The actual agreement, in which Germany would like to have a mechanism to ensure budgetary discipline and France becoming more willing to go along with anything that allows it to keep its AAA sovereign debt rating, would amount to what Mario Draghi, the freshly minted head of the ECB, called a “fiscal compact”.  Mr. Sarkozy indicated his shift in stance while speaking to supporters in Toulon this past week saying, “There cannot be a single currency without economic convergence.  Or the euro zone will explode.”  I’m not sure whether implode might have been the better word to use there but it doesn’t change the sentiment.

Mr. Draghi has indicated that should this compact become concurrence the ECB might be inclined to increase the bank’s bond buying.  This should, ceteris paribus, go a long way to reducing the yields on Spanish and Italian sovereign paper.

Proving that not only can they not get along with themselves but appear more and more not to be able to play nice in anyone’s sandbox, the U.S. Congress has already threatened to stand athwart one of the proposals being bandied about which would include the ECB putting around $270BN in the hands of the IMF, of which the U.S. is already the largest contributor at around 17%, for eventual disbursement to the EU’s economically precarious.  It’s not that our boys and girls in D.C. don’t like deficits; nor do they mind the fleecing of the American public, it’s just that they want that money used to buy votes right here at home.

All of this agreeing to agree to agree is supposed to come to a head on December 9^th when the EU summits once again.  The frequency of which would make even Edmund Hillary jealous.  Dario Perkins, director of global economics at Lombard Street Research in London, believes the sentiment might improve at that meeting but the tension is here to stay.  “I still have major doubts about what genuine commitments we will get next week”, he was quoted as saying.  Stephan Massocca, a fund manager at Wedbush Equities Management spoke from a similar standpoint when he said, “liquidity is the symptom and the disease is solvency for some countries”.  On the liquidity front the ECB is expected to cut its benchmark rate by 25bps to 1% on December 8^th.  The day before the EU leaders gather.

Seemingly insulated, until now, from all of the furor around it; Germany is starting to feel the heat as the yield on the 10-year Bund exceeded that of the British Gilt of the same maturity this past week.  One cause of the uptick in rates could be that the Bundesbank’s leverage ratio now stands at 153:1 versus 75:1 in pre-apocalypse 2007.  Likewise the Bundesbank’s exposure to the ECB’s discount window has ballooned from E84BN in late 2007 to E462BN at the end of September.  It is maybe not surprising then that Gilts have returned 15% in U.S. dollar terms in 2011 while Bunds have returned 6.8%.

Helping to add fuel to the rally fire was news that the PBOC reduced reserve requirements by 50bps effective today, December 5^th, and that Brazil announced a fiscal stimulus package which will include a number of tax breaks focused on increasing domestic demand.  “We won’t allow the global crisis to contaminate the Brazilian economy,” Guido Mantega, Brazilian Finance Minister said.

As a result of all of the international good cheer the DJIA was up 7.01% last week, the largest percentage gain since July 2009 while the 787.64 point gain was the biggest since October of 2008.  Jonathan Golub, chief U.S. equity strategist at UBS AG, characterized the week’s move thusly, “The closer you are to the precipice, the more the market rallies when you get good news.”  But it would appear Jon’s not wearing his rose colored glasses as he continued, “There is a relatively large disconnect between the level of strain in the equity markets and the level of strain in the fixed income markets.  Normally, you’d want these things to be in sync with each other, and as an equity guy, you’re always worried the bond guys are right.”

There is much to be cautious about but the strength of Black Friday and Cyber Monday sales shows some resilience by the consumer and a report that U.S. auto sales hit a 13.6MM  annual pace in November, the strongest in two years, adds some credibility to it.  Especially when one considers that sales of SUV’s topped cars at many auto makers.  Ford Motor Company (F) saw the most drastic difference as cars sales were down 9% while trucks were up 26%.  Sales were up 13% overall for the month at Ford.  Industry wide the average cost of a vehicle sold rose 4% last month to $30,317.

Higher stock prices, a healthy consumer appetite and folks still smoking their “hopium” for a deal from Punch and Judy as Nicolas Sarkozy and Angela Merkel have come to be affectionately known.  It could be the right recipe for a robust Holiday season and that euphemism known as the “Santa Claus” rally.

Speaking of smoking, a quick aside before I let you go.  A working paper published by D. Mark Anderson and Daniel I. Rees for the Institute for the Study of Labor in November found that the fifteen states and the District of Columbia that have passed medical marijuana laws since 1996 have seen a 9% reduction in overall traffic fatalities.  The reason the paper finds was a drop in alcohol related traffic deaths.  Put that in your pipe and smoke it.

Enjoy the week.

Also weighing in this past week was Dan Akerson, CEO of General Motors Co. (GM).  Dan believes “the contagion in Europe could be worse” than the Great Recession of 2008.  Akerson believes this because the government intervention (which included the prepackaged bankruptcy of his company) helped limit the damage back then while a European action plan is less clear today.  “Standing still doesn’t work when you are in a crisis.  This could be contagious,” he said.  While that might sound like a marvelous grasp of the obvious, Dan probably has a pretty good idea of things on a global basis as GM now sells more cars in China than it does in the U.S.

Speaking of which, China, the current model for a command economy, looks well on its way to engineering a soft landing as average property prices in 70 Chinese cities posted their first monthly decline in two years as the Communist Party of China or CPC, appears to be realizing the result of its tight grip on credit and home purchases.

