Chain Bridge Investing: Stock Investing News & Analysis for 2-2-10

February 3, 2010 by cb · Leave a Comment

Good morning, investors and traders! You are reading the Daily Download (”Daily DL”), which includes summaries and links to the day’s selected economic and stock investing news. The Daily DL is maintained by Chain Bridge Investing (“CB”), which is a financial blog at www.chainbridgeinvesting.com. Chain Bridge Investing is constantly improving and adding new financial and investing content to the website. Please let us know if you have any suggestions at the following email address: .

General News & Headlines Summary

CB: Remember that below the summaries are a list of interesting links.

News not covered below: (1) China has expressed that any meeting between the Dalai Lama and President Obama would lead to further strained relations between the U.S. and China; (2) the United Parcel Service stated on Tuesday that increased internet shopping and increased use of premium delivery services helped to nearly triple its income for the fourth quarter; (3) Metlife’s fourth-quarter profit sunk nearly 70% from the prior year as investment losses significantly hurt the company, however, operating earnings experienced double-digit growth; (4) according to Dealogic, developing nations sold a record amount of $112 billion of debt during 2009; (5) Entergy reported an increase of 84% in its fourth-quarter profit as a result of its utility segment, but its nuclear business declined; and (6) according to Autodata, January sales have increased 6.3% from a year earlier.

Upcoming Economic Data for the Day (all times EST)

7:00 AM MBA Purchase Applications

7:30 AM Challenger Job-Cut Report

8:15 AM ADP Employment Report

10:00 AM ISM Non-Mfg Index

10:30 AM EIA Petroleum Status Report

Initial Public Offerings (”IPOs”) for the Week of February 1- 5, 2010

2/2/10 Film Department Hldgs LLC (“TFDI”) – Motion picture finishing and production company.

2/2/10 FriendFinder Networks (“FFN”) – Internet based social networking company.

2/2/10 Patriot Risk Management (“PMG”) – Insurance management company.

2/2/10 Imperial Capital Group (“ICG”) – Independent, full-service investment bank.

2/2/10 Ironwood BioPharm (“IRWD”) – Pharmaceutical company.

Data from the WSJ Market Data Group

For Daily Market Performance Data, Please Visit the Daily Market Sheet

News

Steelmakers Buy Coke at Peak Price – Financial Times

Summary: Coking coal and iron ore are the primary ingredients needed to produce steel. At present, there is significantly more demand for coking coal than supply being produced, thus many steelmakers are purchasing the coal from deferred contracts with miners that were agreed to during mid-2008 and early-2009 at prices of between $300 – $320 a ton. These prices far exceed this year’s current contract price of $128 a ton and are also higher than the spot prices of $220 a ton. Originally, the industry has agreed that the deferred contracts would be spread out over the next several years; however, given the fact that the steelmakers are now resorting to them demonstrates the tightness in the supply of coking coal. Miners that may benefit from this are Walter Energy, BHP Billiton, Xstrata, and others. The lack of supply has been a result of long queues at Australia’s coal ports, supply disruptions, and Chinese buying. It is estimated by Peabody Energy that China imported 35 million tons of coking coal in 2009, compared with 7 million in 2008.

Crude Market’s Axis of Upheaval – The Wall Street Journal

Summary: The following data are used in the article to suggest investors should be bearish on oil:

(1) Tony Hayward, BP chief executive, stated that the company will not ever sell more gasoline to the U.S. than the amount that was sold in 2007.

(2) After oil consumption has declined for two consecutive years in the U.S., the U.S. continues to account for 22% of global oil consumption.

(3) GaveKal Research calculates that transportation efficiencies could reduce U.S. and European oil demand by 5 million barrels a day by 2020.

(4) With China’s economy slowing down, it is unlikely that it will continue to have the same growing fuel demand as it has recently demonstrated.

(5) Iran has cut back on production and it may be tempted during the near term to increase production beyond OPEC quotas to increase revenue.

