Nonfarm Payrolls came in stronger than expected to boost the market but the Greek CDS news deflated those gains.
In theory Greece won its second bailout of 130 billion euros by forcing private sector creditors to absorb heavy losses. Enough of the private creditors (85.8%) voted to accept the cram down and enable Greece to enact the collective action clauses to force those who did not accept the deal into the same losses. Art Cashin believes the numbers may have been manipulated. He wrote that some creditors may have offered sweeteners to hold outs in order to get a positive vote and put the problem behind them. If you were holding a CDS on your debt and knew you were going to get 100 cents on the dollar, if triggered, it might have been worth it to offer a few dollars to the holdouts to get the acceptance percentage high enough to trigger the CDS payments.
Late Friday the International Swaps and Derivatives Association (ISDA) declared the forced restructuring of the private sector creditors represented a default and credit default swaps would be triggered. Because this has been expected for such a long time it was not a major event. Reportedly there are only about 3.2 billion euros of unhedged credit default swaps outstanding out of a total of 4,323 contracts. Another 66.8 billion euros of swaps are said to be fully hedged or collateralized and no longer a threat.
The problem with the ISDA declaring a default and triggering the swaps was not related as much to the Greek debt but the swap business in general. If the ISDA had not accepted the Greek default as a "credit event" and not triggered the swaps the financial sector could have imploded. According to The Depository Trust and Clearing Corporation (DTCC) the notional value of outstanding CDS contracts is over $15.7 trillion. A lot of those contracts are written against other European sovereign debt such as Italy, Spain, Portugal, Ireland, etc. If the swaps were not triggered using the Greek cram down model then a CDS contract as insurance for a sovereign default would be void. All those outstanding swaps would be worthless but that is still not the real problem. That would mean that the practice of insuring sovereign debt with a swap would cease and so would the purchasing of that sovereign debt. Weak credits like the rest of the European PIIGS would never be able to sell debt again until their country had paid down existing debt and again become credit worthy. That would not happen in any real life scenario because without access to the public debt markets they would go bankrupt.
The DTCC began tracking CDS in 2003. The only other sovereign debt default to trigger swaps since 2003 was Ecuador in Jan-2009 with a notional value of $473 million. The DTCC provides clearing and settlement operations for financial transactions. They claim the amount of sovereign debt covered by CDS as of March 2nd was $236.5 billion.
By officially calling the Greek debt swap a default and triggering the CDS the market will breathe easier and go back to business as usual in buying and selling debt. The auction date for the Greek debt covered by the CDS has been set for March 19th. The bonds will be auctioned off with the current value around 20 cents, making the CDS payments in the range of 80 cents on the dollar. The vast majority of the CDS contracts have already been collateralized. Since the Lehman failure owners of CDS have required writers of those contracts to begin putting up collateral once it appeared there might be danger of a default. When Greece confessed in 2009 they were in trouble anyone holding a valid CDS contract would have required the writer to begin putting up collateral equivalent to the perceived risk. That means anyone holding a contract today should have required roughly 80% of the contract to be collateralized.
Before Lehman the contracts were allowed to go to default before the writer had to put up money. Everyone just assumed the big banks and brokers would be there to pay up when the default occurred. After the Lehman disaster that assumption went away and now the CDS owners want collateral when conditions begin to turn negative.
When the CDS trigger was announced by ISDA at 2:30 ET the market began losing its gains and sank to the lows of the day. When a monster black hole did not appear in the middle of the financial universe the dip buyers returned just before the close to ensure the markets ended in the green.
Greece should now qualify for its next tranche of funding from the new bailout on March 20th. There will probably be more sticking points but they should be minor. Once that funding occurs Greece should fall off the market radar for several weeks. It will reappear after the April elections as the various commentators begin speculating on whether the newly elected officials will actually follow through on the bailout terms. The general consensus is no. Greece is likely to default on the bailout terms and that will lead to another showdown in the Sept/Oct timeframe.