The coordination of the Fed and the Treasury that helped stem the outgoing tide in the U.S. that GM’s CEO was eluding to is non existent in the discombobulation that currently characterizes the rescue efforts in Europe.  With the two centers of our modern civilization, Athens and Rome in the hands of technocratic governments there is little else but hope that they can implement the changes necessary to balance their respective budgets while spurring growth.

The new president of the European Central Bank, Mario Dhaghi, summed up the situation during a speech in Frankfurt this week when he said, “We are more than one and a half years after the summit that launched the ESFS (European System of Financial Supervisors)…We are four months after the summit that decided to make the full EFSF guarantee volume available.  And we are four weeks after the summit that agreed on leveraging of the resources by a factor of up to four or five.  Where is the implementation of the long-standing decisions?  We should not be waiting any longer.”

For its part Italy, or at least its lower house of Parliament, voted 556-61 in a confidence vote to back Mario Monti’s “government of national commitment”  which has only the goal of instituting urgent economic measures aimed at restarting Italy’s struggling economy and avoiding a collapse of the Euro Zone.

Unfortunately, the other leg on which the success of any action stands, Greece, unveiled it 2012 budget on Friday with more promises of deficit-slashing while also saying that the country will miss it 2011 target with a gap between inflows and outflows of approximately 9%.

For an idea of how the markets are viewing all of this we need only to look at a few time tested indicators.  For one, the spread between French and German 10-year government bonds rose above 2% on Thursday, a level unseen since the early 1990’s.  Additionally, the cost of insuring E10MM of European bank and insurer debt for five years as measured by the Markit iTraxx Senior Financials index was E300,000 on Thursday, which is higher than the E211,000 level seen in March of 2009.  Another new post 3/09 peak was reached when the 3-month Euribor/OIS spread touched 91bps this past week according to Bank of America Merrill Lynch.  The euro-U.S. dollar cross currency swap was a negative 130bps on Friday according to RBS.  This measure broke below -200bps after Lehman Brothers imploded but quickly recovered.  This time around it has been deteriorating since April.

Niall Ferguson, a professor of history at Harvard University, wrote an entertaining, interesting and informative piece in the weekend WSJ looking back at Europe’s current malaise from a perspective ten years hence.  The euro-zone is then called the United States of Europe of which Britain is no longer a member nor is Ireland with those two having “re-united” using the slogan “Better Brits than Brussels” as their rallying cry.  This new combo is now the most favored destination of Chinese foreign direct investment according to Mr. Ferguson’s account.

Niall also recounts that the newly minted Mario Dragh, “went far beyond his mandate in the massive indirect buying of Italian and Spanish bonds that so dramatically ended the bond-market crisis just weeks after he took office.  In effect, he turned the ECB into a lender of last resort for governments.

Is all of this fantasy?  Only time will tell, but with either side of our own super-committee not willing to sacrifice their respective sacred cows it sounds like a far happier story than we are about to experience.

Mr. Bowles comments aside, enjoy your Thanksgiving holiday.

Andrew Cox, an FX strategist for Citigroup captured this sentiment when he said recently, “Europe is driving all asset markets, we are going through a time when fundamentals matter little”.  Now, while Andrew might have been thinking about all “financial” assets, his comments would seem to also apply to the art market as the fall auctions held by Christie’s and Sotheby’s came to two very different ends last week.

On Tuesday evening Edgar Degas’ “La Petite Danseuse de Quatorze Ans”, a bronze of a young ballerina failed to meet it’s pre-sale estimate of $25MM to $35MM and was sent back to its owner as was Picasso’s “Head of a Woman”.  It should be a surprise to no one, given what we know of Picasso, that he would decapitate the object of his affection, at least on canvas.  Just one day later however, Sotheby’s sold Gustav Klimpt’s “Litzberg am Attersee” for $40.4MM well above its $25MM presale estimate.

Whether these failures and successes were tied to the political bobbing and weaving of Messer’s Papandreou and Berlusconi remains to be seen but the weight with which each and every bit of news out of Europe effects the markets is proving quantifiable.  Mr. Cox and his team at Citibank have developed what they call a “Merkel Signal”.

In creating this strategy they counted the number of news articles Angela Merkel’s name appeared in each day.  They then measured the return they would have generated if they would have bought the Euro when Ms. Merkel’s name appeared more than the average for the last five days and sold it when it appeared less than that same average.  This very simple strategy would have returned 32% since the beginning of 2011.

Jeffrey Saut, chief investment strategist at Raymond James, has a possibly more interesting if less logical way to make money.  It has more to do with the calendar than the newspaper and is based around our current 12 month marker.  For one Jeff notes, 2011 has an abundance of dates that contain all “1’s” such as 1/1/11, 1/11/11, 11/1/11 and 11/11/11 which comes this Friday.  Additionally, people born in the last century will find the sum of 111 when they add the last two digits of their birth year to their age. (Go ahead, I’ll give you a minute to try it.)

Possibly the most constructive calendar coincidence is that this past October contained five Saturdays, five Sundays and five Mondays which, according to Mr. Saut, occurs only once every 823 years and signifies, again according to Jeff, a “Moneybag” year.  Our numerologist friend believes that “If we don’t talk ourselves into a recession, performance anxiety is going to force money managers to buy stocks”.  With just 55 days to go in this year with double ones we won’t have long to wait to see if this theory works.

