The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Kevin Lane is one of the founding partners of Fusion Analytics, and is the firm’s director of Quantitative Research. He is the main architect for developing their proprietary stock selection models and trading algorithms. Prior to joining Fusion Analytics, Mr. Lane enjoyed success as the Chief Market Strategist for several sell side institutional brokerage firms. In those capacities he oversaw the firms’ research departments. He produced a broad range of widely followed institutional research publications ranging from industry specific notes to quantitative/fundamental reports on individual stocks. His buy side clientele consisted of many of the nations top money managers and hedge fund managers. Mr. Lane is a member of the Market Technicians Association.

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On 3/10/09 we said ” Market internals (ie. the number of advancers to decliners and up volume to down volume) on today’s advance were the most bullish internal readings seen since the move off the 2002 lows … ”

We also said ” When the skew of advancers to decliners and up to down volume is this strong it suggests almost a buying panic on the part of institutions to get back into the market. Additionally these strong internals also suggest that there is a confidence and conviction on the part of institutional buyers”

And last but not least, We said ” That said we believe today’s rally is the start of good move higher (again it may not be the ultimate low – only hindsight will tell us that) however the surge of momentum suggests this rally will be worth participating in. ”

So here we are not many days later and up considerably from where we published those comments and now what ?

We still believe the combination of the market getting really oversold, attractive valuations, excessive negative sentiment, portfolio managers having a lot of cash on hand and the quarter end for many mutual funds coming up (ie. Window dressing time. After all if returns looked poor again more redemptions would follow) (and they last thing they want to show is down another 20+ %) led to a lot of capital redeployment. With the market moving higher quickly even more managers felt they would lag behind their peers and subsequent benchmarks thus even more money (ie. managers chasing the move) came into the market.

In addition was not unrealistic for many to think the stimulus package (no matter what you’re thought on its long term ability to be effective or not) will goose the economy to some degree at some point in the not too distant future. So that said we continue to view this current rally as having legs with maybe another 10 – 15 % up from present levels (So buying on dips with appropriate stop losses would make sense for the time being). We also continue to view this as an opportunity to make money on the long side for a narrow window of time (1 to 3 mos).

However, ultimately we think this rally will fade and we will get a retest of the recent lows (check the history books, we almost always get a retest.) How the market handles that retest will tell us a lot in regards to the longer term picture. We believe tech and growth (since they have the best bases and most constructive chart patterns and corrected much less than the broader market during the down draft) still outperform in regards to sector and style bias respectively during this rally/bounce.

In Barron’s this weekend, one portfolio manager, Felix Zulauf, made an articulate case that this will be a violent rally (900 on the S&P 500) followed by a move to new lows (450 on the S&P 500) with that ultimate bottom coming in 2011. This certainly in plausible and would anyone doubt it after what we saw in the last 12 months ? especially if this is a multi-year secular bear. However we believe at present the best one can get from this market is to try and dissect it and game plan for shorter horizons such as 1 to 3 months until more macro economic data allows for longer term forecasting comfort. This is a market where traders will continue to dominate and thrive (provided you try to capture return both on rallies as well as declines). For the foreseeable future Buy and Hold strategies should be kept on the shelf if one wished to make return.

Look for our full blown reports on the S&P 500 and NASDAQ 100 tomorrow, which will provide greater insight into levels where they rally may peter out.

As always don’t BUY BLIND !! Have an exit strategy before you trade/invest (and stick to it) !!!

Its amazing what you find floating around the intertubes: How awesome is this page?

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http://www.aiginvestments.com/AIG/Fixed+Income/Strategies/Structured+Products.htm

Below is the proposal from the FASB meeting.  My view:

** The change is less meaningful to earnings and income than some people may think.  After all, we have taken the pain all these months, so now most banks are looking forward to writing these assets back up!  And the rule looks like it applies to only L3 assets.

** Some people in DC describe this as a revolution, but our friend Josh Rosner calls it rightly evolution.   Another colleague, Alton Cogert at Strategic Asset Alliance, says that the rule will help insurers avoid both M2M loss and Other Than Temporary Impairment (“OTTI”):

“Under specific direction from Congress, FASB has modified both GAAP accounting’s approach to measuring fair value as well as OTTI. As always, the devil is in the details and these are still proposals, subject to finalization.  But the trend is clear on two basic fronts:

1 – You can separate declines in value due to the credit of an issuer or bond from all other impacts. And, only write down through income the amount subject to credit specific to the issuer or bond.

