Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
Strike the TARP And Join the Chorus
“Follow me in Merry Measure”- Deck the Halls, traditional Christmas carol
Movies involving Santa Claus generally spring from one of two premises. The classic “Santa Claus really does exist” theme began with Miracle on 34th Street some sixty years ago. The second notion, “Santa needs help,” got going with Rudolph the Red-nosed Reindeer forty-five years ago. More recent films like The Santa Clause combine both notions. You know, like Wall Street in December.
The 2009 edition of the Miracle on Wall Street involves the country’s largest commercial banks rushing into a very forgiving secondary market with massive capital raises in order to, well, that’s a good question. Was it to launch a major expansion? Nope. Dramatically expand lending? You can’t be serious. Toys for all the children? You’re getting warm.
Of course, you probably already know it was to pay the government back the money lent under the TARP program. The haste in doing so before year-end did not spring from any notions of civic-minded responsibility, or gratitude towards the Treasury for saving them from disaster twelve months ago. You know why – it was to get out from under the heavy-hand of government control, in particular the kind that limits the amount of toys that the companies can hand out to senior management. In sum, these companies diluted the shareholders in massive measure because the bonuses of senior management were at risk.
We aren’t sure why so many shareholders seemed willing to go along with this. Perhaps they were still stuck in the same playbook from last year that said that if you can raise money, the stock price is going to go up. By the time the Wells Fargo (WFC) issue got done, however, sagging stock prices had put that notion to rest. When Citigroup (C) staggered to market with an offering that might kindly be described as lacking in polish, the cheers had turned to jeers and management was getting roundly pummeled by the media and investment community.
Citi did have one mitigating factor that we can sympathize with, which is to say they didn’t want to be the only one of the Gang of Four (Wells, JPM, B of A) left still holding TARP money. Though the bank is still a partial ward of the state, it seems that it doesn’t want others to be reminded of it. It might make them look weak, unlike that lofty stock price of $3.15.
The part that really made us sit up in astonishment, though, was the aftermath of the Citi deal. It seems that the company’s management is furious with the government for not managing the process better. Why didn’t the feds kick out their stake earlier, at a higher price? Why did they let Wells come to market with a competing deal that would shrivel investor appetite for Citi shares (note to Citi management – guys, it really isn’t very hard to slake investor demand for your shares)?
Now this is too rich by half. Citigroup is criticizing the government for poor timing with asset sales? We’re quite aware that government-bashing is always a popular game on the Street, but this is ridiculous. It’s like Bernie Madoff complaining that his investors misled him, or the Corleone family whining about rough play by its competitors. Trust us Mr. Pandit, you are not going to prevail in the court of public opinion on this one.
The excuse for all of this additional bank equity being dumped into the marketplace is that management needs to run without government interference, and that everybody’s best people will leave if they don’t get massive bonus payouts. Surely we are not the only ones who have observed that we’ve already had this system of completely unfettered (and unchecked) compensation, and that it did not work out especially well for the companies or their shareholders in the last decade. However, it did do quite nicely for the bonus recipients.
The other main story on the Street last week was the world’s two most popular trades – short the dollar and long gold – began to finally collapse of their own weight last week. There was nobody left on the other side of either trade. The conventional wisdom is that both trends will soon resume, but in the meantime it could result in some additional bumpy weather for equities. With the holidays serving up very light trading days over the next two weeks, a little bit of money can go a long way.
Although most of the movement in the dollar was fueled by a short squeeze, it was also helped along by tales of distressed sovereign debt, in particular that of Greece. As the saying goes, we have seen this movie before. The most likely course of events will be that a few deep seers will decide to start going long on the safety trade and shed their riskier assets.
That will briefly give the market some jitters, and then conditions will resume to be whatever passes for normal behavior. Any further developments of this sort will be ignored, except to smite them aside in exercises in virility. Then something really will blow up and it’ll get quite nasty, but why worry now? It’s probably at least six months away.
The homebuilder sentiment survey, a.k.a. the Housing Market Index, eased back to 16, its lowest level since June. That was the headline, but the truth is that the index has really been flat since recovering from single digit levels back in April, staying in a range of 15 to 20 ever since. The neutral level is fifty, so these little wanderings of a point or two around the 17-line are just plain meaningless. The industry is still in the ditch, and it will probably stay there at least until warmer weather begins to return.
A careful look at the housing starts data for November furnishes all the explanation needed for the weak homebuilder sentiment. Headlines and spin-meisters may have gushed about the 8.9% rebound in starts – helped along by the usual downward revision to the month before – but a look below the hood explains that funny burning smell.
To begin with, November isn’t the strongest of months, so a lot of seasonal adjustment goes into the data. Real physical starts fell about five percent from October to November, led by a drop in real single-family starts of about ten percent. It’s understood that November drops are typical, so some seasonal adjustment is necessary, but builders can’t pay their bills with seasonal adjustments. Lest you think we’re being flippant, put it into context: through the first eleven months of 2009, real, unadjusted housing starts are down just over forty percent compared to the first eleven months of 2008 (Table Three of the Census Department release). Single-family units are down thirty percent.
When you’re down that much already, it’s hard to get excited about a pickup in name only, especially when real starts are down more than ten percent from the previous November, or more than twelve percent seasonally adjusted. 2009 could go down as the weakest year for homebuilding since World War II. Single-family completions are down thirty-eight percent through the end of November. It’s largely the same story in permits – a headline increase that is down from last year, down from the previous month, but pushed back up by seasonal adjustments.
In the end, the markets reacted little because the data was on consensus. In a stirring sign of faith, though, the CFO of three months duration at builder KB Homes (KBH) left the company by mutual consent. It’s never a good sign.
Inflation data was mixed. The pickup in the PPI (Producer Price Index) that was hinted at in the previous week’s trade price data materialized with a very large gain of 1.8%. That sent the twelve-month change into positive territory (+2.7%) for the first time since last year. The markets didn’t like that bit, but the next day’s consumer report (CPI) told a different story, with optimists focused on the zero percent monthly change in the core figure.
Like the PPI, though, the CPI’s twelve-month change became positive for the first time since last year, and the 0.4% total jump isn’t meek. It still comes out of straitened pocketbooks. The Fed still calls inflation subdued and pointed to resource slack in the economy, along with low inflation expectations. Certainly there is little to nothing in the way of bottleneck-type situations, and while comparisons are bound to suffer for a few months due to the plunge in oil prices a year ago, that effect will wear off by the spring. That is to the good.
Two problems loom, however. One is that it is nearly impossible for any kind of economic pick-up to occur without speculators piling into commodities as a high-beta play. The second is that many companies may have concluded that with demand about as low as it can get, demand has become less elastic and therefore price increases may gain more revenue than they lose from any decline in unit sales. It may seem mercenary, but if the companies don’t raise prices, who is going to eat the difference between the PPI and the CPI?
The December business surveys from New York and Philadelphia told different stories last week, with the New York Fed reporting that growth came almost to a halt (2.55, zero is neutral), along with new orders, and showed declines in employment, workweek, shipments and so, just about everything but prices. However, the Philadelphia measure marched past consensus readings to a result of 20.4 versus the previous month’s 16.7. Although new order growth fell off, employment and workweek improved for the first time in ages, and the twenty-plus reading was the first such result in years.
It’s encouraging, but the six-month outlook fell, and the problem with that is while the six-month outlook is a lousy predictor, it is a good measure of today’s sentiment. The most common view one hears these days is that while we still may be in the bottom, the tide has turned (not that such remarks would have anything to do with keeping the stock price propped up at bonus time, heaven forbid). Perhaps the drop in new orders turned them more sober.
Industrial production continued its slow-but-steady recovery in November. It rose 0.8% versus estimates of 0.6%, but matched against October’s downward revision we can say it was really about spot on. It was a fairly decent report, with no hidden problems. In fact, utility output, the only negative contribution, should mount a strong comeback in December. We’re still down compared to last year, but less so, and capacity utilization crept up again to 71.3, still low, but still getting better.
Echoing that report, the leading indicators improved sharply with a 0.9 reading, and coincident indicators improved also. We think that the strength is overstated by some of its bigger contributors, such as a yield curve that keeps steepening for reasons unrelated to growth, or weekly job claims that are benefiting from a badly fitting seasonal adjustment process, but there’s no mistaking the direction.
Those weekly claims surprised back to the upside this week. The department announced the seasonally adjusted total as 480,000, compared to the raw data number of 555,000. Construction layoffs figured prominently in the total. The reversal of direction hung over the market for most of the day.
The Federal Open Market Committee met and delivered its carefully considered verdict that very little had changed since its last meeting. A nod towards lower job-loss data was expressed as “deterioration” that was “abating’; more importantly to traders, the “extended period” outlook for zero rates was left in. At times the FOMC meeting is the biggest event of the month, but it isn’t the case for recent meetings, where the statements have fallen quickly off the radar.
Next week is a holiday-shortened week, of course, with the equity markets packing it in at 1 PM on Christmas Eve. It could still be volatile, and often is due to the lower volumes. There will be some interesting chunks of news to chew on nevertheless, including existing home sales on Tuesday and new home sales on Wednesday.
The Bureau of Economic Analysis will have another go at third-quarter GDP on Tuesday, along with another revision to corporate profits. Wednesday will see personal income and spending for November and another consumer confidence report along the new home sales, while Christmas Eve will deliver durable goods for November. Good luck with your last-minute shopping.
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