Morning Call

0 CommentsWednesday • August 26, 2009 • by alwaters

Please note: the next Morning Call will be issued on Tuesday September 1st.

“Men should strive to think much and know little.”

Democritus

Morning Call
August 26, 2009

The Hidden Costs of the Financial Crisis

It can be all too easy to overlook some of the hidden costs of the financial crisis. Public opinion has ranged from disdain for the woes of bankers and other financial institutions, to genuine concern for the impact on working families. Somewhere in between those two extremes are the challenges faced by many state governments and authorities. Job losses and the resultant losses in tax revenues have left many states struggling to balance their budgets while maintaining services. The credit crunch has also made it harder and more expensive to raise money in the capital markets. In fact, even the fees issuers pay to underwriters of municipal bonds has increased to its highest level in eight years. This is reflective of the perception of risk for taking on a municipal issuance and also the result of less competition as some past players are now gone. In any case, this presents a serious social issue on the road ahead. State legislators will face difficult choices and many public services will begin to be under pressure. In any case, this is one area of concern that may not be getting the press it deserves.

What to Buy

If, in fact, the housing market has found some stability, and it certainly has shown some positive indications, then one might wonder how best to play it. One big name that comes to mind is Weyerhaeuser (WY); a forest products company with offices in ten countries. The company also participates directly in the construction industry. Shares of Weyerhaeuser are roughly midway between their highs and lows of the year. The stock has been known to overreact to the broader market, but with sentiment picking up recently, Weyerhaeuser could have a significant upside ahead. Another lower priced option is Louisiana Pacific (LPX) which is engaged in the manufacture of building products. The company showed respectable growth in the past quarter and is still more than 50% off of its 52 week high.

Market Outlook

Once again, much attention is being paid to China. Word that China may seek ways to curb overcapacity in several industries, including steel, cement, and power equipment, has some concerned as to what the broader implications will be. Record credit expansion has fueled continuing growth in China and some have feared that an asset bubble was forming that could eventually lead to catastrophe. Unfortunately, growth in China has also been a bright spot for investors, which are equally unhappy with the prospect of reigning in one of the few global economies still expanding.
Despite this, the Asian markets moved higher overnight. China’s Hang Seng index moved only fractionally upward, but the Nikkei gained well over 1% for the day. Interestingly, many industrial stocks led the way, while the financial sector stayed positive as well. A different story in Europe as equities have steadily declined throughout the morning and the major indexes are lower a half percentage point. Trading has also been rather selective in Europe as there have been winners and losers in each sector. US futures are slightly lower this morning and the aftermarket has shown mixed trading here as well.

Demand from China will be a critical element for commodities looking ahead. For now, commodities are holding up in early trading today. The energy sector, however, has pulled back slightly after mostly positive movement for several days. Oil is lower by a half Dollar to $71.50. Gold is off of its early morning high, but remains on the upside at $946. Relative strength on the Dollar, which is higher against the major currencies this morning, is also weighing on commodities today.

A busy economic calendar today includes Mortgage Applications, Durable Goods, and New Housing Sales. Analysts are expecting to see some signs of recovery in today’s numbers and we expect sentiment to pick up at the official release of figures. The earnings calendar includes DSW, JoAnne Stores, Southwest Water, TiVo, Williams Sonoma, and several smaller companies.

We do concur with expectations that today’s economic numbers should show some positive movement. As such we believe that the hesitation we are seeing in the futures market will be temporary. We may see some volatility today but expect to finish higher on the day. Looking ahead, however, we will continue to keep an eye toward China and their policy moves. Attempts to cool overheating in some sectors of the economy, could contribute to more global market volatility. Commodities, in particular, stand to be deeply affected by any reduction in demand coming from the east.

