Toro's Running of the Bulls Market Blog

Companies Do Not Trust European Stress Tests

Should you? 

From the FT

Leading UK and continental European companies are increasingly shunning banks from Spain, Italy and even Germany because they do not believe the Europe-wide stress testing of banks gave a true picture of their financial health.

Corporate treasurers from groups with revenues of more than $240bn told the Financial Times they were conducting their own tests to gauge for themselves banks’ robustness.

“What we are increasingly concerned about is credit risk,” said the treasurer of one of Germany’s largest industrial companies. “Even after the stress tests, we have to ask ourselves: are the banks healthy? The tests have opened up more questions than they have answered, especially here in Germany.”

Stuart Siddall, chief executive of the Association of Corporate Treasurers, said companies were taking a more proactive approach to assessing how financially strong banks are: “Everybody is spending a lot more time today on counterparty risk than they did before.”

Counterparty risk – the risk that a bank will default and be unable to meet its obligations – shot up the list of concerns of companies after the Lehman Brothers collapse two years ago.

Those worries had again intensified around the time of the official European bank stress tests in July, several treasurers said.

“There is an element of whether the emperor has any clothes on and what to do if he doesn’t. The stress tests were a joke,” said the treasurer of a large European media company. ...

A treasurer at a FTSE 100 company in the UK said: “We have no business with Spanish banks and a couple of Italian and German banks. If US banks are refusing to deal with these guys, then why should we?”

I doubt this is over.

Seventh Best September in 82 Years on Weak Economic Data

If September were to end today, September 2010 would go down as the seventh best September for the S&P 500 since 1928.  A mere three days into the month, the S&P 500 has risen 5.26%.  On only six other occasions – 1939 (start of World War II) +14.4%; 1950 (price/earnings ratio of 6.9x) +5.6%; 1954 +8.3%; 1996 +5.4%; 1997 (near resolution of the Asian Contagion) +5.32%; and 1998 (bailout of Long-Term Capital Management) +6.2% – has the market done better in September.

Near-term trading is all about newsflow and expectations. The past week offers evidence of this maxim up in spades.

The market soared this week not because the economic news was good.  It was not.  It was mediocre at best.  The market soared because it was not as bad as thought.  Jamming shorts into an illiquid market pushed the indices into the upper end of their four-month trading range.

The market was exceedingly pessimistic going into the month, with all sorts of chatter about a double dip.  Four pieces of data mattered, three of which caused the market to take off like a scalded cat and one that was ignored.

On Wednesday, the August ISM Manufacturing index handily beat expectations.  Perma-bear David Rosenberg detailed concerns about the ISM print, but the market would have none of it as the S&P 500 rose 3% and the Russell 2000 4% on Wednesday.

On Thursday, pending home sales unexpectedly rose 5.2% in July whereas economists were expecting a decline.  Sales declined 2.8% in June and a whopping 29.9% in May after the expiration of the homebuyers’ tax credit.  Whether or not the increase in home sales is a dead cat bounce remains to be seen, but for the moment, the market interpreted the data as the consumer having a pulse.

Friday was the jobs report.  Nonfarm payrolls in August declined 54,000, half of expectations.  Private payrolls rose 67,000, beating expectations of +40,000.  Perhaps more importantly, there were substantial upward revisions, with July revised from -131,000 to -54,000, and June from -221,000 to -175,000.

Interestingly, manufacturing jobs declined by 27,000, even though the jobs component of the ISM survey increased.  Prior to the release, David Rosenberg questioned the jobs component of the ISM, noting inconsistencies in the data.

An increase of 67,000 was the eighth consecutive month of positive private job creation.  However, job creation is still weak.  The prior seven months were; July +107k, June +61k, May +51k, April +241k, March +158k, February +62k, and January +16k.  Private job creation has been positive but August was below the year's average of +99k.  Over the past four months, private sector job growth has average +72k.  Private job growth has decelerated.

This is consistent with the claims data.  Initial jobless claims last week were 475k, above the 2010 average of 465k. The average of initial claims for August was 486k, the highest monthly average this year.  

According to the ISM non-manufacturing index, employment may even be contracting.  The broad index came in lower than expected at 51.5, signaling continued but slowing expansion.  (A reading above 50 implies expansion. A reading below 50 implies contraction.)  However, it was the lowest reading since January.  Given that the market went ga-ga over the ISM manufacturing index and ignored the services index, it should be noted that services are a much bigger part of the economy than manufacturing.

What was more interesting were the components of the index.  Business activity, new orders and order backlog all declined, while employment and new export orders were in outright contraction.  The reading for employment was 48.2, indicating that employment is falling in the services sector of the economy.  Also, inventory sentiment rose, indicating that managers think their inventories are too high.

Net net, the news releases were better than expected but weak in the absolute.  However, in a market where expectations were clearly negative, incrementally positive news can jam the market higher, especially when everyone is at the beach (except of course the machines that run the market, which never go to the beach).