CB: On the surface, there is much bearish information regarding the oil industry. Yet, much of the bearishness is dependent on large assumptions, while also being near-term oriented. The largest assumption is that current oil supply is maintainable in the long-run. The International Energy Agency has already indicated in 2008 that there are serious doubts whether the current supply levels can be maintained. The article also avoids the issue of steep declines occurring at some of the world’s largest oil fields. The sudden decline in one of the two largest remaining fields in the world, Mexico’s Cantrell, is a perfect example of how quickly a field can decline after peaking. Also, there are the complexities associated with the successful implementation of energy efficiencies. Furthermore, China recently became the world’s largest car market and its the population will continue to grow and purchase gasoline based cars, although the proportion may change. Moreover, one should not forget the impact of India and other nations. Much of the articles in the Wall Street Journal are bearish on oil due to the clean energy policies and alternative fuels. Do they realize what a small percentage these alternatives represent? At this time, most of these alternatives are not economically viable on their own.

China Banks Slapped – The Wall Street Journal

Summary: For the first time in over six years, Fitch Ratings downgraded the credit rating of a Chinese bank. On Tuesday, the company downgraded the China Citic Bank Corp. and China Merchants Bank Co. in a move that aligns their credit ratings with 14 other national Chinese banks. The two banks’ new ratings indicate that they are subject to weaknesses from internal and/or external origins. Fitch claimed that the downgrade was a result of each bank’s aggressive increases in lending during during 2009 and current lack of adequate capital held against each loan. In 2009, Chinese banks issued $1.4 trillion in net new loans, nearly twice the amount issued in 2008.

Obama Retreats from Goal of Cap-Trade Bill – Wall Street Journal

Summary: On Tuesday, Obama mentioned for the first time that in order to pass a bill that would help create more green jobs, the cap-and-trade aspect of the climate bill may have to be removed and pursued separately. Obama still supports the idea of a cap-and-trade system, which would regulate the rights to emit greenhouse gases, but faces significant bipartisan opposition in Congress from those who represent districts that are economically dependent on fossil fuels, smokestack industries, and coal-fired utilities. Furthermore, two House Democrats introduced legislation that would prevent the Environmental Protection Agency from regulating greenhouse-gas emissions under the Clean Air Act.

CB: It is interesting to see the extent of government’s involvement in the energy industry across the world. Much uncertainty has been created in these markets, as witnessed by the large drop in carbon-permit prices in Europe after the the disappointing results of Copenhagen. Nevertheless, whether progress is being made is questionable. One can imagine the troubles the U.S. faces trying to push for the reduction of greenhouse gases on a global level, when such policies cannot be implemented at home. Okay, enough politics back to the markets. At present, many alternative energy investors believe that for their products to be cost competitive with coal, oil, and natural gas, carbon-permit prices must be near €60 a metric ton, which they are currently much lower than. As the U.S. and other countries continue to delay the process, alternative energy will continue to be hurt fundamentally. In CB’s opinion, usually, it is best to avoid markets where the government is actively moving its hands in an unpredictable manner. Many would disagree. Yet, having some exposure to the inside workings of politics, these Congressmen can change policy stances very quickly and unpredictably. Speculation in such markets goes against CB’s preferred risk levels as it is not based on psychology, fundamentals, or logic.

Homeownership Rate Declines – The Wall Street Journal

Summary: According to the Commerce Department, approximately 67.3% of Americans owned their home in the fourth quarter of 2009, the lowest homeownership percentage since the second quarter of 2000. This homeownership percentage was highest at 69% in 2004. Originally, many thought with the extension of the tax credit for first-time home buyers that the percentage of ownership would increase; however, many now believe that the amount of foreclosures overwhelmed the positive benefits derived from the extension of the tax credit. Nevertheless, according to the National Association of Realtors, the index of pending sales of previously owned homes rose 1% in December to 96.6, which is 10.9% greater than its level a year earlier. Such a rise may be a sign of stability coming to the market after the large amount of uncertainty regarding the tax credit.

