Tuesday, May 31, 2011

Operation Twist Redux?

Yes, they could.

It is no secret that to a deflationist like David Rosenberg bond yields have to go lower... Much lower. With the 10 Year flirting with a 2 handle one would think he would be content. Alas no. In fact, as he suggests in his piece from today, Rosie is convinced that the next iteration of QE will be nothing short of a redux of the 1961 initiative to kill the gold spike known as "Operation Twist" (recently dissected by the San Fran Fed). Incidentally it was the same Fed that compared QE2 to Operation Twist. It is only logical that Rosie would then suggest that QE3 would be nothing short of a complete clearing of the 10 Year bond in the market via the Fed in order to anchor expectations that the 10 Year rate would never go up (or reasonably "never") in the biggest gamble of all: that the Fed will attempt to both control its balance sheet and target Long-Term interest rates, a mission doomed to fail...But not like that will prevent the Fed from setting off on such a mission, especially following today's official confirmation of the Housing Double Dip (someone page Jim Cramer). As Rosie says: "Now it is doubtful that the Fed would ever target the long bond. In fact, the Fed may even want it to be higher in yield to ease the pressure on radically underfunded pension funds. While the Fed can either target its balance sheet, which it has been doing with these QE measures, or target interest rates, it cannot do both at the same time. So the next 'QE' will not be called 'QE' but rather something else — maybe Operation Twist 2 (OT2 — you heard it here first). The Fed would buy up all the 10-year notes needed to clear the market at the target "price" (yield). So depending on supply conditions and demand from the private sector, the Fed would basically lose control of its balance sheet, but if in return this policy is the one that blazes the trail for a turnaround in the housing sector and a durable revival in the economy, so be it." And keeping in mind that the true unspoken reason for Operation Twist 1 was to terminate the outflow of gold from the US to foreign bank vaults, we find ourselves agreeing with Rosie that an insane idea such as OT2 is precisely what the Fed would do to avoid a recurrence of the 1961 gold exodus (and attempt to give housing one last failed boost). As many birds would be killed with one stone, the only downside, that of a complete balance sheet implosion following OT2, certainly seems quite acceptable to a central bank now officially run by sociopaths.

Chicago PMI

Drops to 56 and change. Still expansionary, but the biggest drop since October 2008.

When the Fed speaks of a "continued moderate rate of expansion", the operative word is "moderate".

Thursday, May 26, 2011

More GDP

GDP Growth RateClick on graph for larger image in graph gallery.

The dashed line is the current growth rate. Growth in Q1 at 1.8% annualized was below trend growth (around 3.1%) - and very weak for a recovery, especially with all the slack in the system.

GDP revision commentary

Key Take-Aways:

1) Headline GDP--Unrevised at +1.8%, But Important Compositional Revisions
2) Surprising Downward Revision to PCE, Points to Weaker Aggregate Demand
3) Upward Revision to Inventories Points to Lower Inventory Building Ahead
4) Net GDP Revision Points to a Slower Trajectory of Growth than Apparent Earlier


The Second Estimate of Q1-11 GDP revealed a 1.8% rate of gain unchanged from the 1.8% per the Advance release. While the headline Q1 GDP rate of change was unchanged from the Advance estimate there were important compositional revisions, which in combination point to a slower trajectory of growth than appears to be on track prior to this rlease. In other words, we are a bit disappointed with these data.
Guess who is most embarassed by this data. Hint: not Goldman.
For all of 2011 the FOMC anticipates growth of 3.1% to 3.3%, implying a growth rate of around 3-1/2% to 3-3/4% over the balance of the year. This now appears to be a bit optimistic. It now appears as if Q2-11 may post a gain of about 3%. For the FOMC's forecast to be realized we would need 4% growth in the second half.

Wednesday, May 25, 2011

Counterpoint on China - FYI.

Why Jim Chanos is Wrong on China

madhedgefundtrader's picture




Hedge fund titan, Jim Chanos, is well known for his extremely bearish views on China. He says that the cracks are spreading on the façade, real estate sales are falling, and that the economic engine is starting to sputter.
This will be bad news for the rest of us, as China imports 50%-80% of the world’s commodities. Commodity exporting countries will be especially hard hit, like Canada, Australia, and parts of the US. Modern China has only seen a bull market, and he doubts their ability to manage a true crisis.
There is a widespread misperception that the government will step in and provide any bailouts that will be needed. The domestic Chinese banking system has in fact already been bailed out two times. The harsh reality is that while Chinese companies are selling billions of dollars’ worth of new stock issues in the US through IPO’s, a privileged elite is getting their money out of the country as rapidly as they can.
Jim says that he already has short positions in the Middle Kingdom that are profitable. There is no way that even a wrinkle in a market of this size is without global implications, and on that point Jim is right.

However, I think that Jim, who confesses to having never visited China, is missing the broader long term picture here. China has literally been building a Rome a day, the ancient kind, and the modern size every two weeks. In a year, it builds the equivalent of the entire housing stock of Spain, and in 15 years the equivalent for all of Europe.
While a lot of apartment buildings have been built, the country is rapidly creating the middle class to fill them. Even allowing for a pull back from its current blistering 10% per annum GDP growth rate, urban disposable income per person is expected to grow by 2.5 times to $7,500 by 2020. Over the same time frame, some 160 million are expected to move from the hinterlands to urban areas. Rising standard of livings mean that residential floor space per person will jump from 270 square feet to 369 square feet, still tiny by Western standards. That is a lot of housing demand.
China has already taken steps to head off a housing crisis, unlike the US. The People’s Bank of China has raised bank reserve requirements five times this year, now close to 20%, taking them to among the most stringent levels in the world. That is almost Canadian in its conservatism. Many banks are now demanding cash deposits of 40%, well over the official requirement of 30%. The government is in effect forcing the banks to deleverage before hard times hit. Too bad they didn’t think of that here.
I think China still has several good years ahead of it, and I am going to pile into the stock ETF (FXI) and the Yuan ETF (CYB) as soon as the current bout of “RISK OFF” selling exhausts itself. The country’s real challenge arises when its demographic pyramid starts to invert in about five years, the result of a then 35 year old “one child” policy, when too many single children have to start supporting two retiring parents. When that happened in Japan, a 21 year bear market followed.
To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.

MLPs

Master Limited Partnerships   Y. Siegel
Credit Suisse Take on MLPs: NGLs - From Supply Glut to Supply Shortage 212 325 8462
NGL Update Call with Industry Expert Peter Fasullo from En*Vantage: Key takeaways: 1) "The NGL business has never been so good". NGL prices are firm, frac spreads are at record levels and the growth in NGL production is being more than matched by robust petrochemical demand. 2) NGLs extraction is expected to grow by 500,000 bpd (23%) between now and 2015-2020. 3) Ethane extraction (excluding Marcellus) should grow even faster over this time frame. 4) Ethane demand is increasing because it is a cheaper feedstock for ethylene steam crackers. 5) Ethane demand is likely to grow by another 100,000 bpd over the next two years as the ethylene industry converts more furnaces and debottlenecks. 6) Canada is likely to import as much as 90,000 bpd of ethane over the next 10 years. 7) At least 85,000 bpd of Marcellus ethane will be required in the Gulf Coast to satisfy demand. 8) Short-term, planned and unplanned ethylene plant downtime can impact NGL fundamentals. Please contact your Credit Suisse salesperson for a copy of the slides and transcript.

Our Take: We also hold a positive outlook for NGLs and the MLPs that will benefit from building the requisite NGL infrastructure. The following MLPs within our universe have significant NGL exposure. EPD, ETE/ETP, DPM and NGLS are rated Outperform, TRGP and OKS are rated Neutral.

Our Take on EPD's Sale of ETE Units: ETE represents a non-core holding for EPD and we would expect EPD to continue to exit its remaining ownership of 34.5 million units. We maintain our Outperform rating on ETE. Although EPD's sale may create a perceived overhang on ETE's units, we view ETE's leverage to distribution growth and increasing units outstanding at ETP will drive strong distribution growth (9.9% 3-year CAGR).

Takeaways from the AGA Conference: Last week we attended the American Gas Association Financial Forum in Orlando. We had one-on-one/small group meetings with eight companies including CNP, NI, AGL, UGI, SE, MDU, TRP and ENB. Common themes included the continued growth opportunity tied to shale and unconventional resource plays, weakness in natural gas storage fundamentals and the importance of MLPs to energy infrastructure investment. See the full report for key takeaways.

Gross Processing Margins Down Slightly: Margins closed the week at $1.00/gal, down from $1.02/gal the previous week, driven by lower crude oil and NGL prices.

MLPs Up Last Week: The Alerian and Cushing 30 MLP Indices closed the week up 1.4% and 1.1% respectively vs. loss of 0.8% and loss of 0.3% for the Russell 2000 and S&P 500 indices.

Ford Meetings

Begin forwarded message:

From: "Michaeli, Itay "
Date: May 25, 2011 6:59:05 EDT
To: undisclosed-recipients:;
Subject: F: Takeaways from Management Meetings; Reiterate Buy

Key Points:
 
What's New? — We recently visited Ford’s headquarters where we met with members of senior management. We walked away with increased comfort around key issues and reiterate our recently upgraded Buy rating ($18 target).
 
Key Takeaways — Management appeared constructive regarding industry pricing discipline, and noted that its own recent price increases were received well. Although management reminded us that 2011 price momentum could slow after a stellar Q1, an affirmation of the overall price-discipline strategy, May pricing checks and Ford's product cadence point to a continued favorable environment. On costs, management indicated that internal structural cost forecasting has proven itself reliable (limited cost creeps) and that the recent commodity pullback has been a welcome development.
 
Progress Towards Investment Grade— A restoration of investment grade ratings was a key thesis behind our recent upgrade of Ford shares. Though management understandably could not provide a timetable for an upgrade, we sensed that our late-2011/early-2012 timetable resonated as a reasonable base case. Management pointed to the benefits from removing collateral packages and widening the funding sources at Ford Motor Credit, which we think would improve long-term growth prospects. An historical analysis of crossover situations points to a favorable re-rating potential (see Figures 1 & 2) for the shares, particularly given Ford’s captive finance position.
 
Reiterate Buy, Potential Catalysts Ahead — Ford is hosting an investor day on June 7 in New York. We believe management may provide additional medium-term parameters around key metrics. While we don't view out-year consensus estimates as conservative, a reassuring margin outlook should be sufficient to revive sentiment in the shares at the currently low 4.0x 2011E EBITDAP multiple (~10% FCF yield) and amidst industry pricing strength.  The upcoming UAW negotiation will also be a focal point, with the focus on whether Ford is able to narrow the remaining modest cost gap with domestic competitors (even at an upfront cost).
 
Please click on the following link for access to the full report: https://www.citigroupgeo.com/pdf/SNA81019.pdf
 
_______________________________
Itay Michaeli
Autos & Auto Parts
Equity/Debt Research
Citi Investment Research
(212) 816-4557
itay.michaeli@citi.com 
 
"We Value Your Feedback! The Institutional Investor Poll matters to our Analysts. If you value our work, we would appreciate your recognition. Please visit www.institutionalinvestor.com/rankingassistance to request a ballot."
 
 
For important disclosures regarding Citi Investment Research & Analysis ("CIRA"), including with respect to any issuers mentioned herein, please refer to the CIRA disclosure website at https://www.citigroupgeo.com/geopublic/Disclosures/disclosure.html. 
 
 
 
 

Friday, May 6, 2011

Gold man's read on the NFP for April

Results from the household survey were disappointing. Total household employment fell by 190k, and the unemployment rate rose to 9.0% (8.96% unrounded) from 8.8% previously. Results were somewhat better after adjusting for methodological consistency with the nonfarm payroll data; on this basis the household survey measure of employment would have increased by 50k. However, the labor force participation rate was unchanged during the month, indicating that the rise in the unemployment rate reflected job losses rather than an influx of persons into the labor force. While the news was discouraging, it follows four months of declining unemployment, and the level of the unemployment rate remains down 1.1 percentage points from its peak. The employment-to-population ratio fell slightly to 58.4% from 58.5% previously.

Wednesday, May 4, 2011

Services ISM, yuk

The April ISM Non-manufacturing index was at 52.8%, down from 57.3% in March. The employment index indicated slower expansion in April at 51.9%, down from 53.7% in March. Note: Above 50 indicates expansion, below 50 contraction. 

ISM Non-Manufacturing IndexClick on graph for larger image in graph gallery.

This graph shows the ISM non-manufacturing index (started in January 2008) and the ISM non-manufacturing employment diffusion index.

From the Institute for Supply Management: April 2011 Non-Manufacturing ISM Report On 

Monday, April 25, 2011

Is Buffett's Teflon Finally Wearing Out

Is Warren Buffett’s Teflon finally wearing off?

After key lieutenant resigns under cloud, some asking if it’s time for Buffett to go

By Ben Berkowitz

Aside from maybe the odd cheeseburger stain on his tie, nothing much sticks to Warren Buffett.

Whether his underlings are convicted of helping insurance companies inflate results or a major company he helps oversee is sanctioned for accounting shenanigans, his admirers don't seem to care. Or at least, they haven't historically.

But with a key Buffett lieutenant resigning under a cloud recently, some sophisticated investors are no longer willing to overlook the obvious. For all the shareholders who still consider Buffett the epitome of American capitalism, there are others who wonder whether the time may be near for Buffett to take a graceful bow and exit the stage.

Some will clamor for that this weekend, when 40,000 of his shareholders prepare to descend on Nebraska for the annual meeting of Berkshire Hathaway, the ice-cream-to-insurance conglomerate he runs with absolute authority.

"I want to hear more about Sokol, I want to hear more about how they're going to outperform the markets. I want to hear about what (Buffett's recent) trip to India leads us to believe about how the money is going to be invested in the future," said Michael Yoshikami, chief executive of wealth management firm YCMNET Advisors and a widely quoted Berkshire shareholder.

Investor disappointment reflects not just the revelation that David Sokol, once Buffett's presumed successor as chief executive, bought stock in a company he then pushed Buffett to acquire. It is also because of Berkshire's lackluster performance recently, and questions about the firm's ability to thrive after its octogenarian chairman and chief executive moves on.

Berkshire Hathaway has grown exponentially over decades, but many investors question how it can possibly do as well in the future. With the dozens of companies that Berkshire Hathaway owns having had relatively little oversight for years (by Buffett's own proud admission), some wonder how much earnings power Berkshire actually has and whether future earnings can be as strong as past.

"Obviously Berkshire has intrinsic value but now I have to question that intrinsic value," said Janet Tavakoli, an expert on derivatives and author of "Dear Mr. Buffett," a 2009 book laden with fulsome praise for the legendary investor. Tavakoli, like many others, has revised her thinking sharply in the intervening years.

Yet she, like so many others, added an important caveat about Buffett: "(His) brand is so powerful you are reluctant to question."

Sokol affair
By now the details of Sokol affair have been told many times. Citigroup bankers pitched a long list of companies to Buffett's presumed successor, and he told them he thought Lubrizol Corp, which makes lubricants and other chemicals, might make a good acquisition target. He started buying up shares for his own account, and after building up a $10 million position he pushed Buffett to buy the company.

As Buffett put it, Sokol made only a "passing" mention that he owned some Lubrizol shares.

Sokol made about $3 million on the trade, perhaps at Buffett's expense. Buffett has been called to task for how he handled the matter. In a letter to investors, he announced Sokol's resignation, explained the stock issue and offered a grant of absolution: "Neither Dave nor I feel his Lubrizol purchases were in any way unlawful," he wrote.

Less than three weeks later, the first shareholder suit was filed, accusing Berkshire's board of breaching its fiduciary responsibility. More are expected, particularly from bigger firms with a track record of winning large settlements for shareholders.

Governance experts say Buffett blamed the sin but not the sinner.

"The response wasn't as strident as ... I would have hoped for in suggesting that personal stock transactions that are related to corporate stock transactions are problematic and not the sort of thing that the company thinks is a good idea," said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.

"And I would hope in these situations that you would be pretty tough on that in your response."

Some of Buffett's biggest investors also say he should have chastised Sokol or told him to sell his stock. What is murkier, however, is the question of whether Buffett actually did anything wrong from a legal standpoint.

"There's a lot of very problematic behavior here that doesn't easily find an explanation, so the question remains, what in fact was going on here?" said Harvey Pitt, chief executive of Kalorama Partners and the former chairman of the U.S. Securities and Exchange Commission.

"Why would somebody be allowed and be deemed to have acted properly in profiting to the tune of $3 million based on his privileged position at the company?," Pitt added.

It wasn't the first time that Buffett has been close to people behaving questionably. But few of his investors have cared, and the damage to his reputation seemed slight if at all.

In 2008, for example, the government won convictions of four executives from his reinsurance business for helping other insurers inflate their results. The nearly uniform reaction from legions of Buffett fans around the world: yawn.

And in 2005, the SEC sanctioned the Coca-Cola Co, whose audit committee Buffett sat on, for inflating earnings. His admirers barely batted an eyelash.

'That's my guy'
Buffett, of course, benefits mightily from his folksy image. After all, it's tough to imagine how someone who drives himself to work and stops at McDonald’s for a bite on the way home can also be guilty of high crimes of finance.

"Warren Buffett works very hard reflecting an image that 300 million Americans, six billion people around the world say, 'That's my guy. That's the way I'd like to be like.' And he works very hard at that -- not every week or every month, but every day. And I think by working hard at it every day, he drives that image hard into people's minds," said Robert Dilenschneider, a public relations executive who heads the Dilenschneider Group in New York.

The audience at the annual meeting is one of the tools he uses to burnish his reputation. There is no better financial television than footage of Buffett having an ice cream at (Berkshire-owned) Dairy Queen, with hordes of investors thronging him and hoping he might drop a stock tip on the floor with the crumbs of his vanilla cone.

It is hard to interrupt that storyline.

"With the cash that he was able to squeeze out of that dying textile business (Berkshire Hathaway) and astutely reallocating it year after year after year, the business grew from $18 a share to $120,000 a share," said Roger Lowenstein, author of a well-regarded 1995 Buffett biography and a number of other finance books.

"I have no doubt that he'll be regarded as the investor and probably the financier of the era. This incident sort of tells people that he's human."

Performance under fire
While many would agree with Lowenstein on Buffett's place in financial history, his returns of late have not necessarily matched his reputation.

Berkshire shares have only barely matched the S&P 500 since September 2008, the depths of the crisis and the time Buffett made some of his most lucrative bets, like buying Goldman preferred shares that threw off more than $15 a second in dividends.

Just this year, Berkshire has underperformed the S&P 500 by about 4 percent. Buffett has said returns will slow, so it does not necessarily come as a surprise.

There is expected to be less reluctance to question him this year in Omaha. Author Tavakoli said shareholder dissatisfaction was already palpable at the last meeting she attended in 2009, as Buffett went on about his bet on Wells Fargo and investors grumbled that he was not talking about the "crony capitalism" they saw behind the crisis-era bailouts.

"It seems as if Warren Buffett has sort of lost touch with the tone of the people who invest in Berkshire Hathaway and their sentiment," she said.

The Q&A session will again be moderated by financial journalists this year, so even if investors don't ask tough questions, reporters may. Words like "contentious" and even "raucous" are being thrown around. And yet, some investors still do not expect much.

"I don't expect any great revelations but what I want is not necessarily what I'm going to get," said YCMNET's Yoshikami.

Yet he still expects the annual meeting to be a "lovefest," given the overwhelming number of shareholders who flock to Omaha annually for nothing more than pearls of Buffett's wisdom (and perhaps some discount pearls from his jewelry business, one of a number of Buffett companies to offer steep shareholder discounts over the course of the weekend).

Yoshikami said that if Buffett gets away from the Sokol episode unscathed, it will be because he has banked sufficient goodwill with investors in the past.

"When you have an inventory of transparency that you can fall back on I think you get the benefit of the doubt," he said. "I think when you self-disclose enough and you have a reputation for self disclosing it buys you some reputation credits."

But no matter what Buffett says or does in Omaha, there is a growing realization that the old days have slipped by. Buffett and his partner, Charlie Munger, are aging, the questions about the future of the conglomerate are getting louder and people are recognizing, as they do, that all good things have to come to an end.

"The passage of time is hitting home. This year is the end of Berkshire as it used to be," said Alice Schroeder, a former stock analyst who wrote what many view as the definitive biography of Buffett.

"It will never be the same. Even if people think Buffett's not going to address all these issues and the questions won't be as tough as they should be, Berkshire as it used to be is over," Schroeder said.