2 – Fair value is not the last quoted price, if the market isn’t operating in a ‘usual and customary’ manner and there are not multiple bidders. In those situations, you’ve got a distressed value and you can use more analytic approaches to valuation.”

Best,

Chris

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The FASB PROPOSAL

Step 1: Determine whether there are factors present that indicate that the market for the

asset is not active at the measurement date. Factors include:

a. Few recent transactions (based on volume and level of activity in the market).

Thus, there is not sufficient frequency and volume to provide pricing

information on an ongoing basis.

b. Price quotations are not based on current information.

c. Price quotations vary substantially either over time or among market makers

(for example, some brokered markets).

d. Indices that previously were highly correlated with the fair values of the asset

are demonstrably uncorrelated with recent fair values.

e. Abnormal (or significant increases in) liquidity risk premiums or implied yields

for quoted prices when compared to reasonable estimates of credit and other

nonperformance risk for the asset class.

f. Significant widening of the bid-ask spread.

g. Little information is released publicly (for example, a principal-to-principal

market).

If after evaluating all the factors the sum of the evidence indicates that the market is not

active, the reporting entity shall apply step 2.

Step 2: Evaluate the quoted price (that is, a recent transaction or broker price quotation)

to determine whether the quoted price is not associated with a distressed transaction. The

reporting entity shall presume that the quoted price is associated with a distressed

transaction unless the reporting entity has evidence that indicates that both of the

following factors are present for a given quoted price:

a. There was a period prior to the measurement date to allow for marketing activities

that are usual and customary for transactions involving such assets or liabilities

(for example, there was not a regulatory requirement to sell).

b. There were multiple bidders for the asset.

11. If the reporting entity has evidence that both of the factors are present for a given quoted

price, then that quoted price is presumed not to be associated with a distressed

transaction. In that case, the quoted price may be a relevant observable input that shall be

considered in estimating fair value. However, the reporting entity should consider

whether any other factors or conditions warrant making an adjustment to the quoted price

(see paragraph 29). For example, if a quoted price that is not associated with a distressed

transaction is not current or is a consequence of a trade with an insignificant volume

relative to the total market for that asset, the reporting entity should consider whether that

quoted price is a relevant observable input (that is, whether the quoted price requires

adjustment).

12. If the reporting entity does not have evidence that both of these factors are present for a

given quoted price (including because there is insufficient information on which to base a

conclusion), then the reporting entity shall consider the quoted price to be associated with

a distressed transaction and shall use a valuation technique other than one that uses the

quoted price without significant adjustment (that is, a significant adjustment is required,

resulting in a Level 3 measurement). For example, the reporting entity could use an

income approach (that is, a present value technique) to estimate fair value. However, the

fair value resulting from the present value technique shall not be derived solely from

inputs based on the quoted price associated with a distressed transaction. The inputs

should be reflective of an orderly (that is, not distressed or forced) transaction between

market participants at the measurement date. An orderly transaction would reflect all

risks inherent in the asset, including a reasonable profit margin for bearing uncertainty

that would be considered by market participants (that is, willing buyers and willing

sellers) in pricing the asset in a non-distressed transaction.

TRANSITION AND EFFECTIVE DATE

13. The staff proposes prospective transition. Changes in fair value resulting from the

application of the FSP are considered changes in estimate and affect results in the period

of adoption. The staff believes there are two effective date alternatives:

a. Effective for interim and annual periods ending after March 15, 2009.

b. Effective for interim and annual periods ending after June 15, 2009. Early

adoption would be permitted.

14. The staff recommends that a final FSP be effective for interim and annual periods ending

after March 15, 2009.

COMMENT PERIOD

15. The staff recommends a comment period of 15 days ending April 1 so that the Board can

finalize the proposed FSP at its Board meeting on April 2.

Hmmmm:

Sun Microsystems Inc. surged the most ever in German trading after the Wall Street Journal reported International Business Machines Corp. is in talks to buy the company for at least $6.5 billion.