Most analysts still believe Greece will default in total and eventually leave the euro sometime in 2013. Even the countries providing the bailout funds believe this. They are providing the funds to buy time to recapitalize their banks and allow all the short term sovereign debt they own to mature and be paid off. The same thing happened when Argentina failed in 2002. Short term bailouts gave the financial markets time to prepare by hedging their loans and raising additional capital so the eventual default would not bankrupt the banks as well. The 1.0 trillion euros of cheap three year money the ECB just gave the banks was designed to provide liquidity to keep them afloat until after the eventual Greek default.
Payrolls Increase Again
In the U.S. the Nonfarm Payrolls for February came in better than expected and the prior months saw significant upward revisions. The February headline number showed a gain of +227,000 jobs. The December number was revised higher from +203,000 to +223,000 and the January number rose from +243,000 to +284,000. The trend for the last several months has been upward revisions and that suggests the February number will be revised higher as well. Including the revisions Friday's report showed a gain of +288,000 jobs. The separate Household Survey showed a gain of +428,000 jobs. It was a good day for payrolls.
However, the official U3 unemployment rate did not change at 8.3% despite the spike in new jobs. This is because of an increase of 476,000 people in the workforce. As I have explained in the past the commonly used U3 unemployment rate ONLY counts those people who are still receiving unemployment benefits or are actively looking for work. When the 99 weeks of unemployment insurance expires they drop off the Bureau of Labor Statistics (Nonfarm Payrolls) list. They are assumed to have given up looking for work.
I don't know the mechanics for how the household survey decides they have gone back to looking for work but the survey showed an increase of 476,000 job seekers for February. These are people who have looked for a job in the last five weeks and were moved from the "not looking for work" category to "looking for work" based on responses to the household survey. That meant 12.8 million people were unemployed and looking for work.
Officially there were 154,871,000 people in the labor force at the end of February. 12,806,000 were unemployed and still receiving benefits producing an 8.3% unemployment rate. The U6 unemployment rate declined from 15.1% in January to 14.9% in February and represents 23,075,779 people unemployed or underemployed today. Underemployed means they were forced to take a part time job to pay the bills while they look for full time work. There is a lot of difference between the 12.8 million, 8.3% reported in the news headlines and the 23.1 million actually out of work. In February 2009 there were 12.86 million unemployed. Employment has recovered from the 2010 dip to more than 9% unemployment but we are just now starting to return to levels seen before the recession.
Analysts believe that even with strong job gains in the coming months the actual unemployment rate may not change much before year end. It may even rise as more discouraged workers begin looking for jobs again and return to a status that puts them back in the count.
If the February jobs number if revised higher next month we will have the start of a very nice trend. Getting across that 250,000 jobs per month threshold will be critical for sentiment and for a lasting recovery. More than 150,000 jobs need to be created every month just to cover the increase in the labor force from recent graduates and immigration. At February's +227,000 gain that represents only a nominal +77,000 increase over that new worker requirement. Of course this is only the nonfarm payrolls.
The market liked the jobs numbers with the Dow rising to 12,968 (+57) in early trading. The Greek news reduced that to a +14 point gain. The S&P actually traded over its multiyear high close at 1374.09 but could not hold the gains.
In the chart below the spike in March-May 2010 was part-time census workers.
Jobless claims have flattened over the last several weeks at just over 350,000 per week. The slight uptick to 362,000 last week could have been related to the big winter storm that caused havoc across the Midwest and Northeast. We need to see claims dip to the 300,000 range to really improve sentiment. That is a level that equates to above average hiring growth.
Jobless Claims Chart
The Monster Employment Index rebounded strongly from the January drop to 133 with a headline number at 143 for February. This was expected. The index measures the number of help-wanted ads and early January is not normally a strong period for ads. The first couple weeks are slow as everyone recovers from the holidays but then ads ramp up as hiring for the new year begins. The number of ads increased by 11% over the same period in 2011.
Transportation and warehousing saw a +36% increase, agriculture and forestry ads rose +32% and retail trade +22%. The only sector seeing a decline in ads was public administration at -8%.