Morning Call

0 CommentsMonday • August 24, 2009 • by alwaters

Morning Call
August 24, 2009

A Better Option

One of many lessons learned during the financial crisis has been that a hands off buy and hold strategy just doesn’t work well anymore. This is not to say that long term investing is dead but, rather, that a successful strategy will need to include a balanced approach including both long and short term positions. One invaluable but often misunderstood investment vehicle is options. Options offer a low cost opportunity to lock in potential moves with less capital risk than one would incur with the direct purchase of a stock. The purchase of an option contract gives the holder the right to buy shares (or obligate the other party to buy the shares) at a set price if the underlying shares move in the direction the investor expects them to. The difference with options is that, if you are wrong, your loss is limited to the premium paid on the contract.
Options can be complex and being successful does take an experienced hand. The fact remains, however, that there is a move toward option strategies among many savvy investors. The lower cost frees up cash that can be used and invested elsewhere.
Consider shares of IBM (IBM) as an example. With the stock at $116.86, investors can replace shares with a January $120 call; the cost of the trade is $6.60, or 5.65% of spot (cost of the stock), freeing 94.4% of the total notional invested in the stock.
If you have made profits in a certain position and wonder whether to cash in or ride it out, another choice would be to do both. You could accomplish this by taking profits by selling the shares and then reinvesting a portion of the gains in call options on the same shares. If the stock continues to rise you can still benefit.

What to Buy

Generally speaking, commodity plays will be positive today as economic sentiment is holding up rather well. Specifically today we are taking a look at a small but promising gold mining company; Jaguar Mining (JAG). Since making a significant pullback last Monday, Jaguar Shares have been trending higher. Much of the selling was most likely profit taking after a strong move following positive earnings news the week before. The company is primarily active in Brazil and has a joint project with Xstrata.

Market Outlook

Federal Reserve Chairman Ben S. Bernanke and European Central Bank President Jean-Claude Trichet, speaking at the annual central bankers’ gathering in Jackson Hole, Wyoming, said the world economy is pulling out of recession. This expression of confidence, along with word that European industrial orders increased more than economists forecast in June, has led to some positive movement in global equities. Overnight in Asia the major averages climbed by 2-3%. Financial and industrial stocks led the way in Asia; including the automakers such as Mitsubishi and Isuzu. In Europe this morning, equities are moving higher, but at a slower pace. At mid-day, stocks are higher by a half percentage point. The financial sector, however, is exceptionally strong with some, such as Lloyds and RBS up by about 5%. Futures in the US point to a modest gain at the opening bell, although the banking stocks are relatively weak compared to elsewhere in the global markets.

One of the strongest signs of positive sentiment is in the commodities markets this morning. Commodities are strong across the board and both oil and gold have ticked higher. Crude has added a few cents to reach above the $74 mark in early trading. This does bring prices toward the top side of the recent trading range so we could see some retracement between current levels and $75. Gold has also gained some momentum; adding more than $3 this morning to about $958. The move for gold was rapid this morning and we will likely see a pullback to about $954 before moving to a level near $960. The Dollar, for its part, is higher on the Yen and Pound but weaker against the Euro. The Yen is the worst performing currency this morning as the markets move higher and it loses its luster as a safe haven.

Investors will be essentially on their own today as the news calendar is void of any major releases. The Chicago Fed’s Manufacturing Index stands alone for economic news and there are no notable earnings reports scheduled for today.

Famed economist Nouriel Roubini, in a piece in the Financial Times, expressed his concern that a double dip or W-shaped recession is a growing risk. HE went on to point out that policymakers are essentially caught between a rock and a hard place as unwinding stimulus policies too soon could undermine a recovery but running large deficits could push up borrowing rates and cut off economic growth as well. We would add to that cautious undertone the fact that bank failures continue to add up. Eighty one banks have failed this year so far and that number could grow considerably. We could see this number reach 200 or more by the end of 2009 and this will put a considerable strain on the FDIC’s insurance fund. The failures will also put pressure on the banking industry, which could see as much as 25% of its 2010 pretax income go towards FDIC fees. These are among some of the more critical issues that must be resolved before true recovery can begin.

Morning Call

0 CommentsFriday • August 21, 2009 • by alwaters

Morning Call
August 21, 2009

Derivatives

Not too long ago, the average investor may have not even heard of derivatives, much less know how they worked. The financial crisis has, of course, added several new terms to the vocabulary of those even remotely interested in the workings of the financial markets. A Derivative is a financial instrument that is derived from some other asset, index, event, value or condition (known as the underlying). Rather than owning or trading the underlying itself, derivative traders enter into an agreement to exchange cash or assets over time based on the underlying. Options and futures are examples of such.

