Another Friday with Greece hogging the headlines and Portugal waiting in the wings to take the spotlight as the next EU country to move into crisis mode.
Greece is continuing down the road towards a default with another week behind us and still no resolution on the private sector debt swap. The daily claims of "we will have a deal before the weekend" did not pan out on Friday.
The bond vigilantes are not waiting around for the announcement and have taken aim at Portugal as the next country to potentially default. Portugal already received a 78 billion euro bailout but conditions are still worsening. While Greece, Italy and Spain have been able to sell debt at lower rates thanks to the ECB LTRO loans, Portugal has seen the value of its debt plunge and interest rates rise. Rates on the 10-year bond have risen to 15% and a level that is not sustainable. The 2-year now yields 16.7% and 5-year 20%. S&P cut Portugal's rating to junk two weeks ago. There is currently a 70% chance Portugal will default over the next five years. Citi economic analyst, Michael Saunders, said Portugal will eventually face a private sector haircut of 35% or more by the end of 2012 to early 2013. Portugal is expected to soon ask the ECB, IMF and EU (troika) for another 30-50 billion euros.
Greece is moving ever nearer to a default with 96% of analysts now expecting it and Portugal is heading rapidly towards its own default scenario. The new EU fiscal compact is facing numerous problems. So, why has the euro currency risen +5% and the dollar declined -3% over the last nine days? You can thank the Fed for this move. The regional activity reports suggested the recovery was slowing and the Fed basically confirmed trouble ahead when they extended their low rate pledge to late 2014. There is no reason for the Fed to take that extraordinary step unless they fear the fragile recovery is going to stall. In his press conference Bernanke alluded to another QE program in the near future "if conditions were appropriate to stimulate the recovery." Since they just announced in the FOMC statement conditions warranted "exceptionally low rates" until late 2014 the jump to the "appropriate conditions" conclusion was obvious. All we need now is for the equity market to take a dive and put the Fed into panic mode and make a QE3 announcement before the March FOMC meeting.
The falling dollar has pushed the precious metals through strong resistance and out to new two month highs. Silver is up +22% for the year and gold +11%. Copper rallied to a four month high on the falling dollar and also on the Fed's low rate forecast. That boosted expectations for an economic recovery and increased demand. Copper supplies at the London Metal Exchange fell by 2,450 tonnes to 335,425 tonnes and their lowest level since September 2009.
The falling dollar may be the only thing holding equities at their highs. Earnings have been less than exciting with many companies beating on earnings but guiding lower for 2012. That has caused some spectacular volatility in the individual stocks. For instance the earnings for technology sector ex-Apple are actually down -2.9% for the quarter according to FactSet. Including Apple the earnings would be up +11.9%. That shows you what a big impact Apple has on sentiment. I would bet 99.9% of investors are looking at the headline reports of +11.9% earnings growth for techs and thinking this was a decent quarter. How do you think tech buyers would feel if they realized the rest of the sector was negative for the quarter? Including Apple and AIG the overall earnings growth for the S&P drops to +1.0% without those companies. That is the blended growth rate. That is companies already reported plus estimates for those yet to report so there is still plenty of room for further declines since the remaining 300+ S&P companies are the smaller ones with less revenue and earnings flexibility. Most are not buying back billions of dollars in shares for the quarter to increase earnings per share as IBM and others did. You are not hearing on CNBC that S&P earnings growth is only +1.0% ex Apple & AIG. That would be the end to the rally.
Current earnings estimates for 2012 are positively anemic. For Q1 earnings growth is estimated at only +1.2%, Q2 +7.8% and Q3 +5.2%. Q4-2012 jumps back up to +16.7% and Q1-2013 at +15.4%. Good luck with that crystal ball for Q4 2012. The estimates for Q4-2011 were right at +15% at the beginning of the quarter and now we will be lucky to finish positive without Apple and AIG.
Despite the volatility and the wide range in beats and misses the overall earnings actually improved last week. Of the 172 S&P companies already reported 65% beat the consensus estimates. Financials posted the highest growth rate at +60.4%, technology (including Apple) at +11.9% and industrials at +10.6%. The current 12-month forward PE for the S&P is 12.4 and well below the 14.7 average for the last ten years.
On the economic front the first look at the Q4 GDP came in below estimates. The headline number showing +2.75% growth was less than the consensus of +3.0%. That was definitely better than the +1.81% growth in Q3 but it may not last. The drag in Q3 was due to inventories and that was the same factor that pushed Q4 growth higher. Unfortunately that positive push will return as a drag in the first half of 2012. Fixed investment also slowed as did government spending. Consumption (Real GDP) provided only +1.45 of the headline number and inventories added +1.94 points. Exports subtracted -0.11 and government spending cuts subtracted -0.93 points.
