Report from Europe: Traders are Selling the News

It's turning into one of those, “You gotta know when to hold ‘em , know when to fold ‘em” periods, as stocks slipped late Wednesday on the banana skin of a Wells Fargo (WFC) downgrade to a “sell” from CNBC regular Dick Bove, who expressed concerns about “a serious erosion in the bank’s loan quality.” The stock lost 5% and dragged financials down in its wake. Amgen (AMGN) and eBay (EBAY) also disappointed after the bell. It really feels like the equity markets are starting to hit the saturation point. Valuations looked stretched and despite more “better than expected earnings,” it was the outlooks that are worrying me. The shock and awe of stronger-than-expected outcomes is dissipating and the onus is shifting back to the data.

The dive in US equities in the final hour of Wednesday is not an attractive set-up from a technical perspective, either. Firstly, a new high for the year was made early in the day, and then the S&P500 index closed on its low, below the range of the previous day and in fact the low for the last week. This is a key day reversal pattern and suggests significant fatigue and portends a period of retracement. The market is also displaying fatigue in that earnings reports have generally been upbeat and yet the market fell.

As the earnings season reaches fever pitch, today began with a batch of better than expected earnings reports from AT&T (T), Merck (MRK), Kimberly-Clarke (KMB) and McDonalds (MCD), while Xerox (XRX) and 3M (MMM) raised guidance which gave futures an early boost, but they were pegged back by more dastardly data in the form of the weekly jobless claimants number which came in higher than expected. At 15.00, we got bullish news from the Leading Indicators which produced an upside surprise printing 1.0% versus an expected read of 0.8%. But more bad news from the house sector with the house price index falling an unexpected -0.3% against an expected rise of 0.3%.

Today’s Market Moving Stories

• Overnight in Japan, exports fell 0.8% month-over-month, the third straight decline, and 30.7% year-over-year in September (slightly worse than the consensus forecast for a 29.9% decline). So some signs that the strong Yen is beginning to bite.
• Goldilocks growth in China (i.e. not too cold and not too hot, if you don’t believe the numbers are a fairytale of course). GDP grew by 8.9% year-over-year in Q3, as expected, and was up from 7.9% in Q2 and 6.1% in Q1. Li Xiaochao, the spokesman of the National Bureau of Statistics said that “we can say with certainty that achieving 8% GDP growth this year is completely assured. Without doubt”. He added that “according to my understanding, our policy won’t change at the moment."
• Chen Daofu, an economist with the DRC think tank said that “maintaining the appropriately loose thrust, we should use monetary, regulatory and exchange rate tools to implement structural fine-tuning”. Meanwhile, QinXiao, who is the CEO of the sixth biggest Chinese bank, warned that China is developing a bubble economy, requiring immediate tightening of conditions.
• The Obama administrations proposed rules over executive remuneration include a 90% cut for top 25 earners at the seven largest institutions the Government has a big share in (Citi (C), BofA (BAC), GM, AIG (AIG), Chrysler, etc) and a 50% drop for the next 175 unlucky souls.
• There’s chatter about new US FASB rules coming in 2010 which will squeeze scarce bank capital as they are forced to take off balance sheet instruments back on balance sheet and less lending as a result. Not exactly helpful for pump priming the economy.
• White House aide Lawrence Summers said that, “there’s really no doubt that the third quarter registered growth, and growth at a nontrivial rate, and every expectation that the fourth quarter will do the same.” He added that “I think the USD… is going to be the world’s primary reserve currency for… the foreseeable future… I think the most important thing we can do for the USD is make sure that it rests on strong fundamentals.”
• Richmond Fed President Jeffrey Lacker anticipates GDP growth of between 2.5% and 3% in 2010 but notes that there are always risks on both sides of such a forecast. However, he said that “inflation seems like it’s in a pretty good place right now.”
• David Altig has made the observation that the percentage of employee separations labelled permanent is at a recorded high, and concludes from this fact that the odds of a jobless recovery are high. He notes that never in the six preceding recessions did permanent separations reach 45% of new unemployment. Now it is 56%. My view is that as employment is part of the Fed’s mandate, a permanent rise in unemployment is very likely to dampen any fast exit strategies.
• The US may lose its Aaa rating if the budget deficit isn’t cut within the next 3-4 years, according to Steven Hess, head US analyst for Moody’s. Hess said the country’s Aaa rating “is not guaranteed.”
• On the FX markets the EUR/USD cross pierced 1.50 with little fanfare yesterday, serving as a reminder that there is little policy makers can do about unless a) the Fed is ready to raise rates or b) the ECB is ready to cut rates.
• In the UK, according to HM Revenue & Customs, seasonally adjusted basis UK housing transactions (with a value of £40,000 and over) were 81,000 in September. This was 33% higher than September last year and well clear of the November 2008 low of 53,000 (although still circa 40% below the pre-2008 norm of 135,000 transactions per month). Housing transaction activity is an important lead indicator for builders merchants such as Travis Perkins.
• The Scotsman carries an interview with MPC’s Paul Tucker which has the conspiracy theorists twitching. On the economy, he said that if it was deemed necessary to increase quantitative easing beyond the £200 billion proposed under the current scheme then “it would be possible and it would happen” Interesting then that yesterdays BoE minutes confirmed QE at £175 billion. So a typo or a freudian slip by Tucker?

On The Beige Book

The Beige Book as usual provided a fascinating insight into the US economy. As the economic recession most likely ended in statisical terms in August, and real GDP rose a solid 3.75% annualised in 3Q, it is no surprise that the tone of the current Beige Book is slightly more sanguine than it was in early September, and that “reports of gains in economic activity generally outnumber declines.”

It is, however, sobering that at the same time “virtually every reference to improvement was qualified as either small or scattered.” Leading the more positive sector reports were residential real estate and manufacturing, both of which continued a pattern of improvement that emerged over the summer. Reports on consumer spending and nonfinancial services were mixed. Commercial real estate was reported to be one of the weakest sectors. Most important is that labor markets were still “typically characterised as weak or mixed.” The weak labour market remains the Achilles heel of the US economy, preventing the current technical upswing from becoming a self-sustaining, consumer-led recovery.

Many Fed officials are sharing my concerns about an (almost jobless recovery) and the view that the current upswing might not be sustainable. According to the latest FOMC minutes “participants expressed considerable uncertainty about the likely strength of the upturn once those [government] supports were withdrawn or their effects waned.” In addition, the significant underutilisation of resources is removing basically any inflation threat. This notion is underscored by the Beige Book, as “districts generally reported little or no increase to either price or wage pressures, but references to downward pressures were occasionally noted.” In a nutshell, there is uncertainty about the strength of the economic recovery. This is hardly the macroeconomic environment in which the Fed would even talk about tightening monetary policy. Market expectations are for a first rate hike in April 2010. Instead, I think that the Fed won’t start tightening before the second half of the year.

Equity News

• Lloyds is now likely to get permission to exit APS and that would presupposes £26bn capital raise (combo of rights issue £11 billion, sales £4 billion and remainder pref to equity or brand new contingent capital conversion is my guess).
• Nestle’s (NSRGY.PK) Q3 trading statement contained few surprises with organic growth reported at 3.8%, up from 3.5% in H1. The full year outlook was unchanged, and whilst the 2009 share buyback was increased from CHF4 billion to CHF7 billion.
• Ericsson’s (ERIC) share price had a poor morning after reporting a deeper than expected 71% drop in Q3 profits as clients slashed spending, expensive joint ventures and fierce price competition from China.
• Mining giant Anglo American announced plans to further streamline its business by selling non-core assets with an aggregate of 11% of the group’s 2008 EBITDA, take-out a layer of management and create a more streamlined management structure of seven commodity business units. Anglo’s management structure has for a long time been considered cumbersome, and this shake up will be a welcome, if not unexpected change. Anglo remain vague about the use of these proceeds, although they do state that they want to further strengthen the balance sheet and this will help them focus on growing core mining activities. This move does beg questions, but I expected some positive action in response to the Xstrata approach.
• Pernod Ricard’s (PDRDF.PK) Q1 sales figures came in better than feared, with organic sales declining 4%. Expectations had weakened following Diageo’s disappointing 6% fall reported last week. The sales performance varied across divisions and categories. CEO Pierre Pringuet indicated in an interview that he was seeing signs of improvement in the global spirits market.

And Finally… The Galleon Hedge Fund Scandal

Galleon founder Raj Rajaratnam once paid $4 million to have Kenny Rogers come to a birthday party at his house and sing his favorite song, ‘The Gambler,’ over and over again. Kenny refused to go on after a dozen times.

Disclosures: None