CB: The drop in the overall levels of homeownership would be a key indicator for any contrarian investor to begin exploring the housing and durable goods sectors. Housing has been in a downward spiral for a couple years now, and it remains beaten down. CB is aware of the Jewish folktale involving King Solomon’s gold ring with the inscription, “This too shall pass.” Well, eventually things will look up for the housing market and the durable goods market. CB mentions durable goods, due to the fact that historically – and this relationship will need to be rechecked to verify if it still exists – changes in homeownership tended to result in purchases of new appliances and home furnishings. Nevertheless, the housing market may continue to take awhile to recover. Just because an industry is down does not mean that it is the appropriate time to buy. The oil industry suffered nearly a two-decade downturn from the 80s to the early 2000s, while the water transportation industry experiences cycles that can last several years. Basically, the housing industry is worth watching and continuing to learn more about even if now is not the ideal time to invest. There will be a time. At present, there may be a few companies that are taking advantage of reduced land prices and other reduced costs to produce new houses at lower prices and lower costs.

Regarding, the rise in pending sales in December, one should remember that in November pending home sales dropped 16% as potential home buyers rushed to take advantage of the tax credit in October before its original expiration in November – it is not known how many of these pending home sales are foreclosures. Could this be a model for home buying behavior leading up to the end of April when the extension of the tax credit expires? All the behavior being witnessed now is during a time when the government is basically supporting in one way or another 85% to 95% of all mortgages and a tax credit is in place. When, or if, these supports are removed from the market, there could be several months with drops in housing prices and demand. Ideally, the government would want to remove its support and have the market exist at the levels it did before, but this will be difficult with the consumer still deleveraging, consumer spending not significantly improving, and unemployment remaining at its current levels. According to the McKinsey report on debt and develeraging, which can be read about more here, deleveraging usually begins two years after a crisis begins and then lingers for nearly six to seven years. If this effect plays out, it will most likely continue to hurt the housing market, consumer spending, and employment levels.

Volcker Plea Over Wall St. Shake Up- The Financial Times

Summary: Paul Volcker, the former Federal Reserve chairman, stated before Congress that the aim of the Volcker rule is to protect taxpayer support from being exposed to speculative activity. Furthermore, he stated that it is not very difficult to separate proprietary trading from the buying and selling conducted for bank customers. Nevertheless, if the rule is enacted, there will be traders that are tempted to speculate aggressively on the taxpayer money. Yet, there was much criticism expressed in Congress, not so much for the bill but in the manner it was revealed to the public and the lack of substantive detail behind it. According to Chris Dodd, the proposal by the Obama administration appeared to be “transparently political and not substantive.” Furthermore, Dodd believes the Obama-Volcker proposal is derailing the current efforts to agree on financial regulation. Yet, some believe that the proposed reform treats banks like “quasi-public utilities,” which ignore the benefits of competition.

No Help in Sight, More Homeowners Walk Away – The New York Times

Summary: As of the third quarter of 2009, nearly 4.5 million homeowners had homes that were worth less than 75% of the remaining mortgage balance and current estimates suggest this number may peak at 5.1 million homeowners in June – accounting for nearly 10% of all U.S. mortgage holders. New research shows that when homeowners reach the point where their home is worth less than 75% of the mortgage balance they begin to seriously consider walking away from the mortgage and letting it default. Consultants at Oliver Wyman have calculated that nearly 17% of the defaults in 2008 were strategic decisions.

CB: In January Robert Shiller made the following statement:

“Strategic default on mortgages will grow substantially over the next year, among prime borrowers, and become identified as a serious problem. It will grow because of a building backlash against the financial sector, growing populist rhetoric, declining sense of community with the business world. Some people will take another look at their mortgage contract, and note that nowhere did they swear on the Bible that they would repay.

If defaults continue to rise, then the U.S. is looking at more supply on its hands and less people available to purchase homes. Renting may become more favorable if the above takes place. One should consider for every foreclosed home, there are people being displaced and potentially leaving the housing market for the near-term, thus shrinking the market and potential demand unless new buyers can enter at a higher rate than those leaving. Also, there is the question of the “wealth effect.” If someone, particularly one of the prime borrowers, defaults on a mortgage and loses the respective house, then how does this event affect their future purchasing and spending habits. Furthermