What Matters Most July 20 2009


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Mid-year market review and sector focus.

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  • Welcome to What Matters Most for the week of July 20. I’m Jamie Walter. I’d like to begin by saying that what does matter most is certainly not a one-size-fits-all outfit. In my practice I have some clients who are most interested in growth, some who are more concerned with creating steady streams of income, and still others for whom capital preservation is paramount. Which is why I like to highlight a broad array of topics during these presentations, which sometimes I think should be lengthened by 10 or 15 minutes. What does not change is my goal for these presentations, which is to give you a sense of some of the areas where I focus my attention, and the information I find to be important and most useful. This week we take a look at the markets at mid year, and which areas have lead the way. We’ve come a long way in six months, but I honestly don’t think we’re out of the woods yet. We’ll highlight the income side of the ledger and compare yields across the most commonly used bond classes. As we will see the flight to safety has had an affect there just as it obviously has in equities. In our Vital signs segment were going to keep it close to home and look at some Texas indicators. In critical events gives us look at what’s ahead this week, and that’s in addition to all the earnings reports flying around. So let’s get started.
  • Six months ending March 31 2009 down 11.65 Six months ending June 30 2009 up more than 1% The markets are leading indicators, but have they gotten too far ahead? Recovery is not complete and persistent overhangs still exist. Weak US Jobs Data Labor market in tough shape Job losses decreasing only slowly with the pace of improvement expected to be very gradual Prospects for Additional Stimulus I’m not one who believes the government can spend us out of a recession. I think the likelihood that we see another stimulus package before the first one has been fully implemented is very remote. Also consider there is a sizable political debate on whether Obama’s plan has had or will have a positive effect. I will say that like it or not, I believe it’s too early to tell if stimulus working Much of the impact will develop over time, and you can bet that allocations in the out years were intended to provide in essence patronage during election campaigns. Call me jaded, but that’s how this bunch of incumbents works. A Noteworthy Downside Risk One of the key risks to a delayed recovery is a persisting negative loop between deteriorating financial market conditions and the weakening economy Government policy has sought to short-circuit that loop and in the short term may have been somewhat successful in stabilizing conditions. For how long is the question. Rising labor market stress could conceivably trigger renewed financial sector stress as rising joblessness increases loan delinquencies at a time banks are arguably less able to absorb losses potentially associated with a weakening loan book, thus sustaining the negative cycle.
  • Diversified technology up 24% in the six months ending Q2 Chart is of Ishares Technology Includes software, hardware, backbone IBM reported 18% earnings improvement last week on weak sales MSFT AAPL report earnings this week CSCO is on a fiscal year. They last reported improved earnings in May and their next report comes in August.
  • Another way to exploit technology is to focus more on specific groups such as Internet which was up more than 30% in the six months ending Q2 Chart is of Dow Jones Internet Index Google reported improved Q2 3% inc rev despite sluggish sales; largely due to cost savings which gives us insight into management Amazon reports this week Yahoo repors this week Ebay reports this week
  • QCOM reports this week MOT reports next week JNPR reports this week RIMM reported in June mixed results: rev down from previous qtr but up from prior year
  • Dd reports this week Dow reports next week AA reported improved though still negative PPG reported sales and earnings decline versus last year
  • Dr horton reports in aug Pulte Centex holding special shareholder meeting in aug re their proposed merger. The boards have already approved it. Lennar reported in June $.76 per share loss in Q2 09 which equals its results from a year ago. Even with all the turmoil in this space Lennar still declared a quarterly dividend of $.04 per share, equal to a yield of about 1.5%. Generally home builders reported steady news in June with housing starts rising 3.6% to 582,000 for the second consecutive gain and the highest level since last November. Housing permits rose 8.7% to 563,000 following a 4% gain in May, providing some hint of an uptrend. The NAHB reported homebuilder sentiment rose 2 points in July to 17, the third increase in the last four months and the highest level since last September.
  • SHIP SUPPLY—BULK MARKET for the first half of 2009, Chinese have bought 115 dry cargo units and Greeks 98. The Chinese vessels may well be utilized for domestic transportation, as they were destined for scrap, similar to another recent handful of "scrapped" ships that wound up being renamed and now belong to Chinese shipping companies… maybe this is another form of ship "recycling". PIRACY UPDATE—TANKER MARKET Neither piracy nor its presence in the Gulf of Aden is new, but the main cause for alarm about the situation in Somalia is the exponential growth: there were two attempted attacks in 2004, but 42 in 2007. One result of the heavy pirate presence in the Gulf of Aden is a growing preference among shipowners to re-route through the Cape of Good Hope. While this move effectively reduces the chances of pirate attack, it is both extremely costly and time-consuming. While a standard AG-USG voyage costs $25,000 per day, re-routing increases the rate to $37,100 per day. In addition, the growth of insurance premiums are reported to have risen tenfold in 2008. SHIP SUPPLY -- CONTAINER MARKET Activity for inquiries in the larger sized vessels seems to have firmed up recently. While there is still nowhere near the level of activity needed to buoy to market, it is interesting to note that some operators are still willing to look at larger vessels and take advantage of the huge economies of scale in today’s historically low market. Below panamax size there remains very little to report, which may be a good thing as supply needs to contract across all sectors. We actually may achieve that this year as scrapping is set to outweigh deliveries, which may be the shot in the arm this group needs, and is certainly not getting from the charter market.
  • The yields displayed here are approximate which means you can probably find individual bonds paying as much as 50 bps more on less than the current yield on the index. One year ago when the equities markets were beginning their dramatic spiral downward the corporate bond markets followed right along with them. At the time investors’ appetite for any risk, whether real or perceived, was non-existent so the price of government bonds appreciated as demand for safety increased. At the same time corporate debt was shunned along with equities, sending yields to extremes in both the investment grade space as well as high yield. Some of that ground has been made up as 2009 has seen some bit of volatility in bond prices as investors in a very short period of time have alternated between seeking then avoiding risky investments. Two areas of note appear to exhibit increased levels of risk: California muni’s and financials. The California government is in the midst of a severe budget crisis with all the drama associated with furloughs, budget cuts and state issued IOUs. Given what we’ve been through over the past two years, I think it imprudent to glibly claim that default cannot occur in the tax free space I’m not making a prediction, just re-enforcing the fact that there is no risk-less investment. It is also prudent to approach the US banking with the same caution. While the recovery no doubt is coming, it is likely to be uneven and drawn out, with downside risks persisting for some time. Some banks are favorably positioned, while others notably, commercial lender CIT may be poised for bankruptcy. Additionally, banking giants Citibank and Bank of America are apparently under severe regulatory scrutiny and may be under directives ordering them to improve balance sheets, liquidity and risk management. Finally, the FDIC reported 305 “problem” institutions (with $220 billion in assets) as of March 31, and has reportedly hinted that there may be closer to 500 now—the highest number of institutions at risk of failure since 1993. Thus, we have a long way to go before anything close to normalcy returns to the banking sector, which will likely impose significant headwinds on the economic recovery for some time to come.
  • In our vital signs section we focus on Texas. First up employment figures, which in this chart showing the downward trend that began in late 2008. Evidence of the current recession comes from data on jobs and unemployment, composite gauges of current and future economic activity, various industry measures and anecdotal reports from Texas businesses. These indicators suggest Texas trailed the official December 2007 start of the U.S. recession by at least six months. So far, the state’s economic losses have been moderate compared with the rest of the country’s, which means Texas is still faring better than the nation as a whole. The roots of the rising unemployment rates are different. In the U.S., much of the increase has been due to lost jobs. In Texas, the rate has climbed because of slower but still positive employment gains and faster labor force growth.
  • The energy industry was a key factor in the Texas economy’s relative strength in the first half of 2008. The chart that we have here shows gas prices in green, oil prices in orange and rig count in blue. Texas produces nearly a third of all U.S. natural gas, and it employs almost half the workers in the U.S. oil and gas extraction industry. Primarily because of high prices for natural gas, the Texas rig count by the middle of 2008 was at its highest level since the early 1980s. The economic stimulus felt by rising prices has since deteriorated as oil and gas prices have plummeted. As a result, the Texas rig count fell by 410, or 50 percent, from the end of August to the first week of March ( Chart 4 ). The brunt of the decline has been borne by the land-based natural gas industry. The locations where expensive, nonconventional drilling is used led the upturn. For example in North Texas’ Barnett Shale and the Permian Basin’s tight sands. Because of their higher relative cost these areas will also lead the downturn. Offshore and international activity have held up better and should continue to do so, largely because of the involvement of companies with longer-term perspectives and deeper pockets. As drilling activity slows, layoffs are becoming widespread in the energy industry and are expected to grow in 2009. Related manufacturing activity is experiencing cutbacks, especially among producers of bits, pipe and tools.
  • Some key components of the Texas economy echo the broad measures in showing a sudden weakening in the second half of 2008. Take exports. Aided by a falling dollar and strong energy industry, they were a bright spot the first six months of 2008, surging 12.4 percent. Compared with a year earlier, sales were up 15.2 percent to Europe, 13.2 percent to Latin America and 5.7 percent to Asia. However, slower growth overseas and the dollar’s rising value have curtailed international demand, and Texas exports fell 16 percent from June to November
  • Among the most notable and watched indicators being released this week are:
  • Thank you for joining us. Let’s see if there are any questions from the audience. See you in two weeks.
  • What Matters Most July 20 2009

    1. 1. What Matters Most For July 20, 2009 <ul><li>Mid-Year Review </li></ul><ul><li>Corporate Bonds And Yields </li></ul><ul><li>Vital Signs </li></ul><ul><li>Coming This Week </li></ul>
    2. 2. Mid-Year Review <ul><li>What a difference one quarter makes </li></ul><ul><li>S&P 500 6 months ending: </li></ul><ul><ul><li>Q1 2009: -11% </li></ul></ul><ul><ul><li>Q2 2009: +3% </li></ul></ul>SPY at June 30, 2009
    3. 3. Mid-Year Review <ul><li>Technology up 24% YTD </li></ul><ul><ul><li>Microsoft </li></ul></ul><ul><ul><li>IBM </li></ul></ul><ul><ul><li>Apple </li></ul></ul><ul><ul><li>Cisco </li></ul></ul>IYW at June 30, 2009
    4. 4. Mid-Year Review <ul><li>Internet up 30% YTD </li></ul><ul><ul><li>Google </li></ul></ul><ul><ul><li>Amazon </li></ul></ul><ul><ul><li>Yahoo </li></ul></ul><ul><ul><li>Ebay </li></ul></ul>FDN at June 30, 2009
    5. 5. Mid-Year Review <ul><li>Networking up 38% YTD </li></ul><ul><ul><li>Qualcomm </li></ul></ul><ul><ul><li>Motorola </li></ul></ul><ul><ul><li>RIMM </li></ul></ul><ul><ul><li>Juniper Networks </li></ul></ul>IGN at June 30, 2009
    6. 6. Mid-Year Review <ul><li>Materials up 12% YTD </li></ul><ul><ul><li>DuPont </li></ul></ul><ul><ul><li>Dow </li></ul></ul><ul><ul><li>Alcoa </li></ul></ul><ul><ul><li>PPG </li></ul></ul>IYM at June 30, 2009
    7. 7. * Includes ALL vessels on order * Includes ALL vessels on order Mid-Year Review <ul><li>Homebuilders -1% YTD </li></ul><ul><ul><li>DR Horton </li></ul></ul><ul><ul><li>Pulte </li></ul></ul><ul><ul><li>Centex </li></ul></ul><ul><ul><li>Lennar </li></ul></ul>ITB at June 30, 2009
    8. 8. Mid-Year Review <ul><li>Shipping up 9.4% YTD </li></ul><ul><ul><li>Teekay </li></ul></ul><ul><ul><li>Seaspan </li></ul></ul><ul><ul><li>Frontline </li></ul></ul><ul><ul><li>Eagle Bulk </li></ul></ul>SEA at June 30, 2009
    9. 9. Corporate Bond Market and Yields <ul><li>Risk aversion trades see-sawing </li></ul><ul><ul><li>Ten year maturities </li></ul></ul><ul><ul><ul><li>Treasuries 3% </li></ul></ul></ul><ul><ul><ul><li>Investment Grade 5% </li></ul></ul></ul><ul><ul><ul><li>High Yield 11% </li></ul></ul></ul><ul><ul><ul><li>Muni 3% </li></ul></ul></ul>
    10. 10. Vital Signs <ul><li>A Texas Story </li></ul><ul><ul><li>Job losses begin to reflect national trends </li></ul></ul><ul><ul><li>Economic losses moderate compared with nation </li></ul></ul>
    11. 11. <ul><li>Energy Industry </li></ul><ul><ul><li>Natural gas </li></ul></ul><ul><ul><li>Extraction </li></ul></ul><ul><ul><li>Rig count </li></ul></ul>Vital Signs
    12. 12. Vital Signs <ul><li>Texas Exports </li></ul><ul><ul><li>Falling dollar </li></ul></ul><ul><ul><li>Strong energy </li></ul></ul><ul><ul><li>Suddenly weak </li></ul></ul>
    13. 13. Coming This Week <ul><li>U.S. Consumer Sentiment </li></ul><ul><li>U.S. Existing Home Sales </li></ul><ul><li>U.K. BoE Minutes </li></ul><ul><li>U.K. Retail Sales </li></ul>
    14. 14. Thank you for your participation Information, estimates and opinions contained in this report were obtained from sources we believe to be reliable, but are not guaranteed as to accuracy or completeness. This report has been prepared for informational purposes and is not a solicitation or an offer to buy or sell any security. It does not purport to be a complete description or analysis of the securities, companies, markets or developments referred to herein. All expressions of opinions are subject to change without notice, and we do not undertake to advise you of any change in our figures or recommendations. We, our employees, and/or our officers and directors may from time to time have long or short positions in the securities mentioned herein. The securities mentioned in this report may not be suitable for all types of investors; their value and the income they produce may fluctuate and/or may be adversely affected by exchange rates.