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Posted Wed Nov 19, 04:47 pm ET
by Dirk van Dijk, CFA
In October, the Consumer Price Index [CPI] fell 1.0%, its largest decline ever (since the stats started being kept in 1947), although prices are still 3.7% higher than a year ago. Inflation is, like, so last summer, as an economic concern.
The decline in prices was led by a 8.6% decline in energy costs, which follows declines of 1.9% in September and 3.1% in August. Food prices rose just 0.3%, but are still up 6.1% year over year.
In addition to energy, prices also fell for apparel (retailers desperate to get customers in the door) and prices for both new and used autos also fell. But even stripping out food and energy prices, the core CPI fell 0.1%.
Under normal conditions, this would be a huge green light for the Fed to cut the Fed funds rate. However, these are not normal conditions. The Fed funds official target rate is just 1.0%, and even that overstates things since the effective Fed funds rate is just 0.37%. Thus, even if the Fed were to cut by another 50 basis points in December, it would still be behind the curve with the market. On the official target rate, there are just four 25 basis-point bullets left in the gun, and it is not clear just how effective those bullets would be.
The velocity of money is slowing like it never has before, or at least since the 1930's. "Velocity" is the technical term for people just sitting on their wallets and banks just stuffing every spare dollar into 3-month T-bills. This is very important since nominal GDP is equal to the amount of money in circulation times the velocity of that money.
Falling prices are one symptom of declining velocity, which is not offset by higher money supply -- falling output is the other symptom. The yield on the 3-month bill is back down to a measly 4 basis points, almost as bad as the worst point of the September credit crunch. This is the moral equivalent of a bank simply putting every last dollar it has into the vault, closing it up and setting the time lock on it for 2009. The Fed desperately needs to ease monetary policy, but its key tool for doing so is at a point where it will no longer work very well. The Fed is now at the point where it is pushing on a string. What are the Fed's options?
1) It could try to convince the markets that short-term rates will stay low for longer than the market currently expects. This would bring down longer-term rates which would help stimulate the economy. I'm not really sure how credible that the Fed can be in doing this.
2) It can change the composition of the Fed balance sheet. Under normal conditions the Fed holds Treasury securities across the whole maturity spectrum, but heavily weighted towards the short-end of the curve (the average maturity is usually well under four years). However, the Fed has already lent out most of its Treasury securities under its various alphabet soup liquidity programs. The collateral the Fed currently holds is probably of lower quality than that of your average pawn shop on the wrong side of the tracks.
Still, selling short-term bills and buying longer-term bonds would help bring down longer-term yields, at least for Treasury securites. However, several key market rates have disconnected themselves from Treasury rates of the same maturity (i.e. spreads have widened dramatically), so such a policy might not have that much economic impact.
3) The Fed could simply continue to increase the size of its balance sheet by outright buying longer-term T-notes on the open market. In the process, it causes the banks to replace interest-bearing T-notes for non-interest-bearing reserves, which the banks can thus lend out. This is the functional equivelent of "turning on the printing presses." This is a direct attempt to cause inflation to offset the deflation. The size of the Fed Balance sheet has already been ballooning, having more than doubled since mid-September.
In other words, it looks like the Fed has been trying to do the right things, but it still is not working. The massive increase in the money supply that is implied by the huge expansion of the balance sheet does carry dangers. Monetary policy tends to work with very long lags, and the data the Fed has to work with is far from perfect. There is a real danger of an overshoot, which could cause very significant inflation, even to the point of hyperinflation down the road. This is not a path that central bankers like to go down, but at this point it looks like they have little choice.
Given the likely ineffectiveness of monetary policy at this point, I would continue to avoid stocks like JP Morgan Chase (JPM) and Citigroup (C).
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Posted Wed Nov 19, 03:42 pm ET
by Sheraz Mian
EOG Resources, Inc. (EOG) is a major independent oil and gas exploration and production company, with operations in the U.S., Canada, offshore Trinidad, and the U.K. North Sea. The company has historically concentrated on natural gas in preference to exploring for oil.
EOG's third-quarter earnings of $588.3 million were up sharply from the year-earlier level, driven by increased volumes and improved commodity-price realizations, partly offset by higher costs. Domestic natural gas production grew 20%, while liquids volumes rose 65% over last year.
With robust growth from most of its core areas, EOG remains on track to increase production by 15% this year and approximately 12% in 2009. With $886 million in cash and a net debt to total capitalization ratio of 10%, the company is in a strong financial position to face the current downturn in the energy sector.
We maintain our Buy recommendation on EOG shares and see the stock as a core holding in the large-cap E&P space.
Read the full analyst report on EOG.
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Posted Wed Nov 19, 03:17 pm ET
by Ken Nagy, CFA
Intellon Corporation (ITLN) is a fabless semiconductor company that designs, develops, manufactures, and markets integrated circuits (ICs) for powerline communications or high-speed communications over existing electrical wiring. September top- and bottom-line results met consensus estimates as home networks continue to grow.
