What’s the Story

by CC August 20, 2012 9:03 am • Commentary

Calculated Risk

The Chicago Fed released the national activity index (a composite index of other indicators): Index shows economic activity increased in July

Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) increased to –0.13 in July from –0.34 in June. …

The index’s three-month moving average, CFNAI-MA3, decreased slightly from –0.18 in June to –0.21 in July—its fifth consecutive reading below zero. July’s CFNAI-MA3 suggests that growth in national economic activity was below its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.

This graph shows the Chicago Fed National Activity Index (three month moving average) since 1967.


The euro fell and German Bund prices pared early losses after the European Central Bank played down a Der Spiegel report that it may cap the bond yields of fiscally-stretched euro-zone countries like Spain and Italy, but European stock prices barely reacted.

The ECB said it was misleading to report on decisions not yet discussed by its governing council, sending the euro briefly below $1.23, although it then rallied to just above that level. September Bund futures rallied, but then slipped, while European stock prices barely moved in quiet holiday-thinned trading.

Spanish and Italian bond prices pared their gains but remained in positive territory.

An article in Der Spiegel published this weekend stated that the ECB is considering setting interest rate thresholds for each country for the future purchase of government bonds. The article, which didn’t specify a source, said under the proposal the ECB would buy the bonds of crisis-hit countries when their interest rates exceed a certain premium to German government bonds.

A spokesman for the German finance ministry also said Monday he knows of no plans for an ECB interest-rate target and any such plan would be problematic. Those headlines pushed the euro down to the day’s lows. Equities and southern European bond markets were unfazed.


But there are three big reasons to be cautious about the “spread cap.” One is philosophical, another is practical and the third is tactical.

First things first. Buying whatever is needed could amount to a lot. The ECB’s earlier venture into bond-buying–the Securities Markets Program, which was started in spring 2010–was small by deliberate design. Under that program, the ECB ventured into markets and bought bonds from time to time in relatively small amounts. It didn’t say in advance when it was buying, nor whose bonds it bought. The amounts were small enough that the central bank could accept deposits in amounts equal to the cash it spent buying bonds. Those offsetting deposits meant there was no net creation of money.

Setting an explicit cap removes a lot of control from the ECB’s hands. It’s possible that private investors will take the ECB’s declaration seriously and return to the markets to buy bonds themselves, thus negating the need for the central bank to do much at all. But maybe not. Private investors who hold Spanish bonds might decide the ECB’s cap represents a  great opportunity to dump bonds at a decent price. To set a cap, the ECB would have to get comfortable giving up control–and accepting that it might end up with a lot more Spanish government debt than it wants.

The practical question is also vexing. At the last ECB meeting, ECB President Mario Draghi said ECB committees would be charged with figuring out how the central bank’s “interventions” would be structured. These are difficult questions. Should the ECB buy only short-term bonds? If there’s a spread cap, should Spain get a higher spread cap than Italy? And how exactly should such a spread cap be figured? It’s possible that the ECB has all this worked out, but at the August meeting, Mr. Draghi suggested there was plenty of work to be done.

Lastly, there is the grand game of chicken. Mr. Draghi has said repeatedly that a country would need to ask for help from the euro-zone bailout fund before it benefited from the ECB’s largesse. That’s because the ECB wants the countries to be roped into reform programs they can’t easily slither out of. For obvious reasons, politicians in Spain and Italy don’t want to rope themselves in. The desperation of high bond yields–which are a sign that demand for a country’s debt is drying up–is one of the few levers the ECB has over politicians. To announce a spread cap without anyone having asked for help would mean giving it up.


Brent crude oil rose to around $114 per barrel on Monday, supported by tight North Sea supplies ahead of the closure of a key UK oilfield for maintenance and on expectations of more demand before the northern hemisphere winter.

Britain’s largest oilfield, Buzzard, which is the single biggest contributor to the Forties crude oil stream and usually sets the price of the Brent benchmark, will shut next month, suspending output until mid-October.

Production from key North Sea oilfields is due to fall by about 17 percent in September, helping push up prices for nearby crude. But the shortfall should be temporary and traders expect pressure to ease after the maintenance is completed.

Brent for October was up 77 cents at $114.48 a barrel by 1045 GMT after falling more than $2 on Friday on expectations the U.S. might release some of its reserves. U.S. light crude oil was flat at $96.01.


The recent shift out of defensives is clearly highlighted when looking at the percentage of stocks above their 50-day moving averages by sector.  In the entire S&P 500, 80% of stocks are currently above their 50-day moving averages.  But all four defensive sectors — Telecom, Consumer Staples, Health Care, Utilities — have breadth readings below 80%.

The most defensive sector of them all — Utilities — has seen breadth fall of a cliff.


Lowe’s (LOW) tumbled 5.6 percent to $26.31. The second-largest U.S. home-improvement retailer reported second-quarter earnings that trailed analysts’ estimates as comparable-store sales fell. Adjusted earnings per share reached 65 cents, the Mooresville, North Carolina-based company said today. Analysts had projected 70 cents, the average of 24 estimates in a Bloomberg survey. The retailer cut its full-year profit forecast to $1.64 a share from a projection of $1.83 a share in May.

Best Buy erased 4.3 percent to $19.40. The retailer’s board proposed that Schulze, beginning in January, be allowed to take his buyout offer to shareholders, should the board decide to reject any definitive proposal to acquire shares. Schulze didn’t accept the proposal, according to Best Buy.

Corinthian Colleges Inc. (COCO) slipped 6.1 percent to $2.30. The for-profit college operator forecast revenue in the first quarter will be no more than $405 million, missing the average analyst estimate of $406.4 million.

Coventry Health Care surged 18 percent to $41.18. Aetna, a health insurer, will pay $42.08 a share for Coventry in cash and stock, the companies said in a statement today. Aetna’s shares climbed 2.5 percent to $39.

Sirius XM Radio Inc. (SIRI) climbed 2.3 percent to $2.62 as Liberty Media Corp. said it plans to take control of the satellite-radio broadcaster. Liberty Media said in a filing to the Federal Communications Commission after trading ended last week that by increasing its stake to more than 50 percent it can take control of the radio provider within 60 days of receiving approval for the transfer from the regulator.


Camelot Information Systems Inc. shares CIS rose 10%. The company reported financial results Monday and reiterated revenue projections for the full year.

Coventry Health Care Inc. shares CVH rose more than 20% early Monday. Earlier, Aetna Inc.AET had confirmed plans to buy Coventry for $5.7 billion in cash and stock, a move that will make Aetna one of the largest providers of government-financed health care. Read more about the Aetna-Coventry plan.

PhotoMedex shares PHMD rose 8% in pre-opening-bell trades Monday. Over the weekend, the company said its board had authorized the open-market repurchase up to $25 million in common shares over the next 12 months.