C.M.O. 5.24.2010

Credit Market Overview

May 24, 2010

It can be debated whether the Keynesian school of economics is the right or wrong way of managing a nation’s finances but one thing John Maynard said has remained true since the words were uttered.  “Markets can remain irrational longer than you can remain solvent”.

With this in mind and in light of the market’s movements since the “Flash Crash” on May 6th I have noticed an increase in the number of bears that have resurfaced to proclaim the end of the rally and resumption of the coming of the end of the world.

The CBOE’s VIX or Volatility Index peaked at 46.37 on Thursday closing just below that at 45.79, giving credence to the level of trepidation that currently exists.  All of this had even more of an impact since the VIX had closed at a multiyear low of 15.58 on April 12th.  How quickly things can change.

As I have written before good news doesn’t sell newspapers and the media has been feasting on all things downward related since the first week of this month.

In trying to rationalize all of the irrationality I searched to see if there was any heft to the hype and came up with a few interesting tidbits.  I will warn you however, that they aren’t all necessarily in tune with beat of the bear dance.

All those worrying about the Fed raising rates should note that the latest inflation numbers, a YoY increase of 0.9% excluding food and energy, were the lowest in the last 44 years which gives Ben Bernanke & Co. a break on at least half of their stated mandate of price stability and full employment.  With rates near zero and no real reason to raise them another Wall St. adage comes to mind: “Don’t fight the Fed”.

The U.S. trade deficit’s expansion by 2.5% to $40.4BN in March was the result of an increase in both imports and exports.  Ted Wiesman, an analyst with Morgan Stanley said, “If the European crisis prompts the Federal Reserve to keep interest rates lower for a longer period of time, it could spur growth in the U.S.”

In line with a brighter outlook Jeffries & Co. expects a $1.2TN Federal deficit this year while Nomura is predicting a $1.28TN shortfall and Deutsche Bank $1.3TN.  While these numbers are nothing to sneeze at the government’s own projection was for a $1.4TN deficit after digging at $1.6TN hole last year.

The lower deficits will translate into less debt being auctioned which will lower the competition in the capital markets ultimately making it easier for corporations to borrow.  Credit Suisse expects the Treasury to sell just $900BN in debt between now and the end of the fiscal year in September.  That is down from the $1.4TN it sold from last October to April of this year.

A lower deficit and less borrowing would also make the country’s CEO’s less nervous as many cited the nation’s red ink as a major worry when polled by the Business Council and Conference Board which showed that 70.4% of respondents expect the U.S. economy to expand 2.1% – 3.0% this year.  Jamie Dimon, CEO or JP Morgan Chase (JPM) said, “The health of the companies, both large and small, seems to be getting stronger all the time”.

CEO confidence would appear to be more than just words as Credit Suisse’s North American research group said in a recent note: “We believe that U.S. companies are now ending their recent enforced hibernation.  Survival mode is over and Corporate America is breathing easier, with cash as a percentage of market cap and aggregate free cash flow yield at all-time highs.  Now it’s time [for the companies] to cash out.”  Mark Flannery CS’s U.S. director of research believes “share repurchases will be the most predominant – and, generally the most appropriate – choice”, for how the corp’s spend their cash.

The results of the most recent earnings season also support CEO confidence as profit growth is expected to rise 87% for the companies in the S&P 500, a new record and one that blows away the previous high mark of 35% in 2Q93.  “Earnings season was much more impressive than I expected said Alan Lancz, president of Alan B. Lancz & Associates.

Confident CEO’s are a good thing but all we hear is that 70% of our GDP is consumption based and the logic there says people need money to consume and a job to have money.  The news here shows promise as well as the statistics for April showed a net gain of 290,000 jobs.  Alan Levenson, an economist for T. Rowe Price Associates, said: “We’re on more solid ground after these data than we thought we were.  That should reduce, at least at the margins, the concerns that ones might have had of the impact on our economy of what’s going on in Europe”.

Some countered the good news of the increase in non-farm payrolls by saying that the unemployment rate ticked up from 9.7% to 9.9% but Julia Coronado, a BNP analyst, countered right back saying: “People are encouraged to come back in the labor force and start looking for job, its good they’re not so discouraged anymore”.

Monster Worldwide Inc. (MWW) Chairman and CEO Sal Iannuzzi thinks the April jobs numbers could be the start of a trend, “It’s across the board, it’s in virtually every segment, every professional or occupational sector, we are seeing increases in demand.  The mood, the discussion, for our customers is much more positive than it has been.  It looks sustainable”, he said.

The numbers, here too, seem to back up the impression as the jobless rate in 34 states and the District of Columbia fell last month even though the headline number ticked up by 2 tenths.  From a payroll standpoint the numbers were even better with 38 states plus D.C. marking gains.

It’s appears the improvement is not just the number of jobs but that the environment is also improving for those with jobs as a number of companies are giving employees raises.  “They are feeling more confident in how 2010 will shake out” and want to ward off poaching was how David Smith, MD of Accenture PLC’s talent and organization performance group put it.

Another statistic, although a bit quirky, backs up the improving jobs picture; 1.9MM people quit their jobs in March while 1.8MM were fired in what is being interpreted as a sign of growing confidence on the part of employees that more positions are becoming available.

Industrial production was also higher, gaining 0.8% in April as manufacturers raised output of raw materials and construction supplies according the Federal Reserve.  “It’s important to recognize that we’re now in a solid recovery”, said Frederic Mishkin, a Columbia Business School professor and former Fed Board Governor.