Margins are trending up and we see the string of quarterly losses ending in the second half of 2008. The weak macro environment could provide a short-term tail wind as homeowners may upgrade home networks in lieu of taking vacations.
We rate the stock a Buy and adjust our price target of $5.00. Regardless of the short-term tail wind, Intellon Corp. should outgrow the broader semiconductor market. Our price target represents a 27.7x multiple to 2009 earnings.
Read the full analyst report on ITLN.
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Posted Wed Nov 19, 02:37 pm ET
by Paul Raman, CFA
ArvinMeritor, Inc. (ARM) has earned a leading position in most of the markets it serves. Presently, the company is planning to spin off its Light Vehicle Systems (LVS) business. The company is undergoing dramatic cost reductions through its profit improvement initiative "Performance Plus." It is also expanding geographically and outsourcing to low-cost countries.
However, difficult conditions in North American and West European automotive markets are primary concerns for the company. Downturn in the auto industry, which took automakers such as General Motors Corporation (GM) on the verge of bankruptcy, makes us apprehensive about the near term prospects for auto suppliers such as ARM.
Production cuts, coupled with rising steel and fuel prices, lead us to rate the shares a Hold with a target price of $3.00.
Read the full analyst report on ARM.
Read the full analyst report on GM.
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Posted Wed Nov 19, 02:11 pm ET
by David Weissman, CFA
Orbcomm Inc. (ORBC), a leading provider of wireless (satellite) messaging services, declared third quarter 2008 financial results, in-line with our estimates. While we view the satellite business to be extremely competitive, not to mention low margin and expensive to operate, we also believe the barriers to entry for such services are substantial.
Should higher demand applications emerge, such barriers may lead Orbcomm to higher valuations. However, though original equipment manufacturer (OEM) customers and an increased subscriber base contributed to improved service revenues, the company's depleting cash position, coupled with weaker-than-expected cash from operations, may not be sufficient to fund capital spending objectives associated with emerging applications.
We maintain our Hold rating with a reduced valuation target in view of near-term concerns and general equity market conditions. We continue to assess Orbcomm's business expansion initiative across Asia and the Americas.
Nalak Das contributed to this report.
Read the full analyst report on ORBC.
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Posted Wed Nov 19, 01:46 pm ET
by Claudio Freitas, CFA
Companhia Siderurgica Nacional (SID) produces hot- and cold-rolled flat steel, galvanized sheets, and tin plates for the packaging, automotive, and construction industries. Companhia Siderurgica Nacional's integrated steel-making complex in Latin America has the capacity of producing five million tons of crude steel per year.
We are downgrading our recommendation on Companhia Siderurgica Nacional from Buy to Hold based on the international economic slowdown, which creates a challenging business environment for the steel industry. The company's third quarter operating results were solid and the Namisa deal was very positive.
Nevertheless, the loss in odd derivative instruments, the recent decline in steel prices and the falling demand in US and Europe during a recession is a major concern for short term.
Read the full analyst report on SID.
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Posted Wed Nov 19, 01:20 pm ET
by Ann Heffron, CFA
We are maintaining our Hold on Barclays PLC (BCS), but cutting our target price to $9.25. In its third quarter trading update, Barclays noted that profit before tax for the 2008's first nine months was slightly ahead of 2007. Revenue growth was strong, and costs grew broadly in line with the rate of income growth.
Impairment charges grew at a similar rate to the first half of 2008. Barclays announced £7.3 billion of new capital, including £3 billion of reserve capital instruments, with an associated issue of warrants, and £4.3 billion of mandatorily convertible notes.
We are reducing our EPADS estimates to $3.22 from $3.80 for 2008 and to $2.08 from $4.20 for 2009, mainly due to dilution caused from the capital raising and appreciation of the $ against the £. We expect results to reflect global markets turmoil, economic weakening, and the recent $1.75 billion acquisition of Lehman Brothers North American operations. Barclays eliminated its final dividend for 2008.
Read the full analyst report on BCS.
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Posted Wed Nov 19, 12:56 pm ET
by Rob Plaza, CFA
Ctrip.com International, Ltd. (CTRP) reported third quarter results that were in-line with market expectations. However, the company's fourth quarter sales guidance was well below expectations.
We were already below consensus with our fourth quarter EPS estimate, so our 2008 EPS stays at $0.89. However, we lowered our 2009 EPS estimate from $1.11 to $0.96, as we believe the weakening sales trends will continue into the first half of 2009.
The company's near-term prospects have deteriorated because slowing global economic growth has reduced the demand for travel-related services, and that is hurting Ctrip.com's revenues and margins. Longer term, Ctrip.com is well positioned to generate strong growth as more Chinese consumers use online travel-related services. We maintain our Hold rating on CTRP shares.
Read the full analyst report on CTRP.
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Posted Wed Nov 19, 12:30 pm ET
by Paul Raman, CFA
Cliffs Natural Resources Inc (CLF) expects to benefit from robust industrial growth in China and India, which are pushing demand for steel, fueling higher demand for iron ore. However, the company is suffering from a weak production profile, rising energy costs, and high customer concentration.
Recently, it terminated the definitive merger agreement with Alpha Natural Resources, which would have created the largest North American producer of metallurgical coal. Combination of these factors lead us to rate the shares a Hold with a target of $20.00.
In 2008, Cliffs expects revenue per ton in its North American Iron Ore segment to average $91. The company indicated that revenue per ton in its North American Coal segment is expected to average $93 for 2008. Cliffs' Asia-Pacific Iron Ore segment expects average per-ton revenue to be $98.
Read the full analyst report on CLF.
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Posted Wed Nov 19, 11:56 am ET
by Dirk van Dijk, CFA
The news on the housing front continues to be bad from the standpoint of overall residential investment. However, this may be a case where bad news is actually good news.
With far too much inventory still on the market, the last thing we need is more new homes adding to the glut. This is just a simple collerlary to the first law of holes: When you find yourself in one, stop digging. In this case it is literal, as in stop digging new foundations. Still, this does mean that unemployment will continue to rise in the construction industry. In the official statistics the effect will be muted, since so many construction workers are independent contracters (1099) rather than employees (W-2).
In October, housing starts fell to a seasonally adjusted annual rate of 791,000, down 4.8% from September (828,000, revised up from 817,000) and down 38.0% from a year ago. By region it was a mixed picture, though, with starts plunging 31.0% in the Northeast, and down 13.7% in the Midwest on a monthly basis. Starts actually rose 7.5% in the West and were up 1.5% in the South.
Last month, however, the Northeast was unusually strong, so some of the decline there looks like payback for that. On a year-over-year basis, the Northeast is also the weakest, down 51.6%, followed by the West (-39.1%), the Midwest (-38.2%) while the South was realatively the strongest, if you can call down 33.9% strong.
The extreme weakness in the Northeast this month appears to be tied to the multifamily market, as single family starts were actually unchanged. I suspect the weakness on Wall Street is starting to affect the condo market in New York City and Boston.
The best indicator of future housing starts is building permits, and they were even softer than the data for starts. In October, they fell to a seasonally adjusted annual rate of 708,000, down 12.0% for the month (from 805,000, revised up from 786,000 origionally reported) and are down 40.1% on a year-over-year basis.
All regions of the country were weak, but the Northeast was by far in the worst shape, falling 23.7%, followed by the South (-13.5%) and the West (-8.8%). The Midwest was relatively strong on a monthly basis, down just 3.7%. On a year-over-year basis, the Northeast is once again the weakest, down 51.0%, followed by the West (-48.0%). On a relative basis, the South (-36.3%) and the Midwest (-39.5%) were the least weak (can't really call down 36.3% "strongest").
Avoid the homebuilders -- they serve NO economic function at this time, nor are they likely to do so for the forseeable future. I am frankly amazed that we have not seen more of the big publicly traded homebuilders like D.R. Horton, Inc. (DHI), Standard Pacific Corp. (SPF) or Beazer Homes USA, Inc. (BZH) file for Chapter 11 yet. I would not consider buying any of them until they are trading for pocket change prices (well under $1 per share).
Stick with large non-cyclical firms with super solid balance sheets instead, like Pfizer Inc. (PFE) or McDonald's Corporation (MCD). Nobody needs to have stocks like the homebuilders in their portfolios. If you want cyclical exposure, there are much better choices in some industrial names like Joy Global Inc. (JOYG) or Honeywell International Inc. (HON).
Read the full analyst report on DHI.
Read the full analyst report on PFE.
Read the full analyst report on MCD.
Read the full analyst report on JOYG.
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Recent PostsConsumer Prices' Biggest Fall Ever
Wed Nov 19, 04:47 pm ET EOG Resources with More Upside
Wed Nov 19, 03:42 pm ET Intellon a Smart Pick-up
Wed Nov 19, 03:17 pm ET ArvinMeritor Stays in Neutral
Wed Nov 19, 02:37 pm ET Orbcomm Tries for Well-Rounded
Wed Nov 19, 02:11 pm ET Brazilian Steeler SID Downgraded
Wed Nov 19, 01:46 pm ET Barclays Target Cut, Still a Hold
Wed Nov 19, 01:20 pm ET Ctrip.com Guiding Lower
Wed Nov 19, 12:56 pm ET Cliffs Near-Term Outlook Neutral
Wed Nov 19, 12:30 pm ET Is Latest Bad News Good News?
Wed Nov 19, 11:56 am ET
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