has done well but has signalled a faster than expected deterioration of its loan portfolio (mortgages and credit cards). Those two banks are among those who have best resisted the turbulent times and have repaid TARP already, but it remains to be seen whether the likes of BoA (BAC) and Citigroup (C) will do as well today.
- CIT is clinging on for now, still in discussions with potential lenders to bankroll its immediate funding requirements. Official talks have now broken down, with the regulators unwilling to make the necessary changes to allow an asset pass down from the parent to the bank unit. CIT stated after the close that it still had a number of alternative routes to pursue. The WSJ said the latest plan is pretty much a bond holder salvage scheme – the biggest bond holders looking at a $5 bn debt for equity swap in addition to $2 to $3 bn worth of new debt from existing bond holders. The indication is that it needs $2 bn of debt financing today if it is to stay out of bankruptcy.
A Pain in the ARM
A RealtyTrak press release on foreclosures yesterday that stated that option ARMs (adjustable rate mortgages) are likely to lead to higher foreclosure rates. They see peak pressure from option ARM “recasts” in August 2011 and I agree. A recasting, for those unfamiliar with the term, is a change in the payment of an option ARM once a negative amortisation ceiling has been reached or the period of minimum payments on these exotic loans has expired.
In a nutshell, borrowers in this type of loan MUST, after some period of time (usually five years), resume significant principal repayment even if the actual rate on their loan is unchanged or lower than before. This can lead to “sticker shock” as payment amounts increase rapidly even if rates don’t. As such, these were “affordability products”, allowing buyers to stretch incomes to buy houses they wouldn’t otherwise have been able to afford. Many of these borrowers will be in a bind given the fall in house prices and the fact that a lot of them would have made little or no headway in repaying principal. In fact, some have accrued principal as their minimum allowed payments didn’t cover the interest on their loans! This is the kind of situation that leads to “jingle mail”, where you mail your house keys to the lender.
Although the option ARM recasting wave is currently small, it should build next year and crest in 2011 as the sins of 2005 and 2006 come back to haunt us. In this context, the Fed’s statements that the economy is recovering and that their balance sheet will continue to shrink strikes us as a bit premature. These are the housing fundamentals that make us feel more certain that quite a bit of pain still lies ahead.
The British Peso ?
The outlook for the Pound Sterling (at least against the USD and JPY) seems to have darkened again in recent weeks. At the heart of these concerns has been the state of the UK’s public finances.
Ever since Standard and Poor’s lowered its medium-term outlook on the UK’s long-term rating to “negative” from “stable” in May, a wide range of officials and organizations have highlighted this issue (the Bank for International Settlements warned: “Getting public finances in order will …be the main task of policymakers for years to come”). The most damning comment came from BOE governor Mervyn King who told a select committee several weeks ago that the government’s “extraordinary” and “enormous” levels of borrowing had to be reduced faster than the Treasury planned.
The latest organization to express its concern has been the IMF. As The Daily Telegraph reports this morning, the fund published a report yesterday saying that a “credible plan” is needed to reverse the rapid deterioration of the public finances if confidence in the UK is to be upheld. As the IMF’s mission chief for the UK stated: “Market conditions suggest the UK has been getting the benefit of the doubt, both in the Government bond market and also the foreign exchange market. This benefit of the doubt is not going to last forever and it’s going to be important that the Government does not test the limit of the market’s confidence.” He added: “The authorities will need to move more aggressively in their fiscal consolidation plans and to be specific it will be important to set public debt on a firmly downward path faster than is envisaged in the 2009 Budget.”
The problem, however, that faces the government is that the general election (which must be held by June of next year) is likely to be a closely fought affair and that central to its plan of campaign is a wish to characterise the opposition as intent on swingeing public spending cuts. Given this, the last thing the government will wish to do is give the impression to voters that it will make any significant cuts in public spending itself after the election. As such it seems likely that it will studiously avoid carrying out a detailed spending review of budgets for at least twelve months. Indeed, there may have been an inadvertent hint of this recently when Lord Mandelson, business secretary, said that no spending review would take place until after the election (he later stated that he had “mis-spoken” while the Treasury has subsequently said that no decision had been taken).
Given that a twelve month hiatus in dealing with the state of public finances is possibly the last thing that international investors will wish to hear about, the implications for GBP are fairly straightforward. The IMF report spelt these out simply enough: “Should fiscal sustainability come into question, interest rates would rise despite monetary easing efforts, the ability of the Government to provide support to the financial sector would be severely limited and pressures on the currency could emerge.”
All this therefore raises the key issue of timing. I therefore find it very interesting to note that GBP/JPY has already broken down out of the uptrend that characterised the first six months of this year (in fact the rally in the early part of this week executed a neat retracement back to the bottom of the old trend where it then failed). I also note that the uptrend line in GBP/USD is starting to look under threat as well. With momentum moving steadily lower in both currency pairs, could this be the first sign of a fresh downtrend about to emerge?
And they had another really bad hair day over at CNBC yesterday. In addition to their Dr Doom gaff there was also this minor understatement.
Date for your diary. A prediction of a stock market collapse in China with handy exact dates and timing.
What do the Kilkenny Cat laughs festival and the US Federal government have in common ? Well it seems they are both seeking comedians.
Sunrise equity news
With the spectre of global terrorist attacks making a deadly return overnight this time in Jakarta (where bomb attacks on the Marriott and Ritz Carlton killed nine and injured forty-two) the market is a tad unsure what to do first up this morning. European markets are looking for their fifth day of gains.
BA (BAIRY.PK) are up somewhat surprisingly after announcing that they are seeking to raise £600m in funding. Other European stocks on the rise are Sandvik (SDVKY.PK) after reporting a smaller than expected loss, and Swiss drugs giant Novartis (NVS) on an upgrade over at JP Morgan. To the downside is hotels group Accor (ACRFF.PK) whose shares are off 7% + on a 76% decline in profits. Unfortunate timing given overnight events.
Irish snippets. DCC released an IMS this morning and said operating profit for Q1 was ahead of budget but behind Q1 08 as had been guided. The group's outlook for 2010 remains unchanged due the heavy weighting H2 has on earnings (66% of operating profits in 08 came from H2).
The strong performance of Sercom and the Energy divisions which contribute almost 80% of profits is a positive, but with such a large skew towards H2 in earnings there are risks to their forecast.
Biogen Idec (BIIB) posted Q2 profits ahead of analysts' expectations yesterday swelling by 10%, boosted by strong Tysabri sales. Tysabri's strong performance was driven by “a significant” increase in patients taking the drug. The group also saw strong performance from its other MS drug Avonex, increasing profits by 12% to $591.2 million. Elan’s (ELN) chairman Kyran McLaughlin was on the wires yesterday bemoaning the fact that news of their deal with J&J (JNJ) had not had much of an impact on the share price.
AIB’s US operation M&T (MTB) (it owns 24% which is worth about $500m) reports before the open today. EPS of $0.53 is the consensus expectation.
As it's casual Friday today I’m sporting a rather dinky GM T shirt.
US housing starts, June (13.30, all times UK): Starts may be broadly stabilising, but builders should be slow to ramp up new construction. In June, starts should slip somewhat to 520K.
A bumper day for earnings with BoA ($0.28), Citibank (-$0.31) and GE ($0.23) all slated to report and as you can see they have all massaged earnings estimates so low that more upside “surprises” are clearly the risk and no doubt the market will slavishly react to these “better than expected” results.
How to market your new airport novelette
or a little Friday rant