Of note was the decline in inflation as evidenced by the PCE to +0.9% from the 2.1% level in Q3. Excluding food and energy the rate fell from 2.3% to 0.7%. For the Fed this is nearing crisis levels. They don't want to see zero inflation or even worse negative inflation or deflation. This is another clue the Fed is going to announce some new QE program in the near future.
GDP for all of 2012 is expected to average 2.5% and grow to 3% or more in 2013, 2014 and 2015. I would not hold my breath on that. Once the global economy begins growing again the price of oil is going well over $100 and anything close to $125 will weigh on global growth. The world runs on cheap oil and cheap oil is nearly gone.
Despite the rebound in GDP in Q4 I should remind everyone that the prior three quarters all had growth of less than 2%. There are NO instances in history since WWII where three quarters of sub 2% GDP growth did not predict a recession. Of course there is a first time for everything. This is likely another reason Bernanke extended the low rates.
The final revision for January's Consumer Sentiment rose to 75.0 from 74.0 in the initial release. This was a strong gain over the December level at 69.9. Sentiment has been improving significantly since the cycle low of 55.7 in August. It is very close to a breakout to a post recession high. The current conditions component rose from 79.6 to 84.2 and was responsible for the gains. This is more than likely due to the market rally and its impact on individual wealth and retirement accounts.
Consumer Sentiment Chart
We have a full economic calendar for next week with the ISM reports and payroll reports hogging the headlines. The major reports begin on Wednesday with the ADP Employment and ISM Manufacturing. Last month ADP said 325,000 jobs were added. Estimates for January vary from 100,000 to about 275,000. This will be the first of the three employment reports and will set the stage for Friday's Nonfarm Payrolls.
The Nonfarm report for December showed a gain of +200,000 jobs and consensus estimates for January are only +125,000. Seasonal workers will have been terminated and that will depress the overall gains.
The ISM Manufacturing report is expected to show a minor gain to 54.9 from 53.9 in December. The ISM Services on Friday is expected to rise to 53.5 from 52.6.
There were only a few earnings out on Friday. Chevron (CVX) was one of the largest and it was not pretty. Chevron's production declined from 2.79 mbpd in Q4-2010 to 2.64 mbpd in Q4-2011. The reasons for the decline were higher prices on production sharing contracts, lower than expected production from new projects in the Gulf of Mexico and Angola as well as a third party pipeline rupture that halted production. Chevron also experienced decreased demand in Thailand after the floods. Prices received rose by +25% but that was not enough to offset the production declines.
Chevron also saw losses in its refining businesses as the high prices for oil were not being reflected in prices for refined products. The competition at the street level forced prices lower and reduced refining margins. Earnings declined slightly to $2.58 per share or $5.1 billion, down from $2.64 and $5.3 billion in the year ago quarter.
Chevron has plenty of production in the pipeline. The company is spending $32.7 billion in 2012 to complete production facilities in various locations that will greatly expand its production in 2013 and 2014. Chevron added 1.67 billion barrels of reserves in 2011. That is 171% of its production for the year and that is a very good reserve replacement ratio. Chevron shares declined -2.5% on the news even though most of it was expected.
Chevron shares have strong resistance at $110 but with the major new production coming online over the next three years I expect that resistance to be easily broken and shares to move significantly higher.
Ford (F) reported lower than expected earnings as commodity costs rose and results from outside the USA fell short. Losses in Europe increased nearly 400% with worries over the debt crisis keeping consumers out of showrooms. Losses in Europe rose to $190 million from $51 million in Q3. Earnings declined to $1.1 billion or 20-cents per share from $1.3 billion and 30-cents in the year ago quarter. Analysts were expecting earnings of 25-cents. Ford also said the currency exchange rates were a drag on earnings. Ford actually lost $83 million in Asia compared to a $23 million profits in Q3.
Honeywell (HON) reported earnings of $1.05 compared to estimates of $1.04 but they took a big charge for pension fund costs that pushed them to a 40-cent loss. That compared to a profit of 47-cents in the year ago quarter. Honeywell lowered guidance for Q1 saying earnings would rise +11% to a range of 93 to 98 cents. Analysts were expecting $1.00. The company said weakness in Europe was a big reason but the debt crisis was also weighing on emerging markets. GE, UTX, Ford, etc, have also given the same warnings for 2012.
Friday was Facebook day. The Wall Street Journal reported that Facebook is preparing to file its initial paperwork for a public offering. The IPO is expected to raise as much as $10 billion and value Facebook between $75 to $100 billion. The filing could come as early as Wednesday. All the recent IPOs like Linkedin, Zynga, Pandora and Groupon all spiked on the news because it will attract attention to their space. Zynga will benefit since it depends on Facebook for the majority of its revenue.
Assuming Facebook raises $10 billion it would be about the 15th largest IPO on record. Agricultural Bank of China was the largest at $19.3 billion and Visa was $17.9 billion. At a valuation of $85-90 billion it would place Facebook between Bank America and McDonalds in ranking in the S&P 500. MCD is $101 billion and Bank America $75 billion. At $100 billion in value and 825 million users that would value each user at roughly $125. It takes an average of three months from the filing date to actually price the IPO. That takes longer if the SEC has any questions on things like accounting.
Mark Zuckerberg still holds a 24% stake in Facebook that would be worth $20 billion at the higher valuation level. That would instantly catapult him to the 23rd richest human on the planet. The top four as reported by Forbes are Carlos Slim $74B, Bill Gates $56B, Warren Buffett $50B, Bernard Arnalt $41B. Zuckerberg would be worth more than Google founders Sergey Brin and Larry Page at $14 billion each.
I would be smiling too in his situation.
Despite the lousy earnings, lowered guidance and continuing problems in Europe the AAII sentiment survey showed bearish sentiment fell to 18.9% from 23.6%. There have only been four weeks since 2006 where bearish sentiment was lower. Bullish sentiment rose to 48.4% from 47.2%.
However, Investment Company Institute (ICI), reported U.S. equity funds had outflows of $804 million for the week ended Jan 18th. Another report said domestic equity funds have had outflows for four of the last five weeks. Bond funds had inflows of $5.56 billion, compared to $7.87 billion the prior week. Clearly investors are reluctant to put new money into equities but they have no problems putting large amounts of money into bond funds even at record low yields. This should be a serious warning on market conviction. In theory Bernanke extended his low rate pledge to encourage investors to put money back into the market or into real estate. Investors planning on living on their investments in future years can't afford to earn 1% on a bond because that is less than inflation. That should force money into equities but Europe will have to find a solution before the herd changes direction. One analyst said "investors are talking bullish but investing bearish."
You would think the bearish sentiment would be a lot higher given the events in Europe. Late Friday Germany invaded Greece, at least on a fiscal level. Germany is moving to control Greek spending and the backlash is going to be huge. Reportedly Germany is demanding that Greece turn over control of its budget to a person appointed by the Eurogroup. He will have the task of ensuring budgetary control. He will have the power to a) implement a centralized reporting and surveillance system covering all major blocks of expenditure in the Greek budget, b) to veto decisions not in line with the budgetary targets set by the Troika and c) will be tasked to ensure compliance with the above mentioned rule to prioritize debt service. Greece has to ensure that the new surveillance mechanism is fully enshrined in national law, preferably through constitutional amendment. This language was extracted from the "Assurance of Compliance" rules being discussed for the new 130 billion euro bailout. These measures are required because Greece can't be trusted. They have lied repeatedly about budgets in the past and even produced bogus documents to try and cover up expenditures. They have never met a deadline or an agreed upon austerity promise.
Greece is not going to let Germany or the EU tell them what checks they can write with the priority being debt repayments. Elsewhere in the discussion documents Greece has to shrink its public workforce by 150,000. This is a challenge because public workers are guaranteed jobs for life. They cannot be fired, they have short work weeks and they get to retire earlier than anyone else in Europe. There will be riots.
I have been telling readers for the last year Greece will default. They will tell Europe to take a hike rather than give up their sovereignty for the next 30 years. Late, late Friday night the press was reporting that Angela Merkel now believes Greece will default.
On Saturday an article appeared on Examiner.com by Nick Doms asserting Greece will default. "Greece plans an orderly exit out of the Eurozone according to two sources close to Mr. Papademos, Greek Prime Minister, who spoke on condition of anonymity earlier today.â€¨â€¨The sources confirmed that plans are ready to return to a legacy currency given the current circumstances and that such exit would be dealt with, quote 'in as orderly a fashion as possible' â€¦ A Greek exit strategy will probably not be announced officially until early March when the EU finance ministers meet."
That should make interesting headlines on Monday. In another article the chairman of a major German bank said he thought he could get the rest of the German banks to chip in enough money to make Greece go away (as in leave the euro). He also thought Portugal would eventually have to leave and he expects to take a haircut on Irish debt.
After Greece defaults Portugal will be next and then Spain. Did you know that unemployment in Spain is 22.85%? For those under 30 the rate is almost 50%. Good thing all their health care is paid by the government.
On Friday Fitch downgraded Italy, Belgium, Cyprus and Slovenia. Nobody even blinked. There are more downgrades on the way and nobody seems to care. The ECB floated the European boat with half a trillion euros of LTRO three year loans and the interest rate pressure is off for most countries. They are going to do it again in February. The can kicking will eventually end and those without debt insurance will pay a frightful price. With those long term loans that may not happen for a couple years now so Bobby McFerrin "Don't Worry, Be Happy" song applies. Maybe that is why the bearish sentiment is so low.
The U.S. markets may have touched new multi-month highs midweek but they ended the week almost perfectly flat. The S&P was up less than one point for the week. However, support at 1310 went one more day without being tested. There were no gains but there were no losses either. Earnings are failing to impress and most investors don't realize how bad they actually are if you remove Apple and AIG.
There are rumors of a debt deal in Greece on that private sector haircut. They are talking about giving them a 30 year bond with a variable interest rate. We will see if that turns out to be the case or more importantly, will it actually matter?
If the headlines on Monday are about a "debt deal done" instead of "Germany invades Greece" then maybe it will matter for the markets. Otherwise we will be faced with what could be disappointing payroll reports as our market motivation.
The lack of any material reason for equities to rise other than record low interest rates and the falling dollar makes me wonder how much longer this rally will last. S&P support at 1310 followed by 1280 will be the key levels to watch.
S&P Chart - 60 Min
S&P Chart - Daily
The Dow was handicapped on Friday by a -2.63 drop in Chevron and a corresponding drop in Exxon in sympathy. Only two Dow components were positive, AA and UTX. The Dow ran into a brick wall at the 12,750-12,800 resistance level and it has been rock solid. However the declines have been minimal. Friday's -74 points was the biggest drop in weeks but it never came close to support at 12,600. Eventually some headline is going to catch everyone looking the wrong way and we will get a decent drop but so far failing countries and ugly earnings have been unable to produce that event. If 12,600 were to break the next material support is 12,300.
The Nasdaq Composite chart is not sending any signals. It did hold over 2800 for three consecutive days and that is slightly bullish. However, it is not punching through to test the summer resistance highs as the Dow and S&P have done. Techs may be outperforming for the week but with tech earnings minus Apple at -2.9% for the quarter eventually investors will catch on. Current support is 2800 followed by 2775.
The Nasdaq 100 big cap index ($NDX) is the strongest index with a breakout to a ten year high and it held the gains. The Facebook IPO should help to keep techs positive even though most of the stocks in the index have no relation to Facebook. Good news creates positive sentiment across the entire sector.
The NDX should return to test that prior resistance at 2415-2425 and a rebound from there to a new high would be very bullish.
Nasdaq 100 Chart
The S&P-100 big cap index ($OEX) is also holding the high ground just under strong resistance at 600. When taken in conjunction to the strong Nasdaq 100 big caps it simply proves fund managers are still using big caps as liquidity deposits. They are nervous about the market and considering the historical trend for late January declines they have good right to be. However, the Russell 2000 closed at a new six month high and that suggests they may finally be rotating some money out of those high liquidity stocks. That is a telling indicator if it continues.
Confounding the wise the Russell small caps posted a strong gain on Friday and closed at a six month high when the blue chips were weak. They are still a long way from material resistance but strength in this market is bullish. I have been saying to watch for a rotation from big caps to small caps as evidence of improving investor sentiment and Friday was a step in the right direction.
Russell Chart - Daily
I am moving from cautiously bullish in prior weeks to dumbfounded as the market continues to hold its gains with the earnings picture turning so negative and events in Europe taking what seems to be a negative turn. Clearly the desire for any return is motivating some fund managers to put money to work although I don't know where the money is coming from since domestic equity funds have seen outflows in four of the last five weeks.
The only thing I can attribute the gains to is the falling dollar. That is pushing up commodities and apparently equities to some extent. However, with events in Europe worsening the euro could take a serious tumble any day now. If the debt swap deal in Greece gets done soon I am sure that will obscure the bigger picture for a few days and that may give the euro a little more breathing room but as the default talk on Greece and Portugal increases the euro will lose ground. John Mauldin and others are still expecting it to reach parity with the dollar and that would be disastrous for stocks and commodities and represent a 20% gain in the dollar.
Contrary to conventional wisdom I don't think the Fed did us a favor by extending the low rate pledge for another year. Anyone who was thinking about buying a house in 2012 to take advantage of the low rates now has no incentive to hurry. They have a couple years to watch and wait and see if housing prices are going lower. Sometimes a short deadline is a good thing. Extending the free lunch for another 18 months just removed the deadline pressure.
With U.S. growth expected to be around 2.0% for the rest of 2012 and possibly lower given the poor guidance we have seen with earnings, I don't see a strong outlook for equities long term. Obviously that view will change weekly as events unfold but there are so many clouds on the horizon it is tough to see clearly. I would continue to be cautiously bullish based solely on the charts rather than fundamentals and I would look to change that position quickly if we begin to see support levels being tested instead of resistance. The trend is your friend until it ends and a drop under 1310 would be the first warning sign of a detour ahead.
The EOY special is over but we have a few (three) packets left. First come, first served. When they are gone they are gone. 2011 Special
Send Jim an email
"The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens."
John Maynard Keynes