Moving Day

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Kevin A. Donovan

So Are the Days of Our Lives

Before the sand runs out on this anno domini we turn our eyes outward to the great wide world to see what lies ahead when we flip the hourglass over for 2013.  Our only guarantee is that all will work out, regardless of our picks, just as it always has.

·         BCS Champion: Alabama will easily cover the 10-point spread vs. Notre Dame, which should have at least three losses (Pittsburgh, Stanford, USC).  The Irish run out of luck.

·         Super Bowl Champion: Seattle Seahawks.  Russell Wilson is preternaturally confident and should be rookie of the year over RG III and Andrew Luck.

·         NCAA Men’s Basketball Champion:  Butler.  Bulldogs shed bridesmaid role on the strength of Rotnei Clarke’s jump shot.

·         World Series Champion: Toronto Blue Jays.  Ricky Romero wins Cy Young award.  We’re not kidding.

·         NBA Champion:  Who cares, but we’re going with the L.A. Clippers for entertainment purposes only.

·         Stocks of the Year: Tesla Motors (TSLA), Barnes & Noble (BKS) and Cobalt International Energy (CIE).  Tesla, the electric car maker is poised to grow big-time; Barnes & Noble’s Nook device and partnership with Microsoft should pay off; and Cobalt keeps finding oil in what we think will be a rising oil price environment.  You can check out our calls on istockanalyst.com by clicking here and here for TSLA; here for BKS, and here for CIE.

Surprises for the year:

·         No meaningful gun control legislation, despite being a no-brainer.

·         Oil will average over $100 a barrel despite booming production, because . . .

·         . . . economic growth will hit 3% and stay there, because the Fed will not ease off the gas pedal until it does and business and consumer confidence revive.

·          The Republican Party, fearful of joining the Whigs, will turn a corporate cold shoulder on its Tea Party hijackers.

Meanwhile, we bid adieu to 2012 thankful for all the usual suspects – healthy children, loyal friends, a repeatable golf swing.  Happy New Year.

Escape Velocity

The luckiest member of the club, yours truly, was recently fortunate enough to witness this mise en scène one early fall day.

“No,” he said, raising his arm Caesar-like to still the murmuring plebeians in the gallery.  “It is part of my plan.” 

He had used the driver to carry a creek and reach the right fringe of the 164-yard par three.  Choosing his two-ball putter, he navigated the bristly grass to the putting surface but left the ball woefully short, some 30 feet from the hole.  The country club crowd groaned.  Saving par seemed gone with the wind to the Dixie gentry surrounding the kidney-shaped green.

Surveying the slick pool table from every angle, his cool gaze hidden by Ray-Bans, a wry smile cracked the usual steel of his face.  Square in the line of his intended roll laid a crinkly, brown leaf, late of some thirsty dogwood.  The smile on his lips belied the click of tumblers locking into place in his calculating brain.

He addressed the dimpled sphere with something akin to insouciance.  But the expression was tinged with resignation, cuing the parasol-wielding ladies to cluck and the aristocratic Ashley Wilkeses watching the spectacle to shake their heads in sympathy at our foolish Rhett Butler.

Without a practice stroke, he launched the blade.  The ball marched on a straight line to the hole, the dogwood leaf standing athwart history and yelling “Stop!”  This was no Titleist poodle, though.  The determined Top-Flite tank  struck the impediment and veered up a hillock to the devilish location of the hole atop it.  With the satisfying rattle of ball in cup, parasols were flung in the air and shouts of “Good show, old boy” echoed back to the stately clubhouse, rattling the bourbon-filled coffee cups at a meeting of the Ladies Auxiliary of the Knights of the Mystic Mango.  Even cars that used to skedaddle in fear when their operators saw our hero on the tee box that abuts a city boulevard joined the halleluiah chorus with a torrent of horn blowing. 

Our hero doffed his visor with a “my work here is done” flourish and sauntered away to collect his trophy.

This was an up and down for the ages.  No, it was actually a down and up.  Little did the adoring masses realize that every butcher, baker and candlestick maker among them would soon be traveling the same arc of success.  The reason?  Our hero merely recognized that MV=PQ.  All that was needed was more V, velocity, that is, to find the sweet spot.  M, money supply, had been growing, but PQ, price level times quantity of goods and services, had remained anemic.  Velocity, the number of times a dollar is spent, hasn’t done its part – yet.

If history is any guide, V is about to begin pulling its weight.  Here’s a chart courtesy of the St. Louis Fed.  Shaded areas are U.S. recessions.

What the chart tells us is that velocity typically falls in the early stages of recovery, shooting higher as a “virtuous circle” of growing consumer confidence and generous monetary policy conspire to fuel growth.

What could go wrong?  V could continue to fall, facing the “fiscal cliff” that looms in 2013.  That could turn our down and up par save into down and down triple bogey.

Ben Bernanke, Social Worker

The Western World has become central bank-centric.  While China seems to be furiously ginning up public works projects to support growth, Europe and the U.S. are relying on monetary policy.  Financial markets have taken notice, expecting the money spigots to begin gushing again.

That may be the problem for equity investors.  If new money creation is already baked in the cake, the time-worn axiom of buy the rumor and sell the news could well be in play.  We expect swimming in place to be the trend until decisions from the Federal Open Market Committee and a German constitutional court are announced midweek.

First to the old world.  The European Central Bank authorized unlimited bond purchases last week, making good on ECB chief Mario Draghi’s word to do whatever it took to defend the euro.  But a group of German lawmakers are seeking an injunction preventing German participation in the plan.  The court rules Wednesday.

On this side of the Atlantic, all signs point to what we have been expecting since the summer began – a third round of quantitative easing by the Fed.  It has long been our opinion that the Fed was duty-bound by both statute and conscience to act anew.  With the August jobs report showing a disappointing addition of 96,000 jobs and an unemployment rate pushed down only by an exodus from the work force of the forlorn, it seems the Fed has all the cover it needs to boost money supply growth in the hope it translates into real economic activity.

For his part, Fed Chairman Ben Bernanke made it clear at Jackson Hole the week before that policy makers could and would act if needed, remarking not only on the dry numbers describing the economic landscape but the cost to the social fabric of continued bleak employment prospects.

“As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation.  The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years,” Bernanke said.

He also laid the groundwork for further action by defending the efficacy of the Fed’s prior rounds of extraordinary bond buying.

“For example, a study using the Board's FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs[large-scale asset purchases] may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred,” he said. 

The rubber meets the road Wednesday when the FOMC is slated to announce its policy decision.  At the very least, expect language in the directive extending the time horizon for keeping the Federal Funds rate target close to zero.

As for political considerations, we think they are also zero.  The Republican presidential candidate, Mitt Romney, has already said he would replace Bernanke, a Republican, if elected.  And the lags in monetary policy’s effect on the real economy prevent any palpable help for President Obama before the November election.

Meanwhile, the usual round of economic reports that follow the tone-setting employment data is slated for release.  Inflation news should be of no consequence, despite rising food and oil prices.  The biggest market mover outside central bank actions is likely to be Friday’s release of August retail sales.  Economists expect another 0.8% increase over the prior month.  A shortfall could hit markets hard if the Fed has failed to act.

Pool Dancing

You can have your Usain Bolts, Michael Phelpses and Gabby Douglases; we prefer the anonymous practitioners of synchronized swimming, an athletic art that rivals the music of the spheres for precision and elegance – kinda like the sporting life on this side of the Atlantic.  Not.  Equity prices rose and bonds fell, sending the discordant message that economic growth and rising inflation lies ahead.

Considering the fiscal cliff the U.S. is hurtling toward, financial markets are either blissfully optimistic or whistling past the graveyard.  The Dow Jones Industrial Average gained 0.32% Friday and is up 8.9% so far in the second half of the year.  Meanwhile, the yield on the 10-year U.S. Treasury note has risen 20 basis points since June 1 to 1.65%.

The action came against a skeletal backdrop.  Productivity in the second quarter was reported to have risen 1.6% after falling 0.5% in the first quarter, when hiring was more robust.  The cruelest irony of the soft jobs market is that rising output per worker has meant less pressure for firms to add workers.

Wholesale inventories declined 0.2% in July, signaling either increasing demand or business pessimism – take your pick.  And the federal budget went $70 billion further in the red last month versus a $60 billion deficit in June.

The most encouraging news was the surprising drop in initial jobless claims to 361,000 versus an expectation of 370,000.  Our colleague Rich Bieglmeier was spot on with his call on this high-frequency series.

There will be stronger hooks to hang a hat on this week.  Tuesday brings the biggest number, retail sales for July.  Recall that last month’s report of a 0.5% decline in June kindled fresh speculation that the economy was tipping over and the Federal Reserve would be forced to act.  Economists generally expect a 0.2% increase in sales and 0.3% increase excluding automobiles.

The producer price index for July, also on Tuesday, is seen rising a benign 0.2% including and excluding food and fuel prices.  The consumer price index, to be released Wednesday is seen rising a similar amount.  Also Wednesday, the Empire State Index of August business activity in New York, industrial production in July and the homebuilders index are slated for release.

Also on tap are jobless claims, housing starts and the Philadelphia Fed’s survey on Thursday.

On the earnings front, big retailers are in the spotlight.  On tap to report quarterly results are Home Depot, Wal-Mart, Target and Sears.  The results could be key to setting the tone for the week.

This week, we inaugurate our Houdini Award with a nod to Goldman Sachs for escaping criminal prosecution for touting securities it was betting against, proving once again it’s better to be right and lucky.

And our Laurel Wreath goes to Shakespeare’s “scepter’d isle,” for hosting all the Bolts, Phelpses, Douglases and synchronized swimmers while delighting our teenage daughter with a closing ceremony performance of English boy band One Direction.

Meanwhile, U.S. investors prepare for the post-Olympics fiscal cliff-diving competition in 2013.  Good luck.

Real Tough Guys

Spare us the oohing and aahing over the “severity” of the sanctions against Pennsylvania State University football in the wake of an investigation that found the sainted Joe Paterno guilty of covering up for a child rapist.  If we were Southern Methodist University, we would secede from the National Collegiate Athletic Association, hire a lawyer and sue for the revenue it lost when its football program was kicked to the curb.

All SMU got from the NCAA was the death penalty in the early 1980s for the good old-fashioned all-American way of gaining an edge  –  paying its scholars to block and tackle.  But Penn State?  It still gets to play, pack its stadium with 100,000-plus fans for each home game this season, and still be on television.  Great.  If you’re so inclined you’ll be able to watch and listen to the blow-dried bloviators speak of the indomitable Penn State community and the “healing” virtues of intercollegiate competition.

This is what passes for disapproval.  Oh well.  We’ll get over it, though we won’t be as big a college football fan as we used to be.  We’re free of that now.  Of course, Western Civilization will fall if Oklahoma falls to Texas this October, but we can take it.

What we can’t take is the sense that the NCAA is somehow trampling out the vintage where the grapes of wrath are stored.  Self-righteous to a fault, the NCAA proved to be as gutless as the Penn State administration and its hypocritical head coach.  We don’t have the numbers, but $60 million is probably what parking tickets are to Federal Express   –   just the cost of doing business

No, the NCAA flubbed it.  To sleep at night it chose to tell itself a story, the one about what a tough guy it was for making the Lions cut back on the number of linebacking studs it could stuff into Theory of Volleyball 101.

In our ideal world, every male freshman would receive a flyer (or a text message nowadays) informing him of football tryouts the Saturday before Labor Day, leather helmets would be optional, the coach would be a professor wanting to make some extra dough.

But, alas, it isn’t so and never was.  The men who ran Penn State and its football “program” thought it more important than little boys and sought to protect it rather than them.  By not pulling the plug, so did the NCAA.

Rescue Me

Lumberjacks yelled TIMBERRR!  Golfers bellowed FORE! Markets wailed LEMMEE OUTA HERE!  Yep, last week’s reports from the Institute for Supply Management and the Bureau of Labor Statistics provided scary bookends for the mounting body of evidence the U.S. economy is rolling over.  But are equity prices anticipating rescue?

Though the major stock indices went south Friday, they remain higher than the close on June 1, when the May payrolls report ushered in the specter of recession.  The S&P 500 closed Friday at 1,354.68, down 124 points on the day and off 0.8% for the week, but up 6.0% since June 1. Similarly, the Dow Jones Industrial Average, also down 0.8% on the week, is up 5.4% since June 1.  And the NASDAQ Composite, which managed a gain of 0.1% for the week, is up 6.9% since June 1.  The market’s performance leads us to believe sentiment still clings to the expectation that policy levers will be used to keep the motor running. 

Pessimists sing along with Diana Ross and the Supremes that  “… there ain’t nothin’ I can do about it.”  Fiscal policy is all but sidelined by Washington gridlock in this election year, and some central bankers are dogged by the uneasy sense that more action is futile in an economy caught in a liquidity trap.

But Federal Reserve Chairman Ben Bernanke has rejected the notion the Fed has no arrows left in its quiver and has pledged the Fed is ready to act if necessary.  The upshot, we believe, is that QE 3 is inevitable.  We think another round of quantitative easing, that is, printing money by purchasing financial assets from commercial banks, will be launched at the Federal Open Market Committee’s next meeting in August.  The minutes from the June FOMC meeting will be parsed when they are released on Wednesday.  The policy makers extended “Operation Twist” at that meeting.

The argument for further Fed action got support last week from news that the ISM’s diffusion index of manufacturing activity in the U.S. slumped into contraction territory for the first time in three years, falling to 49.7% in June from 53.5% in May.  The production and employment sub-indexes were up, but a steep drop in new orders was the canary in the coal mine.

And the notion of an incipient downturn grew stronger with Friday’s news that nonfarm payrolls grew a paltry 80,000 in June, below expectations that were raised when ADP said Thursday that its survey of private sector employment showed a gain of 176,000.  The unemployment rate was unchanged at 8.2%.

Abroad, the misery continued as Eurostat reported the unemployment rate in the 17-nation euro zone rose to a record 11.1% in May from 11% the previous month.  Spain's unemployment rate was the highest in the euro zone at 24.6%, while Austria had the lowest jobless rate at 4.1%.

Next week, the producer price index and the University of Michigan consumer sentiment survey will be released Friday.  For now, though, it’s up to earnings season to set the tone.