As a quick aside and staying with the numbers theme, social-email software provider harmon.ie recently found that 57% of the interruptions during a typical work day involve a social networking tool and that 45% of workers go no longer than 15 minutes without being interrupted, costing businesses around $10,375 a year per employee.  If the founders of the various social networking companies were not being made multimillionaires if not billionaires by the IPO’s of their respective companies this last number would truly be one for those who seek to occupy nothing more than there own self pity.

Some other numbers of note last week included U.S. auto sales which jumped 7.5% in October, the second fastest pace of the year.  Chrysler, a unit of the Italian car maker Fiat SpA led the pack with a 27% rise followed by Hyundai, Nissan, Ford and GM with 23%, 18%, 6% and 2% YoY respectively.  “No doubt we’re seeing a kick up” in the pace of sales was how Don Johnson, sales analyst for GM put it continuing that, “we see 13mm as the baseline for 2012”.  Adding to this BMW AG announced on Thursday that earnings were up a better than expected 24% with CEO Norbert Reithofer saying, “We achieved new records for sales volume, revenues and earnings”.

Another optimistic number came from MasterCard (MA) which reported a 38% rise in Q311 profit along with a 25% boost in net revenue.  “Double-digit increases in volumes and processed transactions in most regions across the globe” helped drive the higher results, Ajay Banga, president and CEO of MasterCard said in a statement.  While the retail sales figures that came in last week disappointed some it would appear from MasterCard’s results that lots of people in lots of places are using their “plastic”.

Thursday was also the 10^th biggest day this year for investment grade bond issuance this year according to Dealogic as companies sold $11.65BN of debt.  “Today’s deal flow relates to the expiry of the September 30^th earning blackout periods, several M&A-oriented financing’s, a growing recognition that the interest-rate opportunity is, indeed, perishable, and the fact that next week is expected to be exceptionally busy as well”, according to Bryan Jennings, head of fixed income capital markets in the Americas at Morgan Stanley.

In the high-yield market Sprint (S) captured the headlines with a sale of $3BN in bonds with the 7-year selling at 9% and the 10-year yielding 11.5%.  This should be compared to the 8.375% yield on the notes the company sold in August of 2009.  “Historically they have financed at much lower spreads.  But they got downgraded, [to B+] and people are more aware of their issues, so it could be more challenging.  They should have come earlier in the year” was how Brian Hessel, MD at Global Credit Advisors put it.  Also to be noted however is that the deal was slated to be $2BN in size but was increased due to demand.

The volatility in the markets has taken its toll on the high-yield market as the Bank of America Merrill Lynch High Yield Master II Index was trading at 725bps recently as compared to 587bps in early August.

With that said the SPDR Barclays High Yield Bond ETF (JNK) saw $253MM of net inflows for the week ending last Wednesday.  The 30-day yield calculated in accordance with SEC rules is about 7.8%.

With things remaining fluid in Europe and the Super-committee running up against its November 23^rd deadline the headlines are sure to keep things hopping this week.  Hopefully with 11/11/11 in the wings the “Moneybags” will come your way.

Enjoy the week.

Another sign that the season has changed are the fall auctions scheduled for the coming week at Christie’s on Tuesday and Sotheby’s on Wednesday.  There is a total combined $400MM worth of art on the block with a Degas bronze titled “Little Dancer Aged 14” priced to sell at somewhere between $25 and $35 million.  The detail on this piece is supposedly so precise that “the wrinkle of the girl’s tights appears at her knees”.  Emmanuel Di Donna, a former specialist for Sotheby’s said, “I think [the price of the Degas] is high, but they must know something about the market”.  This might be borne out by the fact that last November only one bronze carried a low estimate of $10MM or more and this year there are three.

Also on sale this week is Gustav Klimt’s Litzlberg am Attersee, an oil by the painter that is expected to “command in excess of $25MM” per Sotheby’s.  The twist here is that this work was consigned to the auction house in July, just months after it was awarded to Georges Jorish, an 83 year old Montreal resident whose Viennese grandmother had owned the painting until 1941; when she was deported to a German concentration camp never to be seen again.  Mr. Jorisch has promised to donate some of the proceeds of the sale to build a new wing on the Museum der Moderne in Salzburg, Austria, bearing his grandmother’s name of course, where the painting hung after the war and before a multi-year process culminated in the return of Mr. Klimt’s efforts to its rightful owner.

Masterworks do not seem to be the only thing up for sale this season as there is an $35MM estimate for Roy Lichtenstein’s 1961 painting I Can See The Whole Room! . . . and There’s Nobody in It! (which brings to mind the question whether Roy’s protagonist is peaking in to a window of one of the many buildings in Washington.)

While some might question the logic of spending such money on art in such unsettled times, Phillip Hoffman, CEO or the Fine Art Group fund in London says, “there is demand all over the world for works priced $500,000 and up, and the demand for them is only making them more expensive”.  The validity of this theory is bolstered by William Ruprect, CEO of Sotheby’s who said, “some of the market volatility they’ve seen around the world, in other arenas, we think, has encouraged participation rather than diminished it in our market place.”

Given the appeal of major works at the moment also speaks to an eye for value.  There is, of course, a corollary to this in the stock market which presents itself as a preference for “value” or “growth” stocks.  The former being seen as cheap relative to fundamentals and the latter as pricey as buyers expect fast growth in the various metrics used to grade equities.

Brandes Investment Partners in San Diego has done some work in this area and found that “the cheapest 1/10^th of U.S. stocks relative to projected earnings have out performed the most expensive 1/10^th by 9.1% a year on average since 1968”.  A “Dogs of the Dow” gone wild so to speak.  This might be explained by what Nick Magnuson described when he said, “When investors are fearful, they want to hold comfortable, popular stocks”.

Not to be out done, the S&P 500 Pure Growth index, of which Amazon, Netflix and Apple are members has returned 3.9% a year for the last five years ending this September versus a 1.5% loss for its value sibling.  It should be noted, however, that the Pure Value index has bested its rival in the last month.

David Fondrie, manager of the Heartland Select Value Fund, which has returned 7.9% over the last 10 years versus about half that for the S&P 500 expresses this best when he says, “when Netflix fizzles, it’s painful, I prefer the downside risk of Intel, where I get a 3.4% dividend yield and low expectations”.

Hanging on to demonstrated value makes sense whether it’s a world renown artist or a blue chip stock.  As of Friday’s close October’s equity market return was 13.6% versus a negative 14.3% for the 3^rd quarter as a whole.  Changing the timing slightly puts the market up 17% since October 3^rd and just 6% below its 2011 peak.

Correlation is still the name of the game, however, as the median of that metric hit 0.86 a week ago Friday versus a 0.46 number going back to 1972 on a quarterly basis with 19 out of 20 stocks currently above their respective 50-day moving averages.

Additionally, Wayne Kaufman, market analyst with John Thomas Financial watches this interrelatedness closely and has seen 58 days this year when 90% of the broader S&P 1500 moved in the same direction, including 33 of the past 62.  To put this in perspective the totals for 2006 through 2010 were 14, 23, 39, 44 and 47 respectively.

Even with all of this sameness there is differentiation and much of it points towards the “risk-on” trade.  Bespoke Investment Group found that since the current rally started on October 3^rd, the 50 largest stocks in the S&P gained 15.9% while the 50 smallest were up 29.1%.  This is supported by other measures including the fact that the safe-haven stocks that performed best during the 3^rd quarter rout are up 6.9% since 10/3 while those that got hammered the worst are up 35.3%.

The details out of Europe are forth coming and it would appear that they will continue to be so for some time.  With much still to be decided it would seem that investors might take a clue from the best art collectors who say, “buy what you would like to have hanging on your wall, if it goes up in value that’s just the icing on the cake”.  In stocks that would appear to equate to a well valued stock with a nice chunky dividend.

Enjoy the week.

In the effort of full disclosure Richard Kollodge, editor of the UN’s annual State of World Population report says, “We cannot pinpoint the exact moment when or exact place where that child will be born”.  That is in no way a sense of false modesty given that the UN was not able to use world census data later than 2005 for countries that contain 62% of the world’s population and there is no data what-so-ever for countries that contain 25% of this globe’s inhabitants.

Gerhard K. Helig, chief of population estimates and projections for the UN, hedges the impending threshold further by saying “We made it always clear that Oct. 31 is a symbolic date.  There is no country in the world where you can say the number of people living in a particular day or time.”

If the number twelve represents a dozen and if we stretch that to the “baker’s” version of that quantity and then subtract those number of years from today we come to the first time the S&P crossed the 1200 mark in 1998.  That we have made no progress for 13 years is not the least encouraging but Henry McVey, KKR’s head of global macro and asset allocation, provides some hope as he states in a recent white paper that “we are finally returning to a time of ‘stocks for the long run’, continuing, “anyone who believes in mean-reversion investing has to consider the current starting point for equities at least somewhat attractive.”

Jim Paulsen of Wells Capital thinks 1250 on the S&P represents “fair value” and calculated that every time in the past that the index was flat or down for the prior 12 years it was up an average 7.2% a year for the next 10 versus being up 4.7% when it wasn’t.

That things might get better in the long run is good to know, but getting to the long run is the problem.  Bespoke Investment group has counted 31 “all-or-nothing” days since the beginning of August.  This moniker is used for any day where the advance decline line on the S&P 500 hits up or down 400.  This year’s tally now beats 2008 and we don’t even want to think about that again, now do we?

Another measure of the degree to which everything appears correlated can be found in that there have been 62 days this year when the S&P has had an intraday trading range of more than 1%.  That is the index’s fourth longest stretch of such days since 1995 according to Birinyi Associates and is exactly half the 124 day stretch since the first half of 2009.  Additionally they found that the DJIA has finished 1% higher or lower 38 times since August 1, which compares to 25 times in the January to July period this year.  Strategas Partners says there have been 26 days when 90% of the S&P 500’s components have moved in tandem since July 1^st of this year.  This, they say, should be compared to the period between 2002 and 2006 when that did not happen more than 5 times a year.

Staying with the 12 theme, it is also the number of years the new stainless steel automobile exhaust systems last according to Monro Muffler Brake Inc.’s CEO Rob Gross.  MNRO reported earnings last Thursday saying that income rose 14% YoY and sales were up 6.9% for the same period.  “For 14 straight years our exhaust business was in decline, but for the past two years it has been growing”, Mr. Gross said.  “They’re replacing their exhaust systems at year 11 or 12, (there’s that number again) which means they plan to keep that car for many more years.  You don’t spend $600 on exhaust if you plan to sell a car next year”, he went on to say.

A more conservative attitude can also be seen in total household debt numbers which shrank by $1.1 trillion from the end of June in 2008 to the end of that same month this year, a drop of 8.6% according to the Federal Reserve Bank of New York.  Auto loan and credit card balances dropped more in August of this year than they had since April of 2010.

It would appear that all is not lost however as retail sales were reported to be up 1.1% in September, helped in part by strong auto sales +3.6% and a revision to the August headline number to +0.3% from 0.0%.  Retail sales ex-autos were +0.6% and core retail sales (ex-autos, gas station sales and building material sales) were up +0.5%.  The consumer might be down but these numbers show they’re not out.

Some of the renewed vigor could be coming from the Fed’s Twist 2.0.  The operation’s intent was to lower rates on the long end and while it was initially thought to have little impact it has caused investors to move out of bonds and into other investments.  The stock market’s 5.8% rise MTD could be evidence of this and Kathleen Gaffney, co-manager of the Loomis Sayles Bond Retail fun said recently, “Specifically, what we’re seeing is a very strong bid in high-yield, and that has a very familiar feel to it.  When risk is on, the lowest quality assets, the riskiest assets, rally the hardest”.  This is borne out by Ken Hackel at CRT Capital Group who says risky assets have returned 2.99% so far in October.

Kathleen is not alone as Lipper & Co. reported that investors purchased $2.27BN of Junk Bond mutual funds in the week that ended last Wednesday and the spread to Treasuries is around 764bps versus 910bps at the start of the month.  “The market is being led by riskier names”, said Sean Feeley, MD at Babson Capital.  Mr. Feeley says he worries less about a company’s rating and more about their debt service ability.

More evidence can be seen in the Citi High Yield Master indexes as their CCC index has gained 6.2 cents since an October 4 low of 76.15 while the BB index has gained 3.9 cents and the B index has gained 5.19 cents.

With the hope of a resolution on the Sovereign debt crisis in Europe dashed before the summit even started and any agreement put off at least until Wednesday it is becoming increasing unclear when and what will ever be decided my Ms. Merkel and Mr. Sarkozy.

Let’s just hope it doesn’t take 12 years.

In another, possibly spurious, comparison the S&P 500 closed at 1099.23 on Monday October 3, 2011 which exactly matched its closing level on 10.3.2008.  What was not the same was the unemployment rate which stood at 6.1% then but is 3% higher now.  Douglas Kass of Seabreeze Partners noted in Barron’s this week that the other number that is different is the P/E ratio which was 15 in ’08 but is 12 now.

Additional comparisons to 2008 can be found in the fact that as of September’s close the market has been down 5 months in a row which last happened when things seriously kicked in on the negative side in the year in question; only then it occurred in January.  The $87BN that was withdrawn from U.S. equity mutual funds in the last 4 months is also a number that is only bested in the naught that ended in eight.

All of this negative sentiment can most easily be summed up by quoting Jason Trennert of Strategas Research Partners who recently said that is was hard to believe that a sustained bull market could begin “until policy makers address in a serious manner the great sources of the world’s current misallocations of capital”.

Also relating to an earlier time, John Steele Gordon wrote a piece in this week’s Barron’s which starts off  “A bill that would profoundly restructure the American economy by greatly increasing government control of some of its major sectors passed the House easily but had a tougher time in the Senate”.  Mr. Gordon asks the reader if they think this is a description of the passing of the Patient Protection and Affordable Care Act, affectionately known as “Obamacare”?  He answers his own question by stating that it is not but was instead the National Industrial Recovery Act (NRA) of 1933 which was part of Franklin Delano Roosevelt’s “New Deal”.  It would appear, after cursory review, that another commonality they share is that they would both ultimately turn into a raw deal for the economy.

Within 2 years of its passing public opinion was turning against the NRA and a popular columnist of the time, Walter Lippman, wrote: “The excessive centralization and dictatorial spirit are producing a revulsion of feeling against bureaucratic control of American economic life.”  As they say, “the more things change, the more they stay the same.”  The country is still divided on this later occurrence of “excessive centralization and dictatorial spirit” but if it too has a 2-year life span hopefully the damage will be limited.

Now before you open that window and climb out onto the ledge realize that on Friday the Labor Department announced that the economy added 103,000 jobs in September and revised the “zero” number from August to a positive 57,000.

More people having more jobs along with the more people keeping more jobs translated into more people spending more money as a group of 23 retailers tracked by Thomson Reuters saw same store sales (try saying that three times fast) rise by 5.1%.  In particular Nordstrom’s sales were 10.7% higher while on the other side of the scale; Costco’s were 7.0% higher, so it would appear the increases were even across the socio-economic spectrum.

Craig Johnson, president of Customer Growth Partners, was quoted recently as saying: “For the first time in a long time, there’s some excitement”, when asked about the upcoming holiday shopping season.  He continued, “They may not be doing $50,000 kitchens and bathrooms, but they will spend a few bucks to freshen up their wardrobe”.  Mr. Johnson believes holiday retail sales will be 5.1% higher this year when compared to last and reach $226BN which, if it happens, would top the $222BN figure reached in 2007.

Additionally, U.S. auto sales were up over 14% in the 3^rd quarter as demand for SUV’s and light trucks rebounded.  Looks like folks are getting more concerned about spending their green than being green.