The question now is whether or not the market can break through the fast approaching resistance levels.  My guess is that Tuesday will be up day, as Mutual Fund Monday is deferred because of the long weekend, pushing the market towards the upper end of the trading range.  I think the real test will come later in the week and into the following week as volume comes back into the market.  If volume does not come back into the market, be concerned, even if the market goes up.

The market is a discounting mechanism.  Perhaps the market action of the last three days is signaling that the economy is going to get stronger.  But the economy is going to have to show strength soon.  The data thus far has been weak, consistent with an anemic economy and a market in a trading range. 

 

Dell, HP – Something You Won’t Hear Me Say Anytime Soon

“I want to buy Dell and HP stock.”

Apart from the breathless announcements from CNBC flashing on my screen regarding the bidding war between Dell and HP for 3Par – a company that makes data storage equipment – I have only tangentially been following this farce. 

Frankly, I will proclaim my ignorance.  This may be The Greatest Acquisition in the History of Mankind.  But I am skeptical.

The “winner” to buy 3Par – Hewlett-Packard – will have the privilege of purchasing a company whose stock flatlined around $10 a share over the past year for $33 a share, a full 242% above 3Par’s closing price on August 13 of $9.65 when the bidding frenzy began.

For those not paying attention – which is impossible if you have had CNBC on for more than 10 minutes – HP and Dell have been engaged in a spectacular bidding war for a company most people have never heard of.  On August 16, Dell offered to buy 3Par for $18 a share, nearly double the prior trading day’s closing price.  A week later on Monday August 23, Hewlett-Packard offered to buy 3Par for $24 a share.  On Thursday of that week, Dell upped its bid to $24.30 a share.  Like an antsy day trader who just can’t wait to buy, eight hours later, HP offered $27 per share for 3Par.  Dell then matched HP’s offer the following morning.  Determined to show Dell exactly who was the Baddest on the Block, HP offered $30 a share two-and-a-half hours after Dell's bid.  Both sides cooled their heels over the weekend, and with rumours of Dell readying to up its bid yet again, HP today jacked up its offer to $33 a share, effectively bidding against itself.

In the midst of all this, HP announced a buyback program to repurchase $10 billion of its shares.

Oh, did I mention that HP does not have a CEO?  Former Hewlett-Packard CEO Mark Hurd resigned on August 6 amidst sexual harassment allegations, though both he and the alleged accused denied the charges, which then morphed into accusations that Hurd abused his expense account. So HP has been engaged in a frenzied auction with nobody at the helm.

Surreal.

This frenzied bidding tells me that both companies are saying “We have no growth left so we are willing to crazily bid for a company that the market did not rate three weeks ago.”

HP closed at $39.69 on Thursday.  Dell closed at $12.36.  Ten years ago, HP traded at $62.50, Dell at $43.

Neither will be found in the Toro Portfolio anytime soon.

Market Action, September 2 2010 - Melt-Up

That is what the past few days have been.  Clearly, the market had gotten too pessimistic, including yours truly. 

The catalyst for the melt-up was Wednesday's ISM survey, coming in at a surprising 56.3, handily beating estimates of under 53.  This contradicted several of the regional surveys – Empire Manufacturing, Philly Fed, Chicago Fed – which were more bearish. 

This morning, Housing Sales were better than expected at +5.2%.  Economists were expecting a decline of 1%.  Retail sales have also come in better than expected.

Hence the melt-up.

(Before we get too carried away with housing sales, housing starts the past three months have been as follows; +5.2%, -2.8%, -29.9%, the latter due to the expiration of the homebuyer tax credit.  Thus, it is difficult to say that the housing market is healthy.)

Clearly, Friday’s jobs number is important, especially given the illiquidity in the market.  I said to a colleague this morning that I thought the payrolls data had the ability to move the market much higher.  My rationale was that with pessimism so high and expectations ratcheted down so much, there was a good chance for an upside surprise. 

Given the market action today, however, the bar has been raised for nonfarm payrolls to move the market higher.  The Russell 2000 is up 5% in two days and nearly 8% from its intra-day low last week.  The index is now trading in the middle of its recent trading range.  Likewise, the S&P 500 has clawed back half its losses from August.  The S&P 500 appears to be trading in a well-defined range between 1040 and 1130, and is right back in the middle at 1090.  If the jobs report disappoints, the market could snap back and reverse the gains of the last two days. 

Also bullish for the market has been the reversal of two week groups – banks and the semiconductors.  Unlike the broad indices, both broke down through support last month.  However, both rallied hard Wednesday and Thursday, with the BKX up over 7% from the lows on Tuesday the SOX up 6%.

I am short the semiconductors, which is an industry call, not a market call.  I have traded this group successfully over the past 15 years, and it has been my experience that the first piece of bad news is not usually the last.  It is likely more bad news is coming after Intel’s warning and Cisco’s cautious comments last month.

But will it matter?  Maybe not.  Right now, everything trades off macros.  Correlations are all converging to one.  If the risk trade is back on, industry fundamentals may be irrelevant.