More importantly, derivatives have been used by government entities and other institutional investors to hedge their portfolios, balance cash flows, and minimize risk. Despite much negative publicity following the Lehman collapse, the fact is that the system proved to be more effective and sound than many had believed.

In each transaction, parties and counterparties assume positions that each believes to be beneficial to them and that may reflect differing views of future events. The nature of these Over the Counter transactions makes it somewhat difficult to track but the notional value of the market is said to be about $700 Trillion. Regulators have pushed to standardize derivative trading on an exchange but this will be a complicated proposition. Thus far, derivatives have proven to be a valuable tool and a surprisingly stable market.

What to Buy

With oil prices once again ticking higher, we turn our attention to the energy sector. We expect to see positive movement in the drilling stocks which are typically sensitive to the slightest movement in crude prices. We are also taking a close look at a major integrated play today: Chevron (CVX). Chevron has been upgraded by some analyst from hold to buy on the basis of an estimated Net Present Value (NPV) of $97 a share. Shares are presently trading at $68. The company has a low debt balance sheet and a favorable balance of exposure to upstream and downstream operations. Technically speaking, Chevron shares have just crossed above their 200 day moving average. It also helps that Chevron shares carry a respectable dividend yield of close to 4%.

Market Outlook

It hasn’t exactly been smooth sailing along the way, but the bottom line is that equities have managed to add slowly to their upward movement. We have had some early morning jitters this week that have eventually worn off and the proverbial bulls have repeatedly bought into the dips and led the market to positive territory. For a change this morning, futures are pointing to a positive start to the trading day. At least part of the optimism in the US comes from news that the Conference Board’s coincident index, a gauge of current conditions, was unchanged in July after falling in 17 of the 19 months since the contraction began in December 2007. The Leading Indicators Index also climbed for a fourth month.

Asian equities were mostly lower overnight with the exception of China. The benchmark Shanghai Composite Index gained 1.7%, while the Shenzhen Composite Index for China’s smaller second exchange climbed by 2.5%. Japan’s Nikkei, however, fell 1.4%. Bargain hunting may have contributed to gains in China considering sentiment is actually a little shaky. Word has circulated that Chinese regulators plan to tighten capital requirements for banks, threatening to curb the record lending that has fueled the rally in the nation’s stock market. Banking regulators are concerned about excessive credit creation and the danger of an asset bubble.

In Europe, stocks began climbing at the opening bell and the major indexes are now up by an average of well over 1%. News that services in Germany and manufacturing in France had unexpectedly expanded, supported speculation that the global recession may be easing. In a stark contrast, European banks and industrial stocks are showing strength while in Asia most sold lower. In premarket activity in the US, the banks are somewhat mixed, while technology and retail stocks have gained some momentum.

Despite some trepidation toward events in China, commodities are showing strength this morning. With few exceptions, we are seeing positive movement across the board. Oil is particularly strong as it adds another Dollar to reach close to $74 this morning. After falling through its support line recently, gold is slowly rebuilding momentum; up by $5 this morning to $945. Industrial demand from China will remain a critical issue for gold and, as a result, prices may stay in a tight range in the coming weeks. We should see, however, a move to about $960.

Yesterday, Leading Indicators were positive but Initial Jobless Claims disappointed slightly. Today, the economic calendar includes Existing Homes Sales and the Department of Labor’s Mass Layoffs report. On the earnings side, we will have Ann Taylor Stores, JM Smucker, and a few others.

Investors will also be paying some attention to words from Fed Chairman Ben Bernanke as he speaks to a gathering in Jackson Hole, Wyoming, on the lessons learned from the financial crisis and efforts to aid the economic recovery. Although comments should remain generic in nature, hints of direction for Fed policy will be taken to heart. Questions as to whether Bernanke will stay on as Chairman in January are also on everyone’s mind. The White House had remained noticeably quite on whether Bernanke will receive a vote of confidence from President Obama. All told, we appear poised to finish the week on an uptick as the market has adjusted to a mixed bag of economic news. Metals and Mining as well as the energy sector have been very reactive to economic sentiment, and with that being somewhat positive today, we will expect positive movement in these sectors today.