Back on the metrics front Ned Davis Research says that since WWII quarters that have seen losses greater than 14% (3Q11 was 14.3%) have seen an average bounce of 5.3% the following quarter.

And if all else fails there is always that phenomenon known as the “Santa Claus effect” which uses the fact that since 1945 the S&P 500 has gained an average of 3.7% in the last three months of the year.  What could provide an additional boost this year is that in those years where the average dropped more than 10% in the 3^rd quarter (see above), the average gain has been 7.2%; all this according to Standard & Poor’s Equity Research.  Let’s just hope they’re better at this than rating CDO’s.

Frank Fantozzi, president of wealth management firm Planned Financial Services, is increasing his clients equity exposure by 15% in the next few week to take advantage of what he thinks will be a positive 4^th quarter for stocks.  “I think the market is going to finish much better than people realize”, he said.

Fingers crossed he is right.

Enjoy the week.

Aiding this effort to the downside, 90% of stocks fell on both Wednesday and Thursday and for the week there were 835 new 52 week lows and only 74 new 52 week highs on the NYSE.  It was certainly a “risk-off” week effecting even recent stalwarts like Gold and the emerging markets.  Copper, the metal James Grant of Grant’s Interest Rate Observer says has a PhD in economics was down 7% on Thursday alone and led a broad sell off in industrial metals which included Platinum and Palladium, known for their use in catalytic converters falling 4.3% and 6.9% respectively on the same day.  “Why would you want to own something you make things out of when nobody is there to buy them?” was the question Bill O’Grady, chief market strategist at Confluence Investment asked.

That the recent moves are affecting everything can most easily be seen in that the 10 major sectors of the S&P 500 are averaging correlations of about 96% versus 82% three months ago and high yield corporate securities are mimicking the S&P at an 80% rate.  Robert Bowman, PM with Edelman Financial Services might have described it best when he said, “That’s when everyone starts throwing the baby out with the bath water”.  From a more studied perspective Alan Zafran, co-founder of Luminous Capital was “Seeing some signs of easing, but we believe that investors will continue to see intermittent periods of heightened correlations, until macro issues hanging over the markets come to some sort of resolution”.  The VIX or “fear gauge” as it is affectionately known, is pricing in 4% daily moves from now until November according to Steven Sears, the author of the “Striking Price” column in Barron’s.

Looking at one thing to trade another is not new as the basis for the trading strategy used by the author tracks changes in the credit spreads of companies to generate buy and sell signals for the equities of those companies.  A similar theory is espoused by John Taylor the founder of the $8.5 BN FX Concepts who says, “We use commodities to forecast currencies”, noting that movement of the value of the Norwegian Krone is a function of the price of oil.  The problem with all of these theories is that when correlation reaches the 96% level, all bets are off.  That is, until they are on again.

The driver this past week seems to have been the sovereign debt crisis in Europe with S&P downgrading Italy one notch to –A, which is one tic above where Fitch has the Italians and three above where Moody’s does.  Jason Cimpl at Trademaster Daily says, “No one trusts S&P, so another downgrade by them was viewed as spilt milk”.  The research folks at Nomura Securities North America think “It makes a lot of sense for the Italian Treasury to buy the most distressed parts of the market and reissue in the segment which is supported by central-bank buying and that they should do it while the European Central Bank is actually in the market”.  Adding to the distress Germany’s ZEW Investor Survey’s Current Situation Index fell below 50 for the first time since June 2010.

With S&P’s downgrade of Uncle Sam’s I.O.U.’s fully recognized and Ben Bernanke’s larger than expected Operation Twist 2.0 now announced investors chose to side with Ben and ignore S&P last week pushing the yield on the 30-year to 2.738%, its lowest level since December of 2008 and the 10-year benchmark to 1.672% or 1 “beep” away from that maturity’s 1940 low.  David Rosenburg, Gluskin-Sheff’s chief strategist estimates that “The Fed’s purchases will equal 90% of the Treasury’s long bond issuance through 2012”.  If that’s not robbing Peter to pay Paul I’m not sure what is.

With rates this low conventional wisdom might be to think the economy should be roaring but Polina Vlasenko, a fellow at the American Institute for Economic Research authored a recent study with fellow Fellow, William Ford that found that the Fed’s efforts of boosting the economy through quantitative easing could have cost the economy as much as $587BN and 4.6MM jobs.  “The effect on the depressed income of savers is something nobody talks about”, she says.  “With the additional jobs that might have been created, the unemployment rate could fall to 6.8%”, the study concluded.

Interestingly enough through all of this Q3 earnings estimates have only been reduced by 2% and Q4 by an even smaller 0.8% according to S&P.  Jason DeSena Trennert, chief investment strategist at Strategas Research Partners estimates that if S&P companies earn $95 this year, earnings could fall by 15% to around $80 in 2012.  Using a P/E of 12 that would put the S&P at 960.  This is a number Trennert believes might motivate politicians and world bankers to start coming up with solutions.

Let’s hope it doesn’t take them that long.

Enjoy the week.

