MarketView for September 27

 

 

Summary  

 

The major equity indexes were higher for the third straight day, but the finish was a bit of a disappointment. The large gains put up on the scoreboard early in the trading day evaporated to a great extent by the closing bell as profit-taking took its toll. Those early gains were fueled by talk that Europe was coming up with a plan to stabilize its banks in the event Greece defaults on its debt. Unfortunately, the gains dissipated when the when what was mostly hot air morphed into the hurdles any plan must overcome.

 

Meanwhile, rumors floated around the Street that corporate raider Carl Icahn may be building a stake in Research In Motion, the manufacturer of the Blackberry. Whether there's any truth to that possibility, only time will tell. RIM shares ended the day up 4.5 percent to close at $22.65.

 

In two days of trading this week, the Dow Jones industrial average has gained more than 419 points, its largest two-day gain since Aug. 24. The S&P 500 was up 39 points, making it the largest two-day gain for that index since Aug. 29. The Nasdaq's two-day gain of 64 points was its largest since Sept. 14. 

 

And in spite of remarkable volatility since Aug. 1, losses for the year for the Dow, S&P 500 and Nasdaq have been cut by two-thirds. The Dow is still off 3.3 percent for the year, with the S&P 500 down 6.5 percent and the Nasdaq down 4 percent. The Dow is off 3.6 percent for what once looked like a miserable September. The Nasdaq is off 1.3 percent for the month after actually showing a gain for the month earlier in the day. The S&P 500 is off 3.6 percent.

 

Wednesday's market will contend with a report on durable goods orders and earnings from Family Dollar Stores and McCormick & Co. Futures trading suggests that shares will open lower.

 

Meanwhile, are we seeing the start of the fall rally? I believe that it is very possible, given the assumption that the European Union gets their act together in some shape or form, even if it means kicking the can down the road for a few months or even a year.

 

While there is a movement afoot to try and stop the Greek situation from exploding out of control there are still numerous risks in the thesis, including a vote Thursday from a deeply divided German Parliament to contribute more money to a Eurozone rescue fund.

 

Meanwhile, we do not know how much of the gains on Monday and Tuesday entailed short-covering. Two big momentum stocks were not players in the rally. Apple was off 1 percent to $399.26, despite sending out invitations to a Tuesday event to introduce its new iPhone 5 phone, and Chipotle Mexican Grill, which closed down 2.7 percent at $320.61.

 

Consumer Confidence Up Slightly

 

Consumer confidence was little changed in September amid concerns about income as a gauge of labor market conditions deteriorated to its worst since 1983, an independent survey showed on Tuesday. The Conference Board said its index of consumer attitudes ticked up to 45.4 from an upwardly revised 45.2 in August. Consumer confidence is regarded as a measure of consumer health.

 

"The pessimism that shrouded consumers last month has also spilled into September. Consumers expressed greater concern about their expected earnings, a sign that does not bode well for spending," said Lynn Franco, director of the Conference Board Consumer Research Center.

 

In a sign that people were struggling to find employment, the jobs-hard-to-get index rose to 50.0, the highest level since May 1983, from 48.5 the previous month. Americans worried about their incomes as they struggled to find work in September, holding consumer confidence at depressed levels and pointing to weak spending in the months ahead.

 

Other reports on regional manufacturing and services also pointed to weak economic conditions remaining firmly in place this month, although house prices stabilized in July.

 

The Richmond Federal Reserve's manufacturing index improved to -6 from -10 in August. Separately, activity in the Texas services sector grew solidly this month. The Dallas Fed service sector revenues index rose to 14.1 from 3.2 in August.

 

The S&P/Case Shiller composite index of single-family homes in 20 metropolitan areas was unchanged during July on a seasonally adjusted basis. Unadjusted prices in the 20 cities rose 0.9 percent.

 

20 Times in 58 Years

 

As of Monday's close the S&P 500 dividend yield was higher than the yield on a 10-year Treasury note, a move seen only 20 times in the past 58 years on a quarterly basis according to S&P research. What that means is that for yield-seeking investors the broader stock market offers a greater return than a Treasury note.

 

It all goes back to a simple mantra repeated over and over this year: Don't fight the Fed. The Fed appears to want investors to look towards the stock market. The logic being that you are not going to receive much in the way of returns from treasuries and the Fed doesn't want you to get returns from treasuries meaning that the place to put funds is in the stock market.

 

Many large cap multi-national stocks with strong earnings that are yielding reasonable dividends. At the same time, corporations are sitting on about $2 trillion in cash.  Some examples are Johnson & Johnson, PepsiCo, McDonald's, and Kraft.

