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  • Cheap Money (Them That Has Gets)
    McDonald's this week raised $450 million in 10-year debt at 3.5%, a record low yield for a large batch of debt issued by a U.S. corporate borrower.
    — WSJ, Global Corporate-Bond Boom Gains Pace

    As the old saying goes, "Them that has gets."

    Yield-hungry investors, desperate for a place to put cash to work, have hit upon the strategy of lending to corporations that don't need the money.

    This hunger for corporate bond issuance -- amid the clear absence of better alternatives -- has led blue chip players like McDonald's to finance while the financing is good. Because hey, why not?

    The trouble is that this cheap money is not being put back to work as productive capital investment. As the WSJ reports, corporations are either using the cash to pay down debt, or simply letting it pile up on the balance sheet as a bulwark against lean times ahead.

    This dynamic is a clear example of the classic liquidity trap at work. Lending to blue chip corporations that sit on the cash (or use it to deleverage) is essentially one step removed from stagnant pools of capital in non-lending bank vaults.The Federal Reserve can direct a firehose of money at the economy, but it can't control where the money ultimately goes.

    So far, Washington and Wall Street have been utterly clueless in respect to the problems of the "real" economy, i.e. struggling consumers and small businesses. Because consumer spending is 70% of US GDP and small business accounts for roughly 50% of GDP, this is a deadly serious issue... and Bernanke the master plumber is all thumbs.

    Disclosure: no positions in stocks mentioned
    Jul 30 10:30 AM | Link | Comment!
  • Card Processors - A Tale of Two Tapes
    The two major card processors Visa Inc. (V) and MasterCard Inc. (MA) are down sharply today as a result of Visa's fiscal third quarter earnings report released after the close yesterday.  Considering the optimistic language in the report and the positive coverage by the media, you would think traders would bid the stock higher.

    A few quick bullet points from the release:
    • Operating revenue of $2.0 billion - up 23% over last year
    • Payment Volume of $745 billion - up 13%
    • Total transactions of 11.7 billion - up 14%
    • Guiding 2010 Rev to high end of 11% - 15% range
    • Guiding EPS growth of more than 20% for 2010 and 2011
    The Wall Street Journal endorsed the release saying Visa's numbers "offer evidence on the rising optimism of consumers and cement hopes of a turnaround in the broad credit card industry.  Obviously the traders who actually put capital on the line have a very different opinion...

    Different Types of Risk...

    There is a distinct difference between the way transaction processors such as Visa and MasterCard are trading versus their lending counterparts such as American Express (AXP) and Discover Financial Services (DFS).  At stake is a subtle but substantial difference between the types of risk that the two companies face.

    Visa and MasterCard are vulnerable to spending patterns.  At a very basic level, the companies simply make money off swipes.  Whether consumers are paying with credit cards, debit cards, or even gift cards within the Visa or Mastercard system, the companies receive either a "per swipe" transaction fee, a "percentage of spending" transaction fee or both.

    A big part of the bullish growth story is that as emerging markets increase levels of consumer spending - and begin to rely more on electronic transactions instead of physical cash, Visa and MasterCard will see more growth.  Every time there is concern over the rate of growth in emerging markets, V and MA become vulnerable to selling.

    On the bearish side, investors are concerned with a specific provision which requires merchants to accept at least two payment processing systems.  This provision will not necessarily immediately hurt Visa and MasterCard because the two have basically operated as a duopoly for decades.  But there IS an increased opportunity for a third or fourth competitor to make additional headway, squeezing margins and potentially bringing down the profitability of the entire industry.

    Questions about the growth of consumer spending, both domestically and abroad, are plaguing traders in V and MA.  At this point there is a very key inflection point setting up near $70 and if Visa breaks below this level there will likely be another significant wave of selling.

    Ironically, card companies with the second kind of risk appear to be trading in a much more healthy manner.

    Default Risk Abating

    Companies like American Express and Discover Financial actually lend capital to consumers through their credit card programs.  For the last several quarters, investors have ducked and covered because of the heightened risk for consumers to default on their credit lines.

    While the consumer as a whole is certainly not out of the woods yet, we are seeing a subtle shift away from excessive spending and towards financial responsibility.  (keep in mind we are talking about consumers here - the government has made no such subtle shift...)

    American Express had a strong earnings report with no serious concerns raised from a delinquency or default perspective, and the company may actually benefit from legislation that requires merchants to offer multiple card processing services.

    Considering the differences between the way the market is treating these two types of card processors, I am interested in exploring the possibility of setting up a spread trade - owning stocks like DFS and AXP, while shorting the likes of V and MA.  Both have exposure to the growth of domestic and international consumers, but the risks are skewed differently towards spending patterns versus credit risk.

    Price action remains key, and there are variables to consider such as volatility, correlation, event risk and the potential for political shifts - but for now the concept is worth more investigation.

    Disclosure: No Positions in Stocks Mentioned
    Jul 29 4:09 PM | Link | Comment!
  • MM Market Notes: Unusually Uncertain
    Stocks traded lower Wednesday as broad averages ran into resistance and traders reacted to the release of the Fed's Beige Book survey.  To quote Ben Bernanke, the economic picture has become "unusually uncertain" as the recovery loses steam.

    The term accurately describes the market action as well, with uncertainty leading to volatility.  Second quarter earnings reports have on balance been positive, but corporate strength appears to be largely driven by cost cutting, rather than true business growth.  As the bulls juice the market and send the averages above their key moving averages, uncertainty lingers for the time being.
    Unusually Uncertain...
    • The Fed's latest beige book report of economic conditions showed only modest advances in retail sales across the country. Housing and construction numbers remained weak, while bank lending was still tight. (WSJ)
    • ...the beige book, described an economy struggling under the weight of a depressed real estate market, high unemployment and wary consumers. (NYT)
    • The Fed’s Beige Book anecdotal survey of the US economy said that in some regions manufacturing activity had “slowed or levelled off” but that “economic activity has continued to increase, on balance”. (FT)
    Despite the uncertainty, there are some trading takeaways we can glean from the economic reports - and some attractive setups worth trading as we close out the month.

    Manufacturing Called Out

    Domestic manufacturing got the most attention - not only from the Beige Book survey but also from the Durable Goods Report showed contraction in demand for goods expected to last 3 years or more.

    Steel stocks were weak and are now looking like attractive short candidates depending on the broad market as a backdrop

    Market Vectors Steel (SLX) may be trading above the key moving averages, but the failure to hold its breakout above the June swing high is concerning.

    A steady uptrend which begain in early 2009 has now been definitively broken and
    looking at a weekly chart it is clear that the path of least resistance is lower...  To get comfortable shorting this ETF, I would want to see volume increase on negative days, but there are significant fundamental and technical red flags emerging...

    Speaking of volume,
    ArcelorMittal (MT) saw above average volume Wednesday as the stock slid below the 50 EMA.

    The company missed Q2 earnings expectations and although management is cutting costs, weaker demand has management -
    and investors - concerned.

    Other steel names worth keeping at the top of the watch list include
    US Steel (X) which recently kissed the 200 EMA before turning lower on strong volume, and AK Steel Holding (AKS) which can't seem to get out of its own way.

    Durable Goods and Retail

    While the Beige Book data implied strength in non-discretionary spending, the durable goods weakness was disappointing for retailers selling appliances, hardware, and other big-ticket purchases.

    Home Improvement
    blue chips Home Depot (HD) and Lowe's Cos (LOW) resumed their negative price action with both stocks falling back below the 20 EMA after a brief rally.  The action has gotten a bit choppy, but if economic data continues to point to weakness, the multiples could contract along with continued revisions to earnings expectations.

    You can't think about durable goods without at least considering Sears Holding Corporation (SHLD).  If expectations for appliance sales have been too high, then there is a good chance that earnings expectations for SHLD will be revised lower as a result of the Durable Goods report.

    From a technical perspective, SHLD is completely broken! The stock has experienced unmerciful distribution since its peak in April, and it's recent rally on low volume may now be turned back.  The chart looks ripe for a continuation trade, with the expectation that the stock will at least re-test support at $60 and possibly break lower.

    Fundamentally, Sears is still trading at 27 times expected earnings, and the analysts have been consistently lowering their estimates.  Second quarter EPS will be released on August 16 and if management does not do a good job of reinstating confidence,
    we could see a full-blown rout.  SHLD doesn't have the same debt issues that plagued the company a few years ago, but economic uncertainty could continue to hit this retailer hard.

    Cross currents continue to make short-term visibility hazy.  This means I will continue to keep trade size smaller as I remain in the flow while still protecting capital.

    Flexibility, nimbleness, and a constant willingness to re-visit market viewpoints keeps us in the game and bagging profits - Trade 'em well!


    Disclosure: Positions in stocks mentioned
    Jul 29 8:28 AM | Link | Comment!
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