MorningWord 12/12/12: Vacation at Club Fed

by Dan December 12, 2012 9:21 am • Commentary

MorningWord 12/12/12: Equities the world over appear to be floating for the past week , carelessly, inching higher as we approach today’s FOMC meeting and Chairman Bernanke’s subsequent press conference.   For those of you who missed it, Enis had a great rundown of the consensus expectations for today’s latest QE iteration from the Fed in his MacroWrap this morning.  Handicapping central bank activities is a bit above my pay-grade, so I’ll just copy and paste from my main macro man Enis:

Here is general consensus for today’s actions:

  1. The Fed replaces Operation Twist with QE-financed Treasury Bond purchases of $45 bln per month, in addition to its existing MBS purchase program of $40 bln per month
  2. The Fed will keep the maturity bucket of its Treasury purchases the same, though some expect that it might tilt its buying towards the 5 year bucket (away from the 10 year bucket)
  3. A possible introduction by Bernanke during the press conference of targeting specific inflation and employment thresholds going forward.  Few expect a change in communication at the current meeting, but maybe a signal that such a policy will be implemented in 2013.  Based on recent Fed governor speeches, the consensus thresholds at the Fed seem to be 6.5% unemployment and 2.5% inflation

The main initial focus will be on the size of the monthly Treasury Bond purchases, and any indications by the Fed that it might adjust the monthly purchase program going forward.

To Enis’ point, the Fed is not likely to disappoint, so the question is, what’s already priced in with the SPX approaching key resistance at 1430, and just a few % away from the previous highs made after the announcement of QE3 on Sept 13th?  The 1 year chart below is fairly interesting when you consider how the index, for the most part, has held the uptrend that has been in place since the 52 week lows  made late last December.  With the S&P futures pointing to a slightly higher open, the SPX will likely open just below the levels it broke out to new multi-year highs on the QE3 announcement.

[caption id="attachment_20488" align="aligncenter" width="490" caption="SPX 1 yr chart from Bloomberg"][/caption]

 

To be perfectly honest, none of this technical mumbo-jumbo means jack by itself, it is just one input that I use to help form a broader thesis, and I am merely trying to visualize where I think a rally will or should pause, and where there appears to be some support.   What is clear to me though, is that the SPX is likely to break one way or the other after the FOMC and once there is a clearer path for an agreement on the “fiscal cliff”  Two weeks ago,  with the SPX not too much lower, I bought a put spread in the SPY that expires this Friday with the thought that the V reversal in mid November should pause at 1400 given the uncertainty of events in the first 2 weeks of December and investors likely desire to protect whatever ytd gains they have.  Clearly I have been wrong on the near term, and to be frank, I am not that bearish, this was a bit of a sentiment trade.  Our view is that QE4 and a “fiscal cliff” resolution is likely “in” the market with a few weeks left in the year, but if things go as most hope, many investors could be incentivized to just rip things into year end, the old “close your eyes and hope trade”.

Looking at the 5 year chart, off of the 2009 lows, and considering the power of central bank action and what it has meant for equity performance, it is hard to Fight the Fed.  This will obviously come to an abrupt end at some point but not likely this month.

[caption id="attachment_20489" align="aligncenter" width="490" caption="SPX 5 Yr chart from Bloomberg"][/caption]

 

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MorningWord 12/11/12:  The U.S. Treasury announced last night that they are selling their remaining stake in AIG (234 million shares) at $32.50 which will conclude their 4 yr ownership in the insurance giant since their bailout some 4 years ago for a multi- billion profit.  Considering the magnitude of the risks taken at the time, the tidy little profit for the U.S. taxpayer is not exactly eye-popping, but I guess in these times of dramatic fiscal deficits and impending austerity, we’ll take what we can get!