Sun Microsystems jumped as much as 61 percent to 6 euros in Frankfurt trading. The offer would value Sun’s stock at more than double the closing price of $4.97 in the U.S. yesterday, the Wall Street Journal reported, citing people familiar with the plan. An agreement may not be reached, the newspaper said. Officials at Sun and IBM declined to comment.

Buying Sun would help IBM widen its lead over Hewlett- Packard Co. in the $53.1 billion market for computer servers. Sun is projected to post its third consecutive quarterly loss as Chief Executive Officer Jonathan Schwartz seeks to weather the global recession by slashing as many as 6,000 jobs and offering lower-priced products.

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Sources:
IBM in Talks to Buy Sun in Bid to Add to Web Heft
MATTHEW KARNITSCHNIG, WILLIAM M. BULKELEY and JUSTIN SCHECK
WSJ, MARCH 18, 2009

http://online.wsj.com/article/SB123735970806267921.html

Sun Microsystems Surges on IBM Acquisition Report
Robert Valpuesta
Bloomberg, March 18 2009

http://www.bloomberg.com/apps/news?pid=20601087&sid=a_0CHRWCFx4w&

“Imagine if you had a rabbi and said, ‘All the laws of kosher depend on whether this rabbi decides if food is kosher or not.’ If the rules say ‘You have to use this rabbi,’ he could be totally wrong and it won’t affect the value of his franchise. The rating agencies have been mislabeling the goods for a long time. A lot of investors have been eating pork recently and they’re not too happy about it.”

-Frank Partnoy, a professor of law at the University of San Diego

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The NYT asks the above interesting question of Mr. Buffett. Given he is the largest shareholder (~20%) in Moody’s, its a fair query.

“In recent months, Moody’s Investors Service and its rivals, Standard & Poor’s and Fitch Ratings, have been prominent in virtually every account of the What Went Wrong horror story that is the financial crisis. The agencies put their seals of approval on countless subprime mortgage-related securities now commonly described as toxic. The problem, critics contend, is that the agencies were paid by the corporations whose debt they were rating, earning billions in fees and giving the agencies a financial incentive to slap high marks on securities that did not deserve them.

At least 10 of the big companies that failed or were bailed out in the last year had investment-grade ratings when they went belly up — like deathly ill patients bearing clean bills of health.

Moody’s rated Lehman Brothers’ debt A2, putting it squarely in the investment-grade range, days before the company filed for bankruptcy. And Moody’s gave the senior unsecured debt of the American International Group, the insurance behemoth, an Aa3 rating — which is even stronger than A2 — the week before the government had to step in and take over the company in September as part of what has become a $170 billion bailout.”

As noted in Bailout Nation:

While the investment banks that sold the junk paper, it was the rating agencies that tarted up the bonds. It was the equivalent of putting lipstick on a pig: This paper could never have danced its way onto the laps of so many drooling buyers without the rating agencies’ imprimatur of triple-A respectability.

Yet considering the massive damage they are directly responsible for, the rating agencies have all escaped relatively unscathed. Given their key role in the crisis — were they corrupt or incompetent or both? — one might have thought an Arthur Anderson-like demise was a distinct possibility. Warren Buffett should consider himself lucky — he is Moody’s biggest shareholder, and is fortunate the scandal hasn’t tarnished his reputation.

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Source:
Warren Buffett Unusually Silent on Credit Rating Agencies
DAVID SEGAL
NYT, March 17, 2009

http://www.nytimes.com/2009/03/18/business/18buffett.html

Good Evening: Much stronger than expected housing starts and what some are calling a successful retest of the November lows combined today to push stock prices higher. If the laws of economics have been repealed and housing supply can truly create housing demand, then perhaps this rally can keep going. Before we get too excited about how far it might carry equity prices, however, BAC-Merrill’s David Rosenberg has an updated S&P earnings forecast which just might sober up investors as they celebrate St. Patrick’s Day.

Early clues about just how resilient the major averages might be today after yesterday’s reversal were evident both last night and this morning. First, the disappointing news from Alcoa (a dividend cut cum secondary offering) was rationalized as specific to Alcoa and not applicable to others. Using this same train of thought, investors only punished Nucor when it guided lower this morning. Second, the economic data out this morning was deemed to be positive instead of negative. Housing starts were expected to fall in February from January’s depressed levels, but starts popped a surprising 22% (see BAC-MER’s take below). There may indeed be anomalous reasons behind this jump (weather, seasonal adjustments, etc.), but for me it was the reaction by market participants that represented the real anomaly. Home building stocks were sought and many analysts heralded the release as indicative of a bottom in housing. As for how more supply will somehow create more demand for houses, the analysts were understandably mute.

Equity investors decided not to question this logic and the major averages opened not far from unchanged. But when an early dip could reach no further than S&P 750, more than a few traders bought stocks in the belief that yesterday’s afternoon selling was just a mirage. The major averages began a persistent, saw-toothed rally that only stopped because the closing bell rang. The Dow (+2.5%) was the least frisky of the major averages, while the Russell 2000 (+4.5%) posted the largest gain. Treasury prices were once again on the weak side and yields rose between 3 bps and 6 bps. The dollar was off slightly against its major competitors, and commodity prices continued their recent roll. Though gold and silver were once again left behind, it should be noted that John Paulson’s firm bought 11% of AngloGold Ashanti. Just as he saw the subprime crack up coming months ahead of time, could it be that Mr. Paulson now sees a similar opportunity in the opposite direction for the gold miners? As for the here and now, crude oil’s challenge of the $50/bbl level and mostly firmer grain prices enabled the CRB index to close 1.2% higher today.

Perhaps I wasn’t paying attention during my many economics classes, but I thought I remembered learning that an item suffering from weak demand and ever weakening prices is in need of less — not more — supply. If building 500K more homes can solve a housing crisis where some 6 million already stand vacant, then we’ve truly discovered how to turn lead into gold. Heck, perhaps we can use this same economic alchemy to solve the entire financial crisis. Let’s just print as large a supply of new dollars as it will take to buy up every toxic asset and every vacant home! Supply creates demand and problem solved!

Bank of America-Merrill Lynch economist, David Rosenberg, is also worried about supply and demand. For him, though, the key to U.S. stock prices going forward has to do with our economy not being able to supply the earnings growth investors currently demand. His piece you see at bottom argues that we have yet to see the final low in equities because earnings expectations are still too high. Many laughed at him when he predicted last August that 2009 earnings for the S&P would come in around $63 on an operating basis. The consensus penned in $100 earnings estimates for the same period, giving the prevailing 1300 price for the S&P a very reasonable forward PE of 13. Now that the Great Recession is a reality, guess which of the two estimates is the current consensus?

Now that the consensus has finally joined him at $63 for this year and is making the same “market is cheap at 13 times this year’s earnings” call, Mr. Rosenberg has again broken from the pack in reducing his estimates down to $40 for 2009, which leaves the S&P at a less than cheap 19 times this year’s earnings. As reported earnings are even worse, but let’s cut the crowd some slack and exclude the bad stuff; expectations are still too high, in Mr. Rosenberg’s opinion. Furthermore, he notes that during each of the past few bear market rallies, financials led the bounce, followed by consumer discretionary stocks and materials names. During the March rally, we have the exact same leaders in the exact same order, so the current rally certainly seems to be reading from the bear market script as opposed to the brand new bull market one. Like Mr. Rosenberg, I concede that this rally could carry further, perhaps even another 10% if folks really believe that either the Fed or the Treasury Department can save us from further woe. But if Mr. Rosenberg is anywhere close to right with his new earnings forecast for the S&P 500, then we unfortunately still have some unfinished business to the downside. Despite this less than giddy outlook, I wish everyone a happy and safe St. Patrick’s Day!

– Jack McHugh

U.S. Stocks Advance After Unexpected Gain in Housing Starts

Paulson & Co. Acquires $1.28 Billion Stake in AngloGold Ashanti

Builders adding to supply.pdf

Profit and loss .pdf

We have gotten quite a few emails asking when my partners and I are coming to (your town). We keep hearing asset management horror stories from all too many people who have been mangled by their brokers and/or financial advisers. The carnage is shocking.