The International Trade Deficit for January widened to -$52.6 billion and the third consecutive monthly increase. This is the largest deficit since October 2008. The goods deficit has increased more than $9 billion over the last three months and the most for any three-month period since 2005. You can thank the high cost of crude and imported gasoline for much of that increase with petroleum accounting for $12.1 billion. Automakers were doing their best to lower the deficit with a +8.8% increase in exports. Unfortunately there was a +9.1% increase in foreign auto imports to offset those U.S. exports.
The economic calendar for next week has two important events. The Fed meeting on Tuesday could be a significant problem. The sudden improvement in economic activity may cause the Fed to rethink their "low rates until 2014" scenario. Even if the Fed is thinking about making a change in the statement I would expect them to wait until the two-day meeting in late April to announce it. That will give them another month of data, give them two days to discuss it and the quarterly Bernanke press conference afterwards to explain any change.
The Tuesday announcement will be scoured for any sign of a QE3 or Twist-2. With this being an election year the timeframe is quickly passing for any changes to policy. The Fed does not like to make changes in an election year. This one is especially troublesome with some of the presidential candidates running on a platform hostile to the Fed. Ron Paul is openly hostile and while there is little chance of him being elected the message is still being preached to millions of voters. To put it bluntly I think Bernanke's days are numbered. Odds are about 100% that his appointment will not be renewed in January 2014.
Knowing he will likely lose his job may put Bernanke in the position of wanting to take one more big step to make sure the economy is going to recover. He will want to leave a legacy that is marked by a strong recovery rather than years of a plodding economy. That step could be another QE program of some type or some new program to stimulate investment in the economy. Since the Fed will be sidelined after the April in order to avoid political impact his time is running short. You may remember he alluded to QE2 in August 2010 but refrained from actually announcing it until the day after the elections in November of that year.
The second event of note for next week is the Philly Fed Manufacturing Survey. The Philly Fed is seen as the most important of the regional Fed reports. It tracks closely with the monthly ISM Manufacturing report. Expectations are for a strong gain that pushes it to an 11-month high at 12.0. The Index was as low as -22.7 in August.
I put the Greek CDS auction on the calendar but I doubt it will have any market impact. The press coverage will be minimal since the result is already known.
The strong jobs report pushed the dollar to a new two month high and a gain of more than 1%. That is a monster one day move for a currency. This should have depressed stocks and commodities but they were also up on hopes for a stronger economy.
The euro dropped sharply after the EU reported the economy contracted last quarter. That should have been no surprise. The ECB also held its benchmark interest rate at 1.0%. With the EU economy weakening and the U.S. economy improving the dollar rise, euro decline trend could continue in the weeks ahead.
Dollar Index Chart
Brent crude traded over $125 intraday and WTI over $108 despite the spike in the dollar. This is very rare to have both oil and dollars moving in the same direction and that suggests investors were bullish on the economic outlook.
China reported oil imports that hit record highs of 5.95 million barrels per day in February and +18.5% higher than February 2011. The previous high of 5.67 mbpd was set in September 2010. On a side note China's iron ore imports rose +9.5% from January to 65 million tonnes and +33% higher than February 2011. Copper imports rose +17% from January to 484,569 tonnes and DOUBLE the February 2011 level. China warned that growth could decline to 7.5% for 2012 but their imports are definitely not slacking off.
If China's oil demand remains at the same growth rate in 2012 they would add more than 1.0 mbpd raising demand to more than 7.0 mbpd. That 18% growth in oil demand is not expected to slow appreciably. At only a +15% rate of annual growth their demand will double to 14.25 mbpd in 2017. Of course that assumes that much oil is available. With China's growing wealth it is not China that will be doing without but dozens of smaller, less financially capable countries will be left out in the cold and unable to afford the high price of oil. America will be able to afford it but paying the price will be painful and it will produce a significant economic burden. The only thing that will prevent a significantly higher price for oil by 2017, as in $150-$175 per barrel is the resulting fuel price recession long before we get to those lofty levels.
OPEC production for February rose to 30.97 mbpd and nearly a million barrels more than their stated production target of 30.0 mbpd. This was the highest rate of OPEC production since November 2008. OPEC lowered its non-OPEC production growth estimates to +600,000 bpd in 2012, down -160,000 from estimates just last month. OPEC also said Iran produced 3.42 mbpd in February compared to 3.46 mbpd in January. Apparently the impact from sanctions has not yet been felt as much as outsiders believed, OR, Iran is simply misstating the numbers. I believe that is the most likely explanation. Eventually their continued production at these levels will fill all available storage and they will be forced to cut back.
WTI Crude Oil Chart
Brent Crude Chart
In stock news Green Mountain Coffee Roasters (GMCR) was roasted after Starbucks (SBUX) announced a single serve coffee machine. Shares of GMCR fell -16% on the news. GMCR is one of those stocks that you either love or hate or maybe love to hate. Their control of the single serve coffee market is unshaken despite the Starbucks entry.
The Starbucks machine is called Verismo and is primarily an espresso-based single cup brewer. However, it is thought besides complex drinks like lattes the machine will also be able to brew regular coffee. Starbucks said it did not think the Verismo would hurt its relationship with GMCR. In their announcement Starbucks only mentioned lattes, not regular coffee.
Green Mountain filed a comment with the SEC saying espresso machines only represented 2.7% of the total coffee units sold in the U.S. in 2011. "Prior to the press release issued by Starbucks yesterday and their subsequent public comments, we were not made aware of any additional capabilities of their planned espresso system. We look forward to learning more about Starbucks' new espresso system as it moves toward launch and to continuing to grow the single-serve filtered-coffee opportunity in North America with our Keurig system partners, including Starbucks." GMCR also said they were working with Luigi Lavazza SPA to co-develop a new single-serve espresso-based machine that would complement the Keurig Single Cup Brewers.
Wal-Mart will soon sell a single serve machine called the Nestle's Nespresso. They are currently the world leader in single serve coffee sales if you believe the advertising.
When I started researching the facts on the GMCR/SBUX news I had thought about recommending GMCR as a buy the dip play. I have a Keurig brewer and love it. However, while I do think GMCR will bounce short term I did find more reasons not to be bullish on GMCR than I expected. With a PE of 45 and strong competitors coming out of the woodwork I had to rethink my position.
Starbucks is going to be a strong competitor. Even if their machine is not a straight 1:1 replacement for the Keurig they still have the Starbucks name behind them and that is a fanatical following. Also, quite a large percentage of Starbucks coffee sales are not plain coffee but complex drinks. If they have a machine that can make brewing those drinks as simple as the Keurig brews simple coffee then it will be a major hit.
I think SBUX is the long term play. The machine will not be out until September so we have plenty of time. I would buy GMCR in anticipation of a quick bounce and then bail with a quick profit. I would look for a return to the 50-day average on SBUX and buy them for a long term hold. They are a buy just for their brick and mortar store expansion and the Verismo will be one more profit center for them.
Texas Instruments (TXN) warned for Q1 and blamed the earnings miss on Amazon (AMZN) and Research in Motion (RIMM). TI said a shortfall in sales of its OMAP application processor was to blame for the decline in estimates. This processor is used in tablets including the Kindle Fire and the tablets from RIMM and Nokia. TXN said they saw a rapid ramp in sales in Q4 as those companies added to inventory ahead of the holiday season and they expected sales to slow in Q1. However, TI said "the Q1 demand is lower than we expected as customers (AMZN, RIMM, etc) are now rationalizing their ongoing expectations against their existing inventory." Several analysts blamed a sharp slowdown in post holiday Kindle Fire sales as the main reason for the warning.
TXN shares were flat on Friday but Amazon shares lost $3 on the news. With a PE of 133 Amazon is another stock traders love to hate. Billions have been lost trying to short it over the years but everyone keeps trying. The post earnings decline in Q4 was the best run for the shorts in recent memory but you have to have nerves of steel to maintain a short or long position in Amazon. Volatility is extreme and like this warning from Texas Instruments the news can come from anywhere. Eventually Amazon will have to give up growth and start making profits but that does not appear to be on Jeff Bezos radar today. He is still building like Amazon is going to dominate the entire retail word and laughing all the way to the bank.
Altera (ALTR) also warned that slow Q1 sales would cause them to miss prior estimates. Altera said revenue would be down 7-9% sequentially compared to prior estimates of 5-9%. Altera said programmable chip sales would be at the low end of prior guidance due to slow demand and high customer inventory. Surprisingly shares of ALTR rose +1.5%.
Apple (AAPL) shares fell from $547 to $521 the two days before the iPad announcement with help by the market drop early in the week. The announcement was as expected but no further selling appeared. Even news the iPad website was down for hours on Wednesday afternoon and evening failed to dull investor enthusiasm. I wanted to order one but my excitement faded after trying for hours to reach the site.
Apple shares returned to $547 on Friday and came to the same dead stop that we saw last week. This level appears to be decent resistance and there are not enough buyers with conviction to push the stock higher.
Apple iPad Order Page
Friday was the third anniversary of the bear market bottom on March 9th, 2009. The rebound from that low has been dramatic but not without a lot of volatility along the way. The summer doldrums in 2010 and 2011 saw several months of gains erased but eventually recovered. The tables below show the gains of various indexes, commodities and stocks. While equities and indexes hit their lows on March 9th the price of oil bottomed on Feb 12th. I am sure wishing I had that time machine I spoke about before. Buying a few thousand shares of Fossil or International Paper would have certainly helped a retirement account.
Index & Commodity Gains
Stock Gains From 2009 Lows
The S&P rebounded to temporarily trade over the 1374.09 high close from March 1st but it could not hold the gains. The news about the credit default swaps being triggered caused a knee jerk reaction even though everyone already assumed it would happen. I am sure there was also a fair amount of profit taking from the three day bounce. Going into the weekend with the Greek CDS unknown with a lot of paper profits was not something a lot of traders wanted to do.
Next week is going to be very interesting. The FOMC meeting can be a blessing or a curse and it is a quadruple witching expiration. With resistance so well defined it may take a new headline to push us higher. With daily earnings warnings I don't know where that headline will come from unless it is the Fed.
Support is 1340 but retesting it again soon would probably see it fail. A move over 1380 could trigger a new leg higher but volume is not showing any conviction. The last three days have produced gains but the average volume was only 5.9 billion shares per day. That is very anemic for the market to be back at the recent highs. On Friday up volume was only 2:1 over down volume. Of course it was a Friday with high headline risk. I would not have expected a lot of buyers.
Hopefully, with the CDS headline behind us and the EU saying they would distribute the first tranche of the 130 billion euro bailout immediately, the Greek cloud will be temporarily lifted from the market.
The Dow chart is far less bullish than the S&P. The Dow has a rounding top pattern from late February and the Friday high appeared to be a continuation of that pattern. Support at 12,750 held on the Tuesday dip but the rebound was lackluster. The Dow needs to gain another 100 points to put it back at the resistance that held for the prior two weeks. Just getting to that level could be a struggle and moving higher from there could be a serious challenge.
Support at 12,750 may not hold if tested again. If the Dow was to breakout the next resistance would be in the 13,125-13,150 range.
Dow Chart - 180 Min
Dow Chart - Daily
The Nasdaq mirrored the S&P with a return to prior resistance just below 3,000. Apple helped on Thursday but was flat on Friday with only a $3 gain. Google lost -$7. It is amazing the Nasdaq made any gains at all after the Texas Instruments and Altera earnings warnings on Thursday night. The Semiconductor Index ($SOX) actually gained more than +1% on Friday so conventional wisdom would have been wrong in anticipating a semiconductor decline.
Nasdaq volume was nearly 3:1 positive for the last three days so evidently those investors coming back to the market after Tuesday's dip were looking for tech stocks.
Support is well back at 2,900 and like the other indexes if that level is tested again I would not expect it to hold. Resistance is the large round number at 3,000 and what would be a psychological victory if it is broken.
Nasdaq Chart - 180 Min
The Russell 2000 chart looks like the Dow. The rebound stalled at 820 and well below the strong resistance that held for all of February. The rebound from 785 was slow to start on Wednesday but accelerated on Thursday. I would have been much happier if the Russell had recovered to the 830 resistance level similar to the S&P and Nasdaq. This stall at 820 suggests the willing buyers have run out of money. It is one thing to buy a dip but it requires a different type of conviction to buy just under resistance. That conviction appears to be lacking.
Russell 2000 Chart
Will the Greece bailout funding grease the market wheels and allow the Dow to move over 13,000? Who knows since the eventual bailout conclusion has been baked into the market for some time? Everyone assumed it would eventually get done simply because the impact of a disorderly default was too dramatic to allow.
Maybe the real question is who will be the next Greece? Did you really think now that Greece is about to fade from the headlines that another country would not take their place? Portugal appears to be heading for the cliff. The yield on the Portuguese 5-year bonds is now at record highs of 19.8%. A year ago they were only 6%. A year ago the yield on the 5-year Greek bonds was 12%. Today those yields are more than 50%. FYI - the new Greek debt that is going to be swapped for the old debt is trading in the when-issued market at 71% to 79% of face value. Apparently investors are not confident that debt will survive the eventual Greek default on all debt. Spain and Italy are right behind Portugal although Italy has firmed up slightly.
Spain told the EU last week its budget deficit for 2012 would be 5.8% of GDP rather than the 4.4% they had promised. That was a day after they signed the new fiscal pact vowing even lower deficits in the future. The EU is demanding they stick to the 4.4% number but that is impossible. Last year their agreed target was a 6.0% deficit and the actual deficit was 8.5% before the year was over. They will be very lucky if the actual 2012 deficit is not 8.5% again. Unemployment rose +2.4% month over month in February. Under age 25 unemployment is 50% and that is the part of the population that is causing trouble with riots and civil unrest. Spain is too big to save unless the ECB decides to loan them unlimited amounts of money over the next ten years. The private sector is not going to want to loan any PIIGS country money after the haircut in Greece. There is already talk of a haircut process in Portugal. What works for one country is quickly seized as a possibility by others.
The LTRO 1&2 of 1.1 trillion euros has solved the liquidity problem for Europe for the next several months. Eventually those cash reserves will dry up and the sovereign yield problems will start to make headlines again.
Everyone has probably forgotten the liquidity swap program the Federal Reserve announced back in November. The Fed, the Bank of Canada, Bank of England, Bank of Japan, ECB and the Swiss National Bank announced on November 30th they were opening unlimited currency swap lines from Dec 5th through February 1st 2013. Basically the Fed makes dollars available to the other central banks to cover "liquidity shortfalls" in their member banks. They announced it as a six bank deal but in reality it was five banks supporting the ECB. This is another QE program. The Fed loans newly created digital dollars to the ECB, which in turn loans those dollars to European banks to cover the outflow of funds to depositors. In theory those member banks will eventually become liquid again and repay the ECB and the ECB will repay the Fed. I am not holding my breath on that. This is one more European problem that can come back and bite us in 2013.
The equity market will probably overlook those future concerns over the next Greece and instead focus on the FOMC meeting and the potential for QE3 or Twist-2. The strong jobs numbers should have improved investor sentiment and the strongest homebuyer traffic since 2005 suggests consumer sentiment is also improving. Both of those factors should help the equity market assuming there is not a new headline on Monday to give traders something else to worry about.
If you don't set your clock forward an hour this weekend you will miss the first hour of trading on Monday. This is the weekend daylight savings time forces you to touch every clock in your house and car to account for that time shift. Spring one hour forward Saturday night.
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