The Institute for Supply Management survey of factory purchasing managers showed 17 out of 18 industries experiencing growth in March while the index for new orders rose 4.2 points to 65.7.  This was taken as a sign that the sector’s expansion wasn’t solely relying on growth from businesses restocking inventories after deep drawdowns during the recession.  “It really suggests the strength is sustainable” Michelle Girard, an RBS Securities analyst said adding, “Now what’s becoming evident is consumer and business spending is picking up.”

As evidence that the strength is being built on a solid framework ArcelorMitall, (CSDFY), the world’s largest steelmaker, said recently that it would restart production at a major operations center in Indiana that makes steel for nearly all markets.  French steelmaker Vallourec SA (VK.FP) is expanding its Youngstown Ohio operation and Welspun Corp. (WG.IN) the India based manufacturer is increasing the  hours of operation at its Little Rock, AR facility to 24/7.

One of the major users of steel is the auto industry and Sergio Marchionne announced this week that Chrysler Group LLC is planning to hire 1,100 workers at the plant in Detroit that is set to assemble the new Jeep Grand Cherokee.  “This is the great thing about Chrysler, we announce things and then we do them.  We announced a second shift, and it will be here on July 19th”.  Chrysler also announced that it made a $143MM profit in 1Q10 and is sticking to its pledge to break-even this year.

Chrysler is not alone, Ford Motor Co. (F) recently reported a 1Q10 profit of $2.1BN saying it would be “solidly profitable” the rest of the year and GM might even operate in the black for the first time since 2004.  Ed Whitacre, GM’s CEO said, “Our overarching view is that we have gone through a historic structural change in the industry.  We are going to have better profitability for a while”.

If the 20% increase in car sales isn’t enough evidence of a turnaround Nissan Motor Co. Ltd. (7201 JT), Santander Drive Automobile receivables Trust and Navistar Financial Owner Trust all priced bonds last week.  Mary Kane, MD for global securitized markets at Citigroup (C), said the ease with which they tapped the markets demonstrates that securitization “remains an attractive source of funds diversification”.

The other big worry for many has been the housing picture.  The U.S. Census Bureau reported that single family housing starts surged a seasonally adjusted 593,000 or 10.2% in April.  This could well be in part because of the April 30 deadline for the federal tax credit thinks Ivy Zelman, CEO of Zelman & Associates but the analysts surveyed by MacroMarkets, a Madison, NJ firm co-founded by Robert Schiller an economist at Yale and co-creator of the S&P/Case-Schiller indices thinks the national price index of homes could rise 12% in the next five years.  Joe LaVorgna, Deutsche Bank’s economist sees a number more than triple that as he expects home prices to rise 37% by 2014.  At that rate homes could well turn into ATM’s again.

Retail sales rose a seasonally adjusted 0.4% in April, after rising 2.1% in March which experts say is consistent with annualized inflation adjusted growth of more than 3% in the current quarter.

On one end of the retail spectrum Macy’s Inc. returned to profitability in 1Q10 and kept it’s full year forecast intact saying that its efforts to tailor merchandise to local tastes is paying off.  Michael Niemeira, VP of research at the International Council of Shopping Centers (ICSC) believes a recovery is quietly under way for both the consumer and retail industries, “During the past recession retailers slashed inventories, reduced their personnel and closed unprofitable stores, but that adjustment is now yielding healthy profits which are boosted further by recovering consumer demand.  The hardest-hit retailers, the luxury stores are coming back the strongest”.

Hermes International (RMS FP) is a good example of what Mr. Niemeira described as they recently announced a 19% increase in 1Q10 sales.  LVMH Moet Hennessy (LVMH IX) the maker of Louis Vuitton handbags posted an 11% increase in 1Q10 sales so it seems there is increased demand across the sector.

The “Lux” crowd not only shops but travels and Istithmar World and its partners Mandarin Oriental Hotel Group Inc. and Related Cos. are optimistic on the outlook for the hotel business and especially its New York property.  “The Mandarin Oriental New York is an exceptional property with a strong management team which we think will regain a great deal of value in the coming years” said Andy Watson, Istithmar’s acting CEO.  Lawrence Wolf, SMD for Eastdil Secured Ltd brokerage agrees saying “It’s the most modern hotel of its competitive set”.

While it’s a good sign that people are looking up on Lux others are so optimistic they are buying the whole company, at least when that company is the famed London landmark Harrods’s.  Qatar Holdings recently purchased the L700MM annual revenue generating retailer from Mohamed Al Fayed for E1.5BN or $2BN who announced his retirement after a 25 year reign as its CEO.

Since we’re on the subject of spending why not part with $106.5MM for a “Nude, Green Leaves and Bust” by Pablo Picasso?  The price, recently paid at an auction held by Christie’s once again made Pablo the world’s most expensive artist.  Pablo held the record from 2004 until earlier this year for his “Boy With a Pipe” which sold for $104.1MM but lost the title temporarily to Alberto Giacometti three months ago when Alberto’s “Walking Man” sold for $104.3MM.

In general the spring auctions are coming in above expectations although the older, more established works seem to be where the demand is.  An Andy Warhol painting, “Self Portrait” sold at Sotheby’s for $32.5MM which was twice its high estimate in early May.  Other notable transactions at the Sotheby’s sale included Monet’s “The Effect of Spring at Giverny” ($15.2MM) and the 1880 “End of the Afternoon, Vetheuil” ($6.2MM).  These last two were purchased over the telephone with the caller dialing in from Asia.

The U.S. stock market lost its footing in May, possibly because of some errant computer program, possibly because all of a sudden people started to worry about Greece, a country of 11MM people with a GDP of $356BN, which represents 2.15% of the Euro zone’s $16.5TN GDP and 0.6% of global GDP

Regardless of whether it was one or the other or a bit of both there seems to be plenty of positives to ponder as well.

Enjoy the week.

Jim Delaney

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