Report From Europe: Light Profit Taking Ahead of G20

by: The Mole

US stocks rose modestly Thursday, sending benchmark indexes higher for a second day, as better-than-estimated earnings from eBay (NASDAQ:EBAY) to McDonald’s (NYSE:MCD) and a timely drop in jobless claims helped offset a slump in financial companies amid speculation that banks face more losses from bad mortgages. eBay jumped 6 percent, while McDonald’s climbed 1.3 percent and. Netflix, the movie-rental service, surged 13 percent after raising subscriber projections. But Bank of America (NYSE:BAC) was again under pressure sliding another 3.3 percent and Alcoa (NYSE:AA) and Occidental Petroleum (NYSE:OXY) both slumped at least 1.3 percent as commodities prices sank amid a rebound in the dollar.

Today’s Market Moving Stories

  • French President Nicolas Sarkozy is opposed to Bundesbank President Axel Weber succeeding Jean- Claude Trichet as head of the European Central Bank, French daily La Tribune reported, citing unidentified people close to Sarkozy. The French president has never told German Chancellor Angela Merkel that he is prepared to leave the ECB presidency to a German when Trichet steps down, the newspaper said. Sarkozy would prefer Bank of Italy Governor Mario Draghi, the newspaper added.
  • October’s key German Ifo index continues to surprise the market: with a substantial increase of 0.8pts the index jumped to 107.6, in line with our expectations. The assessment of the current situation gained 0.5pts to 110.2, most likely reflecting the strong profit situation of businesses. Moreover, the expectations component soared 2.2 pts to 105.1, suggesting that the strong recovery of the German economy is set to continue.
  • The FT reports that US bank regulators have eased their tough stance on dividend hikes and share buy-backs as the sector’s fortunes have improved, paving the way for the return of billions of dollars in capital to shareholders, say executives and officials. Banks such as JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C) have in the past week used their third-quarter results’ announcements to detail plans to increase dividends or repurchase their stock.
  • Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC), the mortgage-finance companies operating under U.S. conservatorship, could draw a total of $363 billion in Treasury Department aid through 2013 if the housing market worsens, the Federal Housing Finance Agency said. The FHFA, which oversees the government-sponsored entities, offered the estimate today as the worst-case in an analysis modelled on the stress tests conducted on the nation’s biggest banks last year. The actual total cost to taxpayers under the regulator’s most dire scenario would be $259 billion, because almost 30 percent of the funds would come back to Treasury as dividend payments on its holdings of senior preferred stock. Under the best-case scenario, which assumes a strong near- term recovery in the housing market, the total cost to taxpayers would be $221 billion, or $142 billion after dividends. A middle-ground scenario would require total aid of $238 billion, or $154 billion after dividends. So far the companies have drawn $148 billion and returned $13 billion in dividends to Treasury.

Topic Du Jour: Currency Wars

  • Posturing ahead of the G20 in South Korea this weekend:

In a letter to the G20 finance ministers, US Treasury Secretary Timothy Geithner states:

G20 emerging market countries with significantly undervalued currencies and adequate precautionary reserves need to allow their exchange rates to adjust fully over time to levels consistent with economic fundamentals.

Bloomberg also reports that Brazilian finance minister Guido Mantega was told by Geithner that the Fed’s policies are “being overestimated.”

Canadian finance minister Jim Flaherty agrees with the points addressed by Timothy Geithner’s (in his letter) and states that the G20 aims to draft an action plan for fixing global imbalances this weekend.

On Geithner’s tentative proposals for current account balance targets, Japanese Finance Minister Yoshihiko Noda said:

We need to talk about it first, but numerical targets are unrealistic.

Noda also adds that the G20 is unlikely to discuss individual countries’ currency policies and even comments that it is yet unclear whether the G20 communiqué will mention currencies.

So the US is seemingly trying to insert a clause that would impose a limit on an economy’s current account surplus, as a percentage of GDP. This essentially means that countries would be prevented from exporting too much. It would force export-reliant economies to become less so, and require them to concentrate on generating domestic demand instead. Press reports saying it is the brain-child of the US delegation – essentially a way force China to rebalance. But it could also hit Japan, Germany, and Australia. Of course it all depends on where the threshold is set. If the current account limit was well above current levels, then the idea just might fly, but it is still very very unlikely. You would be talking about re-engineering the entire world economy in a single weekend. And of course, even if it was approved, we’d have, say, oh I don’t know, maybe 20 years to phase the limit in (Basel III gave us until 2019 – and that was only about the banks).

Note: Australia would be exempt from the agreement as an exporter of raw materials(!)

A senior G20 negotiator (speaking on condition of anonymity) tells Reuters:

[Geithner’s] reference to avoiding ‘competitive currency undervaluation’ as a goal between big economies is not new but appeared in a previous G20 meeting in the UK. It will likely appear again in the communiqué this time.

Russian finance official Andrey Bokarev said ahead of the meetings:

One thing is clear the final agreement on this framework agreement (on economic stability) will not be made at the finance ministers’ meeting … There is an action plan, but there are an awful lot of complaints, proposals.

The JoongAng Daily reports that the South Korean government is considering linking a proposed shift in the IMF quotas with the exchange rate issue. The proposal is to give China and other emerging countries more voting power in exchange for their currencies to appreciate.

Belgium’s finance minister Didier Reynders said:

In Europe we are in favour of a strong currency, if it is in line with the capacity to have a strong economic situation.

EU Monetary Affairs chief, Olli Rehn said:

The main issue of this G20 meeting is certainly to agree on policy coordination to rebalance global growth, which could create or save millions of jobs … It is much better that we aim at rebalancing global growth through effective policy coordination than by taking unilateral action.

  • Eurozone:

Asked if he was worried about the euro being overvalued, ECB council member Christian Noyer said:

That is an oversimplification. The EUR does not move alone compared with other currencies. … There is therefore no danger in the current (exchange) level.

  • China:

Wang Xiaoguang, a researcher at the Chinese Academy of Governance, said:

This is only a beginning and there is a lot of scope to expect more interest rate rises … What should be the right interest rate for China? I think 3.5 percent is no problem. Add one percentage point, no problem. It can even go to 4.0 percent.

  • Japan/China:

Japanese Economics Minister Banri Kaieda said:

Against the backdrop of US monetary easing, excessive funds are flowing into Chinese markets, leading to signs of bubbles … If China’s latest interest rate hike proves ineffective and bubbles burst, that would deal a blow to the Japanese and global economies.

  • US:

St. Louis Fed President James Bullard said:

If we do decide to go ahead with quantitative easing … we could think in units of about USD 100 billion … and then I think we could give forward guidance for the next meeting that would suggest how likely the committee thinks it is to continue these purchases.

Kansas City Fed President Thomas Hoenig (a noted hawk) comments that although he is unhappy with unemployment at 9.6 percent, saying:

If you try and bring it down too rapidly you are in danger of creating the next problem.

Company / Equity News

  • Since the last week in August the US airline sector has surged 28 percent and yesterday sentiment was further bolstered by strong numbers from United Continental (NYSE:UAL), JetBlue (NASDAQ:JBLU), Southwest (NYSE:LUV), Alaska Air (NYSE:ALK) and UPS (NYSE:UPS). All of these are guiding positive Q4 and talk of “record” full year profits (JetBlue), “outstanding revenue performance” (Southwest) and “best results in our history” (Alaska Air). Amid this tsunami of effervescence we find unit revenues rising strongly with UC citing 19 percent increases in transatlantic business class sales. That point lights up BA (OTC:BAIRY) as a prime beneficiary given its exposure to the Pond and ongoing evidence that capacity between the US and Europe remains tight. Just a week ago Aer Lingus gave us an insight to what long-haul was doing when it raised guidance for the second time since summer. Ahead of Europe’s Q3 (Sept) reporting season it is best to ride this wave for now. We note the US airline sector in aggregate is almost back to its 2008 levels (and 170% above March ’09). Between 2004 and 2008 it traded in a relatively narrow trading range and to break out we reckon it will need solid unit revenue growth, steady capacity and stable fuel prices.
  • American Express (NYSE:AXP) said Thursday its third-quarter profits soared 71 percent as customers increased their spending by 14 percent, and receding losses from souring card loans allowed the company to reduce the amount it squirreled away for a rainy day. Americn Express’s results offer an insight into the rising optimism of its borrowers – mostly well heeled consumers and companies – as the economy stabilizes despite stubbornly high unemployment. The company’s performance also cements the turnaround in the credit-card industry. Like many banks that reported earnings recently, American Express is benefiting from fewer losses on bad loans, but struggling with weak demand for new loans that would lift revenue. Kenneth I. Chenault, AmEx’s chief executive, said in a statement:

Lending volumes remain below pre recessionary levels as card members continued to manage their finances carefully and pay down outstanding debt.

  • (NASDAQ:AMZN) saw earnings grow in the third quarter as shoppers bought more goods and services, yet costs also rose because the company is having to build new centres to fulfill those orders. Shares fell in extended trading. For the July-September quarter, Amazon earned $231 million, or 51 cents per share — 3 cents more than what analysts polled by Thomson Reuters expected, on average. That compares with a profit of $199 million, or 45 cents per share, a year earlier. Revenue rose 39 percent to $7.56 billion, higher than the $7.36 billion analysts expected. It was $5.45 billion a year ago, a quarter that doesn’t reflect the November purchase of shoes and apparel retailer Zappos. Amazon reported Thursday that revenue from its largest sales category, electronics and other general merchandise, jumped 68 percent to $3.97 billion. Revenue from books, CDs, DVDs and other media grew 14 percent to $3.35 billion. Amazon’s stock fell $6.47, or 3.9 percent, to $158.50 in after-hours trading after the release of results.
  • SanDisk Corp. (SNDK), the world’s biggest maker of flash-memory cards, jumped 5.3 percent in extended trading after third-quarter profit topped analysts’ estimates. Excluding some expenses, earnings rose to $1.30 a share, from 75 cents a year earlier, the Milpitas, California-based company said. Analysts had projected $1.05 on average, according to data compiled by Bloomberg. SanDisk increased profits by shifting production to a more efficient manufacturing technology, Chief Financial Officer Judy Bruner said on a conference call. Demand from makers of phones and tablet computers is strong, helping offset relatively weaker demand for flash-memory cards in Europe and the U.S., she said. Fourth-quarter sales will range from $1.25 billion to $1.33 billion, the company said. That compared with an average analyst estimate of $1.29 billion. SanDisk rose $1.98 to $39.10 in late trading after the report. The shares have climbed 28 percent this year on the Nasdaq Stock Market.
  • Chevron (NYSE:CVX) said Thursday it will invest $7.5 billion to develop two of the Gulf of Mexico’s largest unexploited oil fields. Chevron’s decision signals that oil companies are still willing to stake their future on the deep waters of the Gulf’s outer reaches, despite uncertainty about the fallout from BP (NYSE:BP) PLC’s oil spill. US regulators are in the middle of implementing stricter safety and environmental rules for the offshore energy industry in the aftermath of the environmental disaster unleashed when a deepwater drilling rig burned and sank in April.

And From Europe We’ve Had a Slew of Household Names Reporting:

  • Stocks on the move in Europe today include Micro Focus International (OTCPK:MCFUF) which has rallied 7.1 percent after the Daily Mail reported that International Business Machines Corp. (NYSE:IBM) may be mulling a bid for the software maker for as much as 600 pence a share.
  • United Business Media (OTC:UBMJF) has increased 2.5 percent as the publisher of InformationWeek said it is ‘‘on track” to meet full-year targets after nine-month revenue rose 3.9 percent to £642.9 million pounds and adjusted operating profit rose 8 percent to £109.5 million pounds.
  • And Debenhams (DBHMY) has rallied 1.7 percent after Citigroup raised its recommendation for the retailer to ‘‘buy’’ from ‘‘hold,’’ saying the company is now ‘‘back for good.’’ The stock rallied 7 percent yesterday after the company announced plans to pay its first dividend in more than two years and reported higher operating profit that was inline with company’s forecast last month. London-based analyst Richard Edwards wrote in a report today:

Debenhams is making steady market share gain progress and continues to manage stock levels, gross margins and costs tightly.