]]> http://www.marketstrategiesmgmt.com/2011/09/c-m-o-9-26-2011/feed/ 0 http://www.marketstrategiesmgmt.com/2011/09/c-m-o-9-12-2011/ http://www.marketstrategiesmgmt.com/2011/09/c-m-o-9-12-2011/#comments Mon, 12 Sep 2011 11:33:30 +0000 Jim Delaney http://www.marketstrategiesmgmt.com/?p=3290 “If you had bought Swiss francs when I suggested, you would not have lost three-quarters of your fortune.”  Those words, spoken by the banker of Anna Eisenmenger, a middle-class Viennese diarist in post-WWI Vienna are as apropos today as they were when they were originally uttered and although Anna had taken her lumps in the sovereign debt of Austria, another excerpt from this same conversation is equally telling; “Surely there can’t be anything safer than [government bonds]”, to which her banker replies, “But, my dear lady, where is the State which guarantees those Securities to you?  It is dead.”

These tidbits are from a new book written by Sylvia Nasar titled “Grand Pursuit: The story of Economic Genius” which was reviewed by James Grant of the eponymously named Grant’s Interest Rate Observer in this weekend’s WSJ.

With yields on Greek two-year notes hitting 48% this week as Hellenic 10-year paper yielded 18%% and the probability of default reached 90% it would appear there are going to be more than a few “Anna’s” pretty soon.  And all of this while September still has three weeks to go!

Speaking of September and how it usually goes, Bespoke Investment Group looked at the numbers and found that when the Dow declines by 2% or more in the first three days (it dropped 4.08%), it has averaged a 6.31% decline for succeeding 27 days.  When the decline was 4% the average decline was 13.5%.  Averages can be a bit misleading so a closer look at what makes up this second statistic is warranted.  There have been three previous cases since 1900 when the Dow dropped more than 4% in the first three days.  In 1931 the rest of the month produced a 27% decline, in 1946 the number was -4.83% and in 2002 -8.35%.  It is obvious from this that the rout during the Great Depression has skewed the average but trend is not pretty to start with.

The release of the Fed’s Beige Book last week did little to build confidence that the markets will produce an outlier in September as while overall consumer spending rose in most parts of the country a large part of that was driven by automobile sales.  The question that needs to be asked, however, is what part of that was a reflex from the slowdown in manufacturing caused by the earthquake in Japan in March?  Sales of other big-ticket items a.k.a. furniture and appliances were said to have slowed during the period and businesses said they thought “heightened consumer anxiety was weighing on sales”.

Home builders also reported weakness as customers stopped showing up for open houses and in some cases backed out of deals.  One Philadelphia area builder said that “you could hear the crickets for two weeks”.

To be fair there were some bright spots.  Sales of luxury items remained strong so we can rest easy that the Marie Antoinette’s of the world are well insulated from the turmoil and job growth was said to be stable but with unemployment at 9.1% I am not sure that offers any consolation.

The Boston Fed noted that “one contact saw a pronounced downward sales trend in recent weeks that he attributed to consumer concerns about the debt ceiling debate, stock market gyrations, ongoing unemployment, and continuing unease about the U.S. economy’s medium-term prospects.”  Nothing there that can’t be fixed easily.

It would seem the only thing not mentioned by the Boston Fed’s contact was the sovereign debt crisis in Europe which also seemed to take a turn for the worse last week as Jurgen Stark (whose last name means “strong” in German), the ECB’s chief economist, announced his resignation effective on 12/31/2011.  The reason given was “personal” but the markets took that to mean Jurgen had some ideological differences with the direction he thinks the ECB is headed.  In an op-ed for the German business daily Handelsblatt released late Friday, Mr. Stark wrote “that government efforts to save the euro zone have fallen short”.  He called for a “far-reaching reform of the mechanism for decisions and sanctions.”  That news moved the DAX index to its lowest level since July of 2009 and the FTSE MIB index in Milan to a new two-year low. “At the very least, this adds to the uncertainty and to the sense of division among European policy makers”, said Greg Fuzesi, economist with JPMorgan Chase.

Here at home we were treated to President Obama’s next plan to save the world in the form of a $477BN “jobs” (read stimulus) bill during which he repeated the phrase “pass this jobs bill” 10 times without saying the word “stimulus” once.  Watching the joint session of Congress during the speech there was little of Lady Gaga’s “Poker Face” as the Democrats were clapping at every pause while John Boehner and company were all clenched jawed with lips pursed.

With 19 days left in what is normally called “the cruelest of months” for the stock market and in an environment where correlations between individual stocks as well as entire asset classes are at an all time high and the “risk-on / risk-off” trade is being flipped like a 5-year old playing with the light switch it should be an interesting ride.  Hang on.

Enjoy the week.

Evidence of these shifts can be found in the stock market as the correlation among components of the S&P 500 has hit 80% according to Ana Avramovic of Credit Suisse, which is even higher than the 73% peak reached in late 2008.

Of the explanations given for this, one is that more than 30% of the volume on U.S. stock markets is a result of ETF trading these days as compared to just 2% at the turn of the millennium.   While that might be the case when you have days like August 8^th where every stock in the S&P 500 was down and the NYSE advance/decline line had a 1:589 ratio to the negative it would appear there is a little more than ETF trading going on.

Another sign of tectonic action is that Ned Davis Research counted 5 days in August when the A/D ratio was 1:10 and another 5 when it was 10:1.  Not much stock picking going on there.

The herd mentality might better be described these days as a school mentality, as in a school of fish that darts one way and then the other with the slightest provocation.  News last Monday that two Greek banks were merging boosted the Athens General Index by 14% which triggered a global “up” day in equity markets.  From a different perspective it would seem more apropos to describe that combination as two bricks, not two banks, as the state of the Greek economy would appear to make it unlikely that any loan will be repaid so if one brick won’t float it is tough to see how two tied together will.

Additional evidence of the current state of distress can be found in the synchronization of the stock and bond markets as the stock market has recovered much of what was lost after Standard & Poor’s downgraded Uncle Sam’s debt while the U.S. Treasury market has benefited from the fear that while it might be bad here, its worse everywhere else.

Eric Green, chief interest rate strategist for TD Securities says, “We have a disconnect here, bond guys are a bit more cynical and when I look at the equity market, I see something slightly different – they are more hopeful.”  The cynicism that Mr. Green associates with the “bond guys” might also be questioned as Dan Greenhaus, chief global strategist at BTIG thinks the shape of the yield curve is what is giving the “stock guys” their hope.  “Yields down at these levels still reflect some nervousness, but the curve is much steeper today than anything you got in 2002, 2003, signaling a better economic environment going forward”, he says.

Acknowledging that the yield on the two year note is anchored to the Fed’s zero-rate policy it should be noted that the difference between the 2-year and thirty year bond is currently 332bps which is over twice the 158bp average that existed from 1990 to 2010.  The 5-year:30 year spread adds more weight to the argument as it is currently 260bps which is up from 40bps in early April.

This could all change direction as quickly as that school of fish changes direction as there is reason to believe that while we might not be getting QE3, we could be about to see Twist 2.0 as described by Randall W. Forsyth in this weeks Barron’s.  Mr. Forsyth harkened back to the early 60’s when Chubby Checkers created the craze around the popular dance of the time.  The Fed was doing its own twist back then by buying longer dates Treasuries and selling shorter dated ones.  The cynics in the bond market borrowed the name from C.C. and applied it to the Fed’s maneuver.

With dissention already at historic levels among the Fed governors, changing the focus of securities purchases might be the best way for Ben B. to not only keep rates low but also flatten the curve in the process.

The question that has to be asked then is that if a steep curve signals “a better economic environment going forward” as Dan Greenhaus says, does a flatter one become a self fulfilling prophesy and portend a downturn in the economy?

Swim with the fishes if you like, just don’t get hooked.

He also said: the “very deep slump” in the housing market and the aftereffects of the financial crisis continue to restrain US. economic growth, adding that the divisive debate focused on the federal debt limit “disrupted financial markets and probably the economy as well”; while announcing that the next meeting of the Board of Governors of the Federal Reserve would be expanded by 100% (from  1 day to two) “to allow a fuller discussion” of the Fed’s options which he described as “a range of tools that could be used” in an effort to keep his, yours and my chin up with the statement that “growth in the second half looks likely to improve”, while calling for “good, proactive housing policy”.

The Chairman of the Federal Reserve mentioned the d-word (deflation) six times in his speech on Friday after not mentioning once last year.  RBS economists also noted that “Unlike last year, there was no discussion of the tools that could be employed” and “in fact, the specific tools under consideration were not even named.”

The Dow Jones Industrial Average first interpreted these remarks negatively as one might expect and dropped 211 points before rising 355.72 points to close 134.72 points higher at 11284.54.  If that’s not making lemonade out of lemons I’m not sure what is.

Robert S. “Steve” Miller, non-executive chairman of American International Group Inc. (AIG) said after Mr. Bernanke spoke, “He has driven interest rates as low as they can go, interest rates are not the problem for investment.  The problem for investment relates to concerns for the economy and worries about fiscal policy.”

If, in all of this, the market has decided that the policies that keep everyone waiting for the “Bernanke Put” are ultimately more destructive than the short term fix (which could actually be harder to comprehend) then maybe the zero rate junkies have decided to enter rehab.

And speaking of junk or in this case its high-yield bond equivalent, offerings of below investment grade debt were at there lowest level in August to date since December of 2008.  The return for the month reached a negative 5.1% in the 26 days that have passed this month.  Trading volumes have also decreased to about $3.46BN last week versus $4.72BN for the other weeks this August and $4.74BN per week this year.  Spreads in the below BBB world widened to 766bps which was the widest since November of 2009 and should be compared to 587bps at the end of July.

What is interesting in all of this is that the default rate on junk bonds fell to 2% in June down from 11.7% in 2009 and 3.3% in 2010.  A similar state occurred during the beginning of the financial crisis as the world appeared to be going to hell in a hand basket and high yield debt sold off precipitously only to have default rates come in way under what was projected hence making the genre a very profitable investment.  David Steinberg, a portfolio manager at Mast Capital Management is not a believer in a repeat however as he was recently quoted as saying, “I’m short and getting shorter”.

Long time readers of this space know that the investment theme here is that credit spreads are a good indicator of stock price movement.  To that end the current increase in spreads on high-yield, investment grade and cross-over names would lead one to believe the direction off equity prices is lower.

This theory was put to the test this week with the DJIA rising 466.89 points or 4.32%; the S&P 500 rocketing 53.27 points for a 4.74% rise and the NASDAQ soaring 138.01 points to ratchet 5.89% higher.  Describing that kind of equity price movement in an environment of widening credit spreads Mr. Steinberg simply said that stock investors were “smoking Jackson Hole Hopium.”  There’s that junkie again.

Enjoy the week.