 

EU Rescue Not Going Well for Germany’s Merkel

 

German Chancellor Angela Merkel may fall short of a majority in her own coalition for a crucial reform of the euro zone rescue fund meant to stop a sovereign debt crisis spreading. Talk of proposals to leverage up the 440 billion euro bailout fund to multiply Europe's financial firepower lifted global stocks on Tuesday but made it harder for Merkel to unite her fractious Center-right coalition.

 

The Bundestag (lower house) is likely to approve a widening of the scope of the European Financial Stability Facility to aid weak states and banks, agreed by European leaders in July, since the opposition Social Democrats and Greens say they will vote for the measure on Thursday.

 

But a revolt by those hostile to further bailouts among Merkel's conservatives and their liberal Free Democratic coalition partners may leave her without a majority in her own camp. In an internal vote on Tuesday, 11 deputies from Merkel's CDU/CSU group voted against the motion and two abstained.

 

If more than 19 coalition lawmakers vote against or abstain, Merkel will be dependent on opposition votes in a political humiliation that could weaken her ability to push through future rescues, analysts say.

 

Meanwhile, the cost of insuring Italian, Spanish and French debt against default also fell on hopes of a bold solution, which appear to have little grounding in immediate political reality. As a result, French Prime Minister Francois Fillon told parliament France would set out proposals to step up the battle against "speculative attacks" on the euro zone once the German vote was over.

 

Merkel was to meet Greek Prime Minister George Papandreou on Tuesday evening after he promised German industrialists that Greece would meet its commitments under its EU/IMF bailout program despite missing key fiscal targets so far. "I can guarantee that Greece will live up to all its commitments," Papandreou said.

 

Merkel told the same forum: "We will provide all the help desired from the German side so that Greece regains trust." However, some of her ministers have openly questioned the country's ability to avoid default and stay in the euro zone.

 

The Greek parliament was due to approve a deeply unpopular new property tax later on Tuesday, one of several extra austerity measures the government is rushing through to plug a budget hole uncovered by EU/IMF inspectors earlier this month. At the same time, many Greeks are becoming exasperated by pay and pension cuts, mass unemployment and tax increases, staged new strikes and demonstrations outside parliament.

 

German and French government economic advisers urged in a joint article on Tuesday that Greece be allowed to write off around 50 percent of its debt and called for support for banks with large Greek holdings.

 

Greek Finance Minister Evangelos Venizelos, back from talks with the International Monetary Fund, said speculation on default scenarios was harming his country and it was crucial to stick to the July 21 agreement on a second rescue for Greece.

 

Venizelos said the so-called troika of senior EU/IMF inspectors would return to Athens this week and Greece would receive the next 8 billion euro instalment of aid in time to avoid bankruptcy next month. A source close to the team said they would probably return on Wednesday to complete a review of compliance with the bailout program.

 

Most analysts expect Greece to get the cash but default anyway within a few months, perhaps early next year.

 

European Central Bank board member Lorenzo Bini Smaghi fueled expectations of a larger bailout pool by saying on Monday that policymakers were working on "how to leverage the money out of the EFSF in a more innovative and efficient way."

 

Citing U.S. programs to rescue banks during the 2008-9 financial crisis, he said EFSF funds could be used as collateral to borrow from the central bank, making more money available for crisis fighting. His ECB colleague Ewald Nowotny also said an increase in the funds available was being discussed, though it might not be as high as some expected.

 

But German Bundesbank chief Jens Weidmann, the leading hawk on the ECB's governing council, poured scorn on such options, saying they would discourage politicians from taking tough decisions to cut budget deficits and weaken faith in the euro.

 

The European Investment Bank, the 27-nation EU's soft-loan project finance arm, denied a U.S. television report that it might get involved in leveraged finance for euro zone bailouts, which diplomats said was legally impossible.

 

Credit ratings agency Standard & Poor's was quick to warn when talk of leveraging the EFSF became public last week that such a move could potentially trigger ratings downgrades for leading euro zone countries Germany and France.

 

A senior EU official said many ideas for how to leverage the rescue fund were being floated but it would take time to check the legality of such options and build political consensus in the 17-nation euro zone for any change.

 

Does Buy Back of Berkshire Hathaway Mean the S&P 500 Index Is a Bargain

 

Berkshire Hathaway is planning to repurchase its own shares for the first time in four decades as long as its price is less than 1.1 times book value, or assets minus liabilities, according to a released statement. The level is 29 percent below Berkshire’s average of 1.55 since 2000, almost the same discount investors are getting in the S&P 500, according to data compiled by Bloomberg. Shares of Omaha, Nebraska-based Berkshire fell to $100,000 for the first time in almost two years on Sept. 22.

 

Declines that have erased about $2.8 trillion from the value of American equities in the last two months are luring Buffett, who said his company spent more to buy stocks on Aug. 8 than any other time this year. The S&P 500 tumbled 6.7 percent that day and has lost 15 percent from its 2011 high on April 29, driven down by concerns Europe’s debt crisis will spread and shrink the global economy.

 

Repurchasing Berkshire stock is a bet that market valuations are too low partly because so many of its investments are public, Berkshire owns stakes in 27 companies whose trading is overseen by the SEC, an August filing showed.

 

The plan may signal that Buffett, Berkshire’s chairman and chief executive officer, is finding fewer opportunities in the stock. While the S&P 500 is priced close to the same discount to its historical book value as Berkshire, fewer than 20 percent of its companies are trading below the 1.1 ratio Buffett requires for his own repurchases, data compiled by Bloomberg show.

 

Buffett previously preferred to use profits to buy companies and securities issued by others. “Not a dime of cash” has been spent on buybacks or dividends in four decades, the billionaire told investors in his annual letter, published on Feb. 26. Buffett invested $5 billion in Goldman Sachs and $3 billion in General Electric in 2008 when the Lehman Brothers failure cut companies off from traditional sources of funding.

 

Archer-Daniels-Midland, Goldman Sachs, CME Group and 89 other companies have price-to- book multiples below 1.1. Excluding intangible assets, such as goodwill, 47 of the 500 companies in the benchmark U.S. equity gauge meet the criteria.

 

The S&P 500’s book value fell from about $533 a share in May 2008 to $442 a share in March 2009, monthly data compiled by Bloomberg show. The decline occurred as banks and financial companies were in the process of writing off more than $2 trillion in loans tied to subprime mortgages.

 

Lowering the S&P 500’s price-to-book ratio to match Berkshire’s would cut the index’s price by 42 percent, data compiled by Bloomberg show. The benchmark gauge for American equity has combined book value of $611.38 a share, based on the most recent filings of its companies. Cutting the multiple from 1.9 to 1.1 would send the S&P 500 to about 673 from 1,162.95, according to data compiled by Bloomberg.

 

Berkshire’s Class A shares fell 17 percent to $100,320, prior to the buyback announcement. They were trading at 16.3 times earnings as of Sept. 22, the lowest price- earnings ratio of 2011, according to data compiled by Bloomberg.

 

“The underlying businesses of Berkshire are worth considerably more than this amount,” Berkshire Hathaway said yesterday. “If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares.”

 

Buffett bought Burlington Northern Santa Fe last year for $26.5 billion in what he described as an “all-in wager” on the U.S. economy. In July, Buffett told Bloomberg Television he expected economic growth to continue and would “bet very heavily” against a second recession in three years.

 

Buffett said his company spent more on stocks on Aug. 8 than any day this year, when the S&P 500 tumbled 6.7 percent, the most since December 2008. “I like buying on sale,” he said in an Aug. 15 interview with Charlie Rose broadcast on PBS.

 

Berkshire Hathaway has a lot of investments in the largest companies, so putting money in Berkshire is another way of being bullish on the market and believing the market is undervalued.

 

Gold Futures Advance after 3-Day Decline

 

Gold gained for the first time in five days in New York as the biggest three-day drop in 28 years spurred some investors to buy the metal on concern about economic growth and debt crises.

 

Bullion slumped 12 percent in the previous three days as some investors sold to cover losses in other markets, which plunged on concern there may be another global recession. The metal has slid 13 percent from its Sept. 6 record and last week’s plunge prompted CME Group Inc. (CME) to raise margin requirements on futures contracts. Physical demand for gold is “exceptionally strong,” UBS AG said today in a report.

 

“Although not many are yet prepared to dip their toes back in the market, there is a small but growing group who believe this pullback will prove to be a good buying opportunity,” Edel Tully, a London-based analyst at UBS, wrote in a report. “Gold needs to stabilize for now, after suffering a good deal of reputational damage with recent wild moves.”

 

Gold for December delivery gained $73.20, or 4.6 percent, to $1,668 an ounce by 8:16 a.m. on the Comex in New York. It dropped to $1,535 yesterday, the lowest level since July 8, and capped the biggest three-day decline since March 1983. Immediate-delivery gold was 2.5 percent higher at $1,666.40 in London.

 

Gold is in the 11th year of a bull market, the longest winning streak since at least 1920 in London. Futures reached a record $1,923.70 on Sept. 6 as investors sought to diversify away from equities and some currencies. The metal slipped 18 percent in October 2008 as the worst recession since World War II sent global equity and commodity markets tumbling. Bullion jumped 23 percent in the next two months.

 

CME raised margin requirements on gold and silver after trading yesterday and the Shanghai Gold Exchange will increase requirements from Sept. 29. Silver for December delivery gained 11 percent to $33.16 an ounce, after falling 26 percent in the past three days and touching a 10-month low of $26.15 yesterday.