  • Swedish network equipment vendor Ericsson (NASDAQ:ERIC) Friday posted slightly stronger than expected third-quarter net profit as rising gross margins helped compensate for short component supplies and a strengthening Swedish krona against the US dollar. Ericsson posted net profit of 3.68 billion Swedish kronor ($554 million)for the three months to Sept. 30, up from SEK810 million a year earlier when the result was hit by heavy restructuring costs, and slightly ahead of analysts’ expectations for SEK3.47 billion. Ericsson’s closely-watched gross margin, excluding restructuring costs, increased year-on-year to 39 percent from 36 percent and was flat from the previous quarter. So far this year, the company has been able to raise margins on a more profitable sales mix with increased network upgrades and software sales. The year-on-year increase was due to a more profitable business mix as well as the positive effects of previous cost cuts, Ericsson said. Chief Executive Hans Vestberg said:

A key priority has been to mitigate the effects of industry-wide component shortages. The situation has gradually improved during the quarter but it remains a challenge to fully meet the demand for mobile broadband.

  • French cosmetics giant L’Oreal SA (OTCPK:LRLCF) Thursday reported a 15% rise in third quarter sales that beat expectations, with the fastest growth coming from its consumer products division. The company behind Maybelline mascara and Garnier shampoo said sales grew 15 percent in the quarter ended Sept. 30 to €4.85 billion, beating analysts’ expectations of €4.75 billion, according to a Dow Jones Newswires poll. The fastest sales growth came from its consumer product division which grew 6.5 percent on a like-for-like basis to €2.39 billion. Thierry Prevot, L’Oreal’s head of financial communications, said:

The market confirmed its global rebound at the end of September. We estimate it at up 3.5 percent or 4 percent worldwide and L’Oreal is clearly outperforming this market.

  • Nestle SA (OTCPK:NSRGY) Friday reaffirmed its full-year outlook as the Swiss food and beverages giant reported a 4 percent rise in nine month sales, bolstered by strong sales in emerging markets and only partly dented by the strong Swiss franc. The Vevey, Switzerland-based company – which owns a range of brands, including bottled mineral water San Pellegrino and pet food Dog Chow – said sales for January to end-September rose to 82.77 billion Swiss francs, or about $85.6 billion from CHF79.55 billion a year earlier, beating analyst forecasts of CHF81.03 billion. Nestle doesn’t publish quarterly earnings. The company, which earlier this year had warned that the second half of 2010 will be tough due to high raw material prices, stuck to its full-year outlook. It aims for full-year organic growth – which strips out the foreign exchange and acquisition impact, but includes price changes – of about 5 percent, up from about 4 percent during the height of the recession in 2009. In the first nine months of 2010, overall organic growth reached 6.1 percent. The growth rate was most pronounced in Asia at 10.7 percent, followed by the Americas with 5.5 percent and 3.3 percent in Europe, where the difficult economic environment is continuing.
  • Fiat (FIATY.PK) reported strong headline figures with Trading Profit €586 million versus €409 million expectations. CNH (NYSE:CNH) and Iveco continued their strong recovery. Focusing on the businesses to be retained in Fiat Group post-demerger – Automotive trading profit was flat YOY, as strong performance from Ferrari offset declining volumes at FGA. The components businesses also performed well with revenue plus 23 percent and trading profit nearly tripling YOY. Fiat has increased FY10 guidance for Group trading profit (to over €2 billion) and expects net debt to be below €4 billion.

Disclosure: No positions

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