The mechanics of the overnight secondary offering, while routine for the large investment banks who handle and allocate shares of the deal and the mutual, pension and hedge funds that receive shares on the deal are quite ordinary,  the resulting short term profits by “fast money” hedge funds is somewhat extraordinary.    While the majority of shares likely went to the largest existing shareholders, (those that have shared the risk with the U.S. Govt for years) there are just so many shares and so much demand, for what Wall Streeters call a “clean up” sale, that Hedge Funds that are good commission payers to the underwriters demand participate.  In the end, the underwriting banks are in the business of soliciting deals and allocating them and then trading the underlying in the after market, so they get creative how to make everyone happy.

So lets walk through how the last 16 hours has gone for most fast money hedge funds looking to make some “free money” on the AIG deal…..The syndicate of banks give their equity sales-man the heads up at 4pm that they need to get indications for the massive deal (they have already pre-sold it with most large holders, and have already set the price), so most smaller hedge funds will need to be a tad aggressive to get in on this action….. For example lets say fictitious XYZ Capital, knowing that they will not be a huge priority in the allocation process, but they know the deal will be a lay-up, puts in an massively out-sized order for shares in the Secondary, coupled with an indication of how much more they will buy in the after-market.  Once all of these indications are in, then the allocating bank decides how much they will allocate to XYZ based on the annual commission run rate, how much of their balances they keep in the bank’s prime brokerage unit, what sort of “partner” they are etc etc.   So  XYZ gets their allocation at $32.50, the stock closed the previous evening at $33.86, and now the stock is actually trading up at $34.2099 in the pre-market………so what is XYZ capital doing, they are selling hand over fist; why you may ask?  SO they can book the instant profit and then deal with the risks of the stock they will own with their after-market order.  The whole thing sounds kind of convenient, well it is, and this is how the game works.  Even if your broker was kind enough to get you in to make up for your over-allocation in FB, by the time you got your allocation the trade will be over.

 

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MorningWord 12/10/12:  In the MacroWrap this morning, Enis took a look at the charts of some European indicies and suggested that the recent breach of long term resistance, and it’s subsequent failure could signal a near term top as we head into the year end.  False breakout or not, most market participants, need to digest many inputs, macro and mico, in their efforts to develop their “market call”.  While the price action in Europe this morning off of near term highs is not particularly encouraging, its far from disastrous and very well may be the back and filling needed to sustain a convincing breakout.

Aside from some mixed data from China over the weekend, the single stock news that I find most interesting is the better than expected same store sales data from MCD, coming in at up 2.4% globally vs analyst expectations of up .2%.    Whats most interesting about MCD’s Nov results is that it comes off Oct data that marked multi-year lows, and actual sales declines for all 3 of their major regions for the first time since 2004.  Aside from the recent volatility in their sales performance, MCD’s stalled stock performance off of an all time made in Jan of this year was a bit of a “Tell” for those anticipating a stall in global growth after the multi-year expansion from the lows of the “great recession”.  As Enis touched on False Breakouts for some European Indicies, could MCD’s recent breach of support of the $85 level and subsequent bounce (trading above $90 in the pre-market) on better than expected fundamental data signal a false break-down?

[caption id="attachment_20365" align="aligncenter" width="490" caption="MCD 1 Yr chart from Bloomberg"][/caption]

 

Whats important about MCD’s is that sales from Europe are greater than that of what the company gets from the U.S. and Asia represents a large part of the company’s expected future growth.  A sustained rebound in these regions that have struggled of late could signal another “less bad” data point for the global economy.  On the micro front, I would suggest that it will be very important for MCD’s to hold today’s early gains, a failure would likely cause many like Enis to use the price action to support the view that the near term macro price action is looking a tad toppy.

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MorningWord 12/07/12:  One of the major equity themes of 2012 was investors desperate search for yield,  causing massive rallies in some unlikely stocks and sectors, while another trend was the search for safe-haven investments with little exposure to a recessionary EuroZone that was at one point this year on the precipice of a credit crisis.    T and VZ were, and to some degree remain beneficiaries of these trends, but with incrementally positive economic data in the U.S., and the notion of systemic risk off of the table in Europe, will investors begin to rethink these crowded trades in 2013 if rates began to tick higher on the potential for reflation of global growth?  

At one point this year T was up nearly 27% and VZ up 18%, with both stocks matching 4 year highs as investors found the 4-5.5% dividend yields just too inviting, regardless of the 2 companies fierce competition in their cozy duopoly.

While both stocks’ performance has been fairly correlated over the last year, as one would expect, there has been a recent divergence since the mid November lows, with VZ fairly dramatically under-performing T.

[caption id="attachment_20254" align="aligncenter" width="490" caption="T and VZ ytd relative performance from Bloomberg"][/caption]

 

T’s under-performance may be explained away by its slightly higher valuation trading at 13x next years expected earnings that analyst see growing at only 7%, vs VZ’s PE of 15x expected 2013 earnings growth of 16%.  Another thought would be that AT&T’s miss on their attempt to buy T-Mobile earlier this year, which gave way to T-Mobiles combination with PCS, and Softbank’s near acquisition of Sprint have now made for a much more competitive wireless landscape in the U.S.  Regardless the reason, T doesn’t act that well, failing to rally with the market as it makes new 1 month highs.

As we head into year end, as the big money re-jiggers their portfolios, it makes sense to look for divergences, as they could be telling to the investment themes of the year to come.  Lots of money chases a few sectors that offered yield, and if the big money starts to position for a higher growth higher rate environment, stocks like T could go from “Bell of the Ball” to the guy that was served one too many!

 

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MorningWord 12/06/12:  The divergence btwn the Dow Jones Industrial Avg (yes, I just mentioned the Dow) and the Nasdaq Composite was the widest I have seen in a very long time. I don’t track that data regularly, but I really can’t remember the last time there was more than a 1% spread in a single trading day.  For Bulls, this is likely to be a fairly positive indicator, that while the euphoria around AAPL is finally breaking the broad market is able to absorb the selling and find other places to park the cash.  The flip-side for those who lean to the Bearish side would be that AAPL, and a few other large cap stocks (generally among banks, homebuilders, retail) have done most of the heavy lifting for a year with double digit returns and the market can’t possibly go higher without them.

This is the chart of the DJIA vs. the Nasdaq Composite over the last 3 years:  

 

 

In the long run, these two indices are still tracking very closely together.  But as Enis pointed out in late October, the performance of the Nasdaq over the last 6 months has been a signal that this 3.5 year bull market could be over.  When the leaders of the bull market start to fail, it’s usually a sign to get more defensive.  In 2000, that was tech rolling over.  In 2007, that was financials rolling over.  And in 2012, once again, it’s tech rolling over.

For large cap indices to build on the 2012 gains, they will likely need to find some new horseman, meaning, the rally will need to broaden out.  While BAC’s break-out above $10 yesterday, to new 16 month highs could signal some new leadership, the likelihood of bank stocks’ fundamentals driving further gains seems a bit flawed given the challenges facing their core businesses from a weak environment and increased regulation.   I think it is safe to say that Homebuilders trading at 5 year highs have adequately discounted a good bit of our supposed housing recovery and consumer discretionary stocks may face some serious headwinds in the post “fiscal cliff” era.  So while I am not by any means a fist pounding Bear, the breadth of the market disturbs me, and the index divergence (while I concede AAPL is a special situation) makes us consider that a lot of things have to go right 0ver the next couple months for the markets to make new highs.

 

 

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MorningWord 12/05/12: Yesterday’s price action in U.S. equities on the surface was fairly unexciting with the SPX and the Nas down about 17 bps after trading in a fairly tight range for the most of the day. But taking a closer look under the hood told a slightly different story and may be a decent guide for investor appetites for the balance of the year.  AAPL’s weakness (down 1.76%) obviously stood out like a sore thumb on a day that saw most sub-sectors in tech trade fairly well.  Enis laid out the case for $600 serving as near-term resistance for AAPL yesterday in his chart of the day (here.) I think there is a decent chance in Jan that the stock consolidates to $650, and I would be very surprised to see the stock make a new high anytime in the near future without the aid of a full blown market explosion to the upside. It is becoming clear that the fever has broken as it relates to investors’ once panic to own the stock, and maybe just maybe investors and analysts will recognize that margin compression and two consecutive earnings misses are not the sort of thing to be glossed over for a stock that has represented so much performance for so many investors in the last 3 years.

In other down stocks besides AAPL, it appeared that investors were shooting first and asking questions later.  A good example would be the 10% sell off in GPS yesterday.  This is a company that has been in the midst of a fairly remarkable sales turnaround in a very competitive space, the stock had been up about 75% on the year prior to yesterday.  Just last week the company disappointed on same store sales and the stock sold off accordingly, but yesterday out of the gate the stock was weak and then continued to crescendo after the company issued the following statement: *GAP SAYS NO CHANGE IN POSITION ON RETURNING CASH: REUTERS

Woops, so yesterday’s selling was a result of investor disappointment over the company’s refusal to pay a special dividend.  Doesn’t make a ton of sense to me that there was that much “fast money” in the name for a non-fundamental reason, but maybe just a an excuse to book some profits.

I also find it interesting that there was considerable weakness in Chinese internet names yesterday  with stocks like BIDU (-6%) making new 2 year lows, while SINA, NTES, SOHU & QIHU were down about 5% on average in front of what was a massive rally overnight in the Shanghai Composite.

There weren’t just losers though in yesterdays trading, NFLX was up 14%, GMCR was up 7.86%, FSLR was up 7.6%, P up 5.5% (prior to last nights sell off of 17% on disappointing results  and even HPQ was up 5%.  It appeared there was a run on controversial names with high short interest, (NFLX has 28% SI, while NFLX, GMCR & P of SI of 40% or higher.

I guess the point is that single stocks are starting to move around a bit, despite the general complacent broad market price action.  Not counting the moves in stocks with high short interest, I think the most interesting take-away is investors continued emphasis on selling names with perceived bad news, which was a trend throughout Q3 earnings season.  So the 2 way volatility in singles names could be the result of investors using any excuse to take profits, or cut losses and shorts finally throwing in the towel.

 

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MorningWord 12/04/12:  I am not gonna pull a Tom Cruise on Oprah’s couch on you here, but it seems like the longer I do what I do for a living, the more convinced I become that a traders success and failure in the markets has more to do with psychology than sound research.  This notion appears to play out more frequently than one would think, and in the last 2 decades has likely become more prevalent (since Gecko’s Fear and Greed speech in the movie Wall Street ……JK) with proliferation of the internet easing the flow of information (or mis-information in alot of cases), dramatically increased focus dedicated to financial news by huge conglomerates, and the advent of accessible investment/trading tools that have leveled to the playing field (to some degree) btwn institutional and retail investors. None of the above suggest that investors will make better decisions based on more sound research/information, just that there are more inputs to consider, most of them causing our brains to reject common sense in place of joining the herd.  

Let’s take MSFT for example. For most of us, we have been convinced that MSFT’s products serve some important service in our lives.  But the truth is, most of us don’t make a conscious choice to use their products. We do by default and for the most part, if asked, remain wildly unsatisfied with the user experience. MSFT is a utility company with little brand loyalty.  Looking at MSFT’s  10 yr price performance, it is obvious to me that consumers’ indifference to the company and their products has been reflected in investor psychology.  The stock has basically traded in a $5 range for most of the period as if it was a utility.

[caption id="attachment_20088" align="aligncenter" width="490" caption="MSFT 10 yr chart from Bloomberg"][/caption]

 

While the stock has clearly returned cash to shareholders in the form of dividends in that period the stock has gone nowhere. Aside from a few fits and starts. But every rally in this time period has seen the stock return back to the long term support.  Take this year’s almost 27% rally from Jan 1st to mid April…..what were investors thinking?? They got excited that there was going to be an Old Tech Renaissance with the release of MSFT’s new operating system for PC’s and mobile.  What rational investor could have come to the conclusion that MSFT’s new OS and mobile products could stem the deceleration in their core businesses like Office and Server divisions, that at last check, accounted for nearly 45% of the company’s sales.  My point is, if you want to buy MSFT up 27% at the high end of the 10 year range because they have $55 billion in net cash on their balance sheet, a massive share buyback, low valuation, pay a 3.4% dividend yield and generate tons of cash due to their recurring nature of their sales, be my guest. But don’t be surprised when continued product failures bring the stock back to the low end of the 10 year range, like a Pavlovian response, as investors become resigned to the fact that the company will be stuck in single digit earnings and sales growth forever.

I bring this up because it was such a head scratcher. As an investor, I look for stocks that can grow. MSFT’s products are becoming increasingly irrelevant and may never see growth again, the company has proven the chances of them innovating in a way that customers care about is basically off the table.  So if you want to consider MSFT’s equity as a high quality corporate bond, have a ball, but don’t convince yourself to buy the stock for the reasons you want to buy AAPL, QCOM or AMZN.

 

 

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MorningWord 12/03/12:   We often make fun of the financial media’s infatuation with Jamie Dimon.  By all accounts, there are few CEO’s who have captained their ships with near flawless precision as Dimon has over the last 5 years, but isn’t that what they are paid the big bucks to do?  There is no wonder that shareholders consider Dimon a “rockstar”, as JPM’s stock is only about 20% off of the 2007 high, vs BAC and C that are down 80% and 90% respectively in that same time period.  It appears this out-performance is warranted when you consider JPM is expected to cap 2012 with a new all time high in earnings, compared to BAC and C who will earn a fraction of peak earnings, while analysts see neither getting back to pre-crisis levels for years, if ever.  

Which brings me to the  a story reported in the WSJ journal this weekend, suggesting that BAC has postponed plans to raise fees on checking accounts of retail clients for fear of a re-do of last year’s fiasco trying to do the same with debit card fees.  What’s amazing about this is that fear of backlash from customers and regulators has made it nearly impossible for BAC to grow again.  Fot instance, JPM this year will see its revenues rise 46% from 2008 levels, but earnings up 3.5x 2008 levels.  In contrast, BAC earnings will be well below 2008’s; while revenues will be up from pre-Merrill Lynch merger levels, they will still be down 26% from 2009’s combined revenues.   SO I guess my point is, if these guys can’t raise fees when they want to on core products, how will they ever grow themselves out of the earnings hole they are in?

With the increasing restrictions of Dodd-Frank expected to be enacted in 2013 and 2014, the levers BAC can pull for growth will be further diminished.  Buying BAC at these levels is predicated on its existing value, because I don’t see much in the way of growth prospects.  So the crux of the stock argument over the next year will be, is BAC’s balance sheet worth what BAC says it’s worth, with none of the myriad ticking time-bombs that investors have witnessed in the past few years?  Quite a leap of faith…but I can see how those with 1-3 year time horizon are willing to make that bet.

While we lean a bit towards caution as it relates to investing in bank stocks, there are clear “have and have nots”.  BAC’s 77% gains ytd appear extraordinary, but when you consider the stocks sits 80% below it’s pre-crisis levels, much less so.  A couple weeks ago, I looked for a low premium/low delta way to get some short exposure on a move back below $9 (see Jan13 1×2 Put Spread here) in the coming weeks as my thought was that any investors who have bought the stock in the last 12 months could face far higher taxes taking gains in the new year than in December 2012, and this could possibly cause a scenario where everyone headed for the door at the same time.  While BAC trades within a couple % of the 52 week highs and banging up against long term resistance, I am fully aware that this stock could be off the races for purely technical reasons in the new year, which is why I do not have an outright bearish bet on in the name.  2013 will likely see a continuation of JPM’s out-performance on an operating level, and BAC’s from a beta perspective.