We are heading out West to meet with some current and potential clients. We still have a few slots left If any one wants a review of their portfolio, along with a discussion about our asset management approach, you can email myself and Joe Fitzgerald, who is one of our managing directors.

We still one last opening in San Jose on the morning of 3/30, and in the L.A. area, the only days left are April 2 and 3rd.

All information will be kept confidential.

Asset Management email

Estate Planning email

We also offer inter-generational wealth transfers, estate planning (including family and charitable trusts), blah blah blah.

Congratulations to Paul F. Desmond, president of Lowry Research Corporation, for being named by Technical Analyst Magazine as their 2009 TECHNICAL ANALYST OF THE YEAR.

If memory serves, Desmond also won the Charles Dow award some years ago . .  .

BEST EQUITY RESEARCH AND STRATEGY
awarded to Lowry Research Corporation

TECHNICAL ANALYST OF THE YEAR
awarded to Paul Desmond, President of Lowry Research Corporation

The awards were presented to Paul Desmond at the Annual Awards ceremony in London on March 12, 2009.

Congratulations to Paul . . .

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Previously:
Q&A: Paul Desmond of Lowry’s Reports
The Street.com, 02/18/06 – 09:39 AM EST

http://www.thestreet.com/markets/marketfeatures/10269345.html

Q&A: Paul Desmond of Lowry’s Reports, Part II
The Street.com, 02/19/06 – 09:50 AM EST

http://www.thestreet.com/markets/marketfeatures/10269355.html

The NYT reports:

Seventy-three employees were paid more than $1 million in the newly minted bonuses at the insurance giant, American International Group, according to the New York attorney general Andrew M. Cuomo.

The attorney general provided some new details on Tuesday about some of the $160 million in bonuses that the insurance giant paid out last week in a letter sent to Representative Barney Frank, the chairman of the House Committee on Financial Services.

Mr. Cuomo did not name the recipients of bonuses, but said one employee received more than $6.4 million. The top seven received more than $4 million each, and the top 10 received a combined $42 million. Eleven of those who received “retention” bonuses of $1 million or more are no longer working at A.I.G., including one who received $4.6 million, he said. (emphasis added)

This story gets more and more interesting. Bloomberg is reporting that:

“American International Group Inc., the insurer under fire for handing out bonuses after its $173 billion government bailout, budgeted $57 million in “retention” pay for employees who will be dismissed.”

AIG disclosed the payments, part of a larger $1 billion program meant to retain staff, in a March 2 filing. The insurer was chastised yesterday by President Barack Obama for awarding $165 million to staff of the derivatives unit blamed for the firm’s near collapse, and New York Attorney General Andrew Cuomo said he’ll subpoena AIG to get details on those payments. (emphasis added)

The latest idea: 100% taxes on bonuses from bailout firms:

Well it looks like the whole American International Group Inc. (NYSE:AIG) bonus hoopla might not blow over after all. With public anger growing, Congress is jumping all over the issue and vowing not to let the troubled insurer’s executives walk away with the money, even if it means writing laws specifically to get money back.

While Democrats haven’t yet matched Iowa’s Republican Sen. Chuck Grassley’s suggestion that AIG’s brass commit suicide, they are throwing out some radical threats on the $165 million in bonus money.   According to The Associated Press, “House and Senate Democrats were crafting separate bills to tax up to 100% of generous bonuses awarded by companies rescued by taxpayer money.”

Right now my long pitchforks and torches trade is looking pretty sweet!

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Hat tip Dan Greenhaus

Sources:
Cuomo Offers Some Details of A.I.G. Bonuses
LOUISE STORY
NYT,  March 17, 2009

http://www.nytimes.com/2009/03/18/business/18cuomo.html

AIG Plans Retention Pay for Staff Facing Dismissal
Hugh Son
Bloomberg, March 17 2009

http://www.bloomberg.com/apps/news?pid=20601087&sid=arI_buLviQ9g&

Congress prepares 100% taxes for AIG
The Deal, March 17, 2009 at 3:16 PM

http://www.thedeal.com/dealscape/2009/03/congress_prepares_100_taxes_fo.php

My pal Prieur du Plessis, who does the terrific weekend Words from the investment wise in the cafe, sends along this St. Patricks Day amusement: