Alcoa, the contrarian indicator

Posted by Ray on July 12, 2010 under Economy, Markets | Be the First to Comment

Alcoa is infamous for having lousy numbers and missing its estimates, even Cramer came out today saying who cares about Alcoa, they have lousy numbers. Last quarter they had lousy numbers, but everyone else had great numbers, so what does this mean? To me, it means that Alcoa is the contrarian play since they beat their numbers and raised guidance. Although one analyst says he was not happy with the results as he thought they would guide higher and attributed last quarter’s beat to the airline and auto industries higher demand, basically he said the rest of the year would be weak. I have not looked through the company’s numbers because I do not own Alcoa and I do not want to own Alcoa, so why bother.

Alcoa had good earnings, at least good headline earnings, and CSX had good earnings, which is no surprise since the rail reports have been looking better, but I think we are in for some serious outlook shocks moving forward. All the initial signs are there as the economy is cooling off, frankly it was never that hot to begin with, as retail sales are not stellar, consumer credit is contracting and unemployment remains incredibly high. For some reason the unemployment aspect has become a new normal that most people are immune to, 454,000 initial claims last week was not good and a 466,000 4 week average is not good, in fact it is disturbing that more people are not concerned about this. Not to mention, unemployment benefits for some 3M people are about or have already ran out, not good at all for future earnings outlook, in my opinion, or maybe this fits into a V shaped recovery story somewhere along the way, I get confused nowadays.

One surprise last week was the news that Wells Fargo was closing down 638 stores that catered to non-prime, a.k.a. sub-prime, borrowers, I thought they got out of that business 2 years ago? The firm is expected to has a $.02 charge because of this closure which leads me to believe there may be more losses which led to the closure of the division, not a stretch, I know. Also considering that their pick-a-pay mortgage portfolio still looks terrible I think there is more to the story, but, frankly, with the suspension of mark-to-market accounting what does a bad loan really mean anymore? I will say even with the accounting gimmickry that a bad loan still impairs the balance sheet even if it ‘looks’ good in the reporting and over time a loss will catch up to the bank it is just a matter of how long. I also suspect that there is probably no more perfect quarters for the trading desks f Goldman and JP Morgan, my heart bleeds for them. What I am trying to say is that we might be shocked to find that financials do not perform as well as expectations and their outlook gets more cautious.

There is also technology which has been on fire for the past year, there is no denying that. Earnings have been fantastic and growth has been abundant for pretty much anyone in the technology arena, but will it continue? I fear, no. One of the dirty little secrets is the fact that for the bulk of the last years Asia has been the driving force of growth and these firms have had the benefits of a declining dollar which meant a lot of positive FX results. This is true for Google to Intel who all had several hundred million in earning kickers thanks to a depreciating dollar, but that trend stopped at the end of 1Q10 when Europe started to really catch on fire. I am sure 2Q earnings are going to be good, but guidance might not be as robust as many believe and there is now greater possibility for misses on the top or bottom line as well.

There is also Europe to contend with, I know, everyone says Europe is no big deal and the impact in the U.S. will be minimal. Well, the same people also said the sub-prime crisis was contained in 2007 as well, how did that work out for you? The fact of the matter is that 30% of the S&P 500 earnings are coming from Europe and they are going to stop spending as much, that is just a fact. This slow down will have an impact on earnings moving forward, how much? I do not know, no one knows which is why guidance will probably be more cautious this quarter. You may be saying, well Asia is growing like a weed and I will agree with you, but only somewhat.

I will say that the population in Asia will probably be more liberal with their wallets than businesses will be. China has a lot to contend with right now between property bubbles blowing up, banks worrying about capital requirements, loans becoming harder to come by, profit margins being squeezed by employees wanting higher pay, but their top importer, the EU, has a falling currency and the U.S. consumer is also not buying as much either. They probably are not going to be buying as much as they would be or had in the past. A good barometer of this is the Baltic Dry Index which has plummeted over the past few weeks. China is the reason why the BDI expands and contracts, for the most part, and it shows that China is importing less because they are uncertain or at the very least done stockpiling for now. I believe that means Chinese companies are not doing much capex right now, I could be wrong, but I just don’t see it happening.

The other thing I know people will rip me apart on is the $1.7T, or there about, in cash U.S. companies has on its balance sheets. Many believe all that money will be spent or used to hire, well, what planet are you living on? How long has that money been there for? 6 – 9 months maybe a year now? This is like the cash on the sideline argument, it doesn’t hold water. I agree that eventually that money will go to work somewhere, but not now there is simply too much uncertainty out there. These companies will not go out and hire people, why would they do that, they just fired them? They don’t hire people just to give people jobs, that what governments do. The bottom line is there is no end demand right now, all the evidence shows that as the consumer is deleveraging and so are companies.

That money is sitting on the balance sheet right now because firms are worried about what is going to happen. Most firms paid down debt and are preparing to hunker down for a bad business environment for a long period of time which is why they are not raising dividends to much higher levels or buying new equipment. There is simply no reason to invest right now when the current employee level and technology can met their needs which is the problem with deflationary depressions. Over time this may change, but given what we see right now and the sharp drop in the leading indicators, drop in retail sales, etc. companies are just going to hold that cash until they absolutely have to spend it. I hope I am wrong, but it doesn’t look that way.

I believe that we have plenty of reasons to be worried this earnings season. There has been tremendous technical damage done to the S&P and unless we get stellar earnings and good guidance I do not see the markets going higher. The headwinds are just too strong right now and there is little sign that things are getting better, the opposite is true. I believe we are heading for an immense P/E multiple compression and that is a good thing for value investors, bad for those who own AAPL though. Speaking of which, AAPL is also another reason to be weary of the market right now, it is the only alpha holding out there, take that bad boy out and it will be like trying to get an elephant through an eye of a needle. Plus, if AAPL broke the trust they have with their users who can the people trust? Look for lower guidance.

The Birth/Death Model

Posted by Ray on July 10, 2010 under Economy | Be the First to Comment

I just read John Mauldlin’s weekly newsletter and he apparently got into a discussion over the much misunderstood and hated, by myself and many others, birth/death model used by the BLS. I have not been receiving the newsletter on a regular basis, some type of server issue I guess, but someone did not like what he had to say about it and I guess John misspoke about it. The whole thing about the birth/death model is it is meant to be a smoothing mechanism, I know that, everyone knows that, but it stinks and is not accurate which is what John ultimately said it was in his letter or at least it has not been accurate the last few years.

Now, I may have misspoke or led many to misunderstand what the birth/death model is and does. It is this little provision that helps the BLS make up for data they either do not receive back by survey participants or never receive, but it leaves room for interpretation and is never fixed in real time. In fact, they wait until February of the following year to correct any errors in the birth/death model that it may have had on the unemployment rate, fantastic, right? The model is not seasonally adjusted so when the BLS says 83,000 jobs were created it is not as if they added in the 147,000 (June’s B/D adjustment) figure to come up with that figure, that would be lying and a government agency would never do that.

Instead, what they do is add in the not seasonally adjusted B/D figure to the not seasonally adjusted employment figure and THEN seasonally adjust it. Now, you are thinking, big deal that shouldn’t make a big difference. Well, you may be right and you may be wrong. If you are talking 1M as a figure and the B/D adjustment is 50K it is no big deal, but if you are talking about a headline figure of 800K and the B/D adjustment is 147K (June figure) or 241K (May figure) well, you tell me, would that impact the seasonally adjusted figure? I would say yes it would. I have history on my side on this as well.

You see, in the fall of 2008 when Lehman collapsed and the world came to an end we all saw unemployment shoot to the moon, remember? Well, the BLS thought since so many people were losing their jobs and the business environment was so good that must be why so many survey respondents did not get back to them, they were busy making money! So, they added in hundreds of thousands of jobs from September of 2008 until the end of 2009. They were so aggressive in their B/D modeling they underestimated unemployment by 880,000 people, that is a pretty large underestimation by anyone’s standards considering the total ‘official’ unemployment total is 14M people and the underestimate for that time frame was about 10% of the total of the newly unemployed.

One could say, well, that is within the margin of error, but I don’t buy that since the government is the one who processes unemployment benefits and receives the initial claims data. In other words, it is pretty easy to correlate the data within a reasonable time frame, in my mind at least, but I am not a bureaucrat, so what do I know. Basically, if one removes the B/D figures from the non-seasonally figures and seasonally adjusts them you would have a bit of a difference in the monthly numbers. The series would be much more volatile, but it would also, in my mind, be more accurate and real time which seems to be something no one wants anymore with this figure which is why Santelli and Liesman get into screaming matches about it every first Friday of the month.

The bottom line is the adjustments matter, they boost the jobs number every month and they don’t come clean about any adjustments until the next year. That does not help anyone except for politicians and when more and more people are saying employment is now a leading indicator we need a better way to report unemployment. At the very least the BLS can correlate with the state data bases along with the household survey and that might give us a better view of what is going on. I think it is pretty much a proven fact that when we have the government guessing at any figure it is pretty much going to be wrong so why anyone would defend the B/D model is beyond me. The idea is fine, I guess, but how the BLS does it and how no one questions it, especially when it creeps up month after month when it really shouldn’t be, is very odd as, again, the only people who truly benefit from it is the political class.

Quantitative Easing 2.0

Posted by Ray on July 8, 2010 under Economy, The Federal Reserve | Be the First to Comment

I have written about money velocity at length and what I think will eventually happen and much of my thesis is about to be put to the test. For whatever reason the market seems to think massively shrinking consumer credit is a good thing and that the Federal Reserve will be starting a new QE process very soon, which is the news this afternoon that coincided with the parabolic move late in the day. However, I cannot disagree with this more and believe that any quantitative easing will do nothing to help expand credit or increase the money supply to the public. We have at the very least disinflationary forced if not outright deflation and the Fed is already running negative real interest rates.

If you recall about a year ago there was a paper from a Fed of IMF official, the authors name escapes me, that recommended real interest rates to run at -5% annually. At the time everyone thought the man was nuts and he was/is in my opinion, but the only way to get real rates that low is through loose money policy and quantitative easing. The Fed has maintained, and will continue to maintain a zero interest rate policy forever as far as I can tell, a loose monetary policy and performed the only quantitative easing policy the U.S. has ever seen, $1.5T in agency and U.S. treasury paper. Unfortunately we still have no idea what the long-term impact of these policies will be, but they cannot be good. These policies are causing real rates to go negative and mortgage rates to plummet.

In order to get the target rate to -5% the Fed will need to buy much more paper than it owns now. My guess is another $2-3T in additional paper and, again, we will not know what the impact of this QE program will be to our economy or currency for some time, but it will not be good. I am not sure why the Fed or this President cannot figure out that interest rates really don’t matter and declining credit is actually a good thing. In fact, all of the “bad news” is really long-term good news as far as the consumer is concerned, not the employment or housing data, but consumer credit. This de-leveraging is just what is needed as we were all awash in debt and most people cannot or could not ever repay their debts. I have never seen a government so desperate to reignite indebtedness of the public like we are seeing right now, it makes no sense long-term.

So, the Fed will start QE again, what will this do? Nothing. Will it increase the money supply? Yes, but not the public’s money supply merely the banking sectors balance sheet which is supposedly flush with cash anyhow. Banks are not lending money because they know they will not get repaid, but borrowers simply do not want more debt either, a good thing! We have mortgage rates below 4.6% and there is no demand, it just doesn’t get much better than that right now, although I think mortgage rates go sub 3% soon. Quantitative easing will do nothing to improve that situation and it certainly will not boost the confidence in the USD which is more than likely the goal, remember, the only way to double exports in 5 years is to devalue the dollar, but it will not work.

The point is that all the QE in the world will not put money in your pocket or your employer’s bank account to give you a raise. Essentially, from a monetary point of view the Fed is done as it cannot get money into the system. QE will merely create inflation, but not the kind of inflation Ben wants, Ben wants wage inflation and QE will merely create dollar devaluation which is Weimar Republic type of inflation. The public also does not want more games or trickery from the government and it frightens me to think what could happen if Ben goes down this reckless path. Remember, just because there is not an impact from his current policies today does not mean there will not be negative implications from these idiotic policies a year or 5 years from now.

What Ben will tell Obama is to create a direct QE program, i.e. a Bush style stimulus, a big one. I do not believe this will go over very well nor do I think voters are in any mood to be bribed with their own money this year, but if one is unemployed and offered $2,000 could or would they say no? Probably not. This type of stimulus would create what Ben is looking for, wage inflation and money velocity, but make no mistake it will be a short-term boost only. We have a long time before we are out of this mess and we have much pain ahead of us. We need to suck it up and deal with it. Contrary to popular belief it is not Bush’s fault, it is all politicians fault going back 30 years and the only cure is pain.

We will still look for an easy way out and probably do QE with another stimulus, but make no mistake that will be suicide for our countries long-term financial health and our currency will be in major trouble if we choose that path. I hate to say it, I have friends who are unemployed, but we must take the pain as it will be shorter than looking for the quick fix. We are all credit junkies and we got to kick the habit.

Retail sales figures, initial claims

Posted by Ray on under cnbc, Economy, Markets | Be the First to Comment

It is official, bad news is now permanently good news. I am not sure how this happened or why this happened, but this is the case as CNBC just confirmed that 454,000 initial claims were below expectations and continuing claims declined by 224,000. This sounds like great news until you realize that, well, continuing claims fell off because Congress did not reauthorize extended unemployment benefits, which has happened before I might add, and initial claims came in light because of the holiday week, just as I thought. Nevertheless, how we can be 3 years into this thing and think a print of -454,000 on initial claims with over $1T in stimulus spending is a good thing is disingenuous and, in all honesty idiotic. However, this is what we are being told by the talking heads, 454,000 initial claims are a good thing in the new normal.

One must trade the market that is in front of them regardless of what the data says, even though one knows the data smacks of a double dip or at least a massive slowdown at the least. Retail sales figures came in as well and if you were paying attention only the nice figures were making headlines, like JW Nordstrom +14.1% vs. 9% est. and Abercrombie +9% vs. 2.8% est., but these numbers were not encouraging as total expectations were for retail sales to come in at 3.2% and they came in at 2.8%. The really sad news is that these numbers were reduced in recent weeks because analysts knew the figures would be weak and the stores had pretty good sales as well. Consumers just are not buying the way they were used to and I know the argument is going to be, well this is June and the numbers are always weak in June. Sure, I will give you that, but the analysts know this and adjust accordingly and, more importantly, the chains know this and run deeper discounts to drive traffic. Look what happened, not very encouraging.

The discounters were even a mixed bag, Target missed estimates by 1% to the downside, Kohl’s missed by .5% to the downside, TJX missed by 1.2% to the downside, BJ’s Wholesale was off by 1.2%, the Gap was off by 3.4% and Costco was off 2.6%. I guess the bright spot was the high end retailer who had some solid numbers, Macy’s beat by .4%, Saks beat by .5%, Nordstrom’s beat by 4.5%, the Limited beat by 2.8% and Dillard’s, not really high end, but throwing it in, beat by 3%. This is a pretty big disparity between the discounters and the higher end retailers which raises the question of why the difference is so large.

The answer is pretty simple, first the wealthy shoppers are still wealthy and are more than likely taking advantage of deeper discounts at the high end stores. Don’t kid yourself, the high end retailers are cutting prices to drive traffic, everyone is including Walmart. Second, the discounters customers who were relying on their unemployment benefits had the rug pulled out from under them in some cases or knew it was coming so they cut back even more. The wealthy shopper can spend more and the less wealthy are still tightening their belts and this trend will continue for the foreseeable future.

Overall, this was one month of data, but the trend is on track, frugality. Same store sales did disappoint and I am a little surprised, actually I am not, that no one is mentioning the overall miss of .4% (overall expectations of 3.2% versus actual of 2.8%). Instead expect to hear about Nordstrom’s all day long today as the beacon of light in the retail world as the consumer comes flooding back to the stores as if they don’t have a care in the world. Even though some 454,000 just got their pink slip last week before our nations fabled birthday, for the record, last week’s claims were revised UP to 475K and the 2 week total for Americans receiving their pink slips were 929,000. So, congratulations all you lucky people, the world is turning around because apparently you being fired is great news for the economy, or just Wall Street. We officially live in Bizarro World now.

Recap

Posted by Ray on July 7, 2010 under Economy, Main | Be the First to Comment

Today was interesting to say the least, a massive rally on the back of no real news, I guess stress tests that really don’t stress banks balance sheets were the primary driver along with a technical bounce, but other than that all the other news was negative. Let’s review the bullish news that moves the markets 3%. Dallas Fed President Fisher calls out Congress and the President by saying they are inhibiting growth by creating confusion, no surprise there. Delinquencies on homes are stabilizing at extremely high levels, CNBC.com. Reis Inc. released a report showing that retail shopping center vacancies are rivaling all-time highs at 10.9% and rents are dropping, they should recovery by 2016, somehow that must be bullish. Lindsay Lohan is going to jail, I guess, for 90 days, now that really is bullish for whoever makes the drugs to sober people up.

I guess on the heels of all that bullish news it is little wonder that the market rallied so hard today. The only other piece of news that would have sent us to 11,000 for sure is if we declared war on Iran, based on this track record.  We blew through several layers of resistance on the SPY, which I am short and yes today did hurt, thank you for asking, and we could reach as high as $107.12 on the SPY, but overall it is still in a bearish trend, sorry. The volume was nothing to write home about today either and, frankly, yesterday’s mammoth reversal speaks volumes about the condition of this market, it is structurally unsound. However, we have some pretty big news coming up Thursday morning, retail sales and initial claims data will dominate the headlines.

First, if you watched CNBC this morning and caught El-Erain from PIMCO he said something you might have heard before. He said; “Unemployment is no longer a lagging indicator, but a leading indicator.” Any idea where you would have read that? I have been saying that for months now and many have said some pretty nasty things to me about making that claim. What El-Erain and PIMCO have figured out and the people who have no clue that a “V” shaped recovery does not exist have not figured out is that in a post credit collapse world unemployment is not a symptom of the cancer, but part of the actual cancer itself. If the credit collapse occurred because people could not pay their bills it would stand to reason that the more people who are unemployed the worse the problem will get. Perhaps this is why mortgage modifications are failing and defaults are picking up on credit products, depending on how a default is actually measured nowadays. It is just nice to have a high profile person repeat what you have been saying even though he has no clue who I am.

As for the initial claims tomorrow, my guess is that they will be ugly, again, as in +450,000, but less than the 472,000 from the week before because of the July 4^th holiday. Employers tend not to fire people before the holidays, but they will be elevated in my opinion. If, for some reason, initial claims are above 470,000 that will be horrible news and my guess is that will merit a reversal of fortunes in the markets. It is just amazing that we are coming up on 3 years into this thing and we are still seeing initial claims coming in at well over 400K a week. I know the President likes to make the claim that when he came into office over 750,000 people were filing for initial claims a week, but that was for only a few weeks during the peak of the crisis and, frankly, the fact that we have stabilized at 450K a week is nothing to really brag about, sorry.

To make matters worse the emergency extension of unemployment benefits were not passed before Congress went home for the holiday. That left almost 2M people without unemployment benefits and, in my opinion, that will have an impact on retail sales. How much of an impact? I do not know, but more than most people think. The other major thing people have to remember about retail sales is that many retailers closed a ton of underperforming stores so you are looking at retail sales numbers from the top performing stores they have to offer. No longer can we say that these figures include the dogs of the industry which means the figures you see can actually be much weaker, or stronger, than they initially appear. Regardless, credit is still contracting, unemployment is still sky high and that means retail sales are probably not going to be as strong as most people think, but analysts knew this and started heavily revising estimates lower. Not to mention that retailers have zero pricing power so even if sales are good their margins are going to be miniscule.

There is little to be bullish about out there as all the data has been bad and should not be read any differently than being bad. The ISM was bad, the employment report was bad, the housing data is horrible, the political picture is uncertain and the charts are certainly bearish, just look at the RUT. I am not saying don’t own stocks, but be careful what you own, strong balance sheets and dividends are key. Anyone outright bullish on this market is either selling you a fund or is simply out of their mind. Patience is key and there is no need to jump into any stock for any reason as we are in for a bumpy ride. I don’t even think earnings season will do much for us, sure 2Q10 earnings will be good, but the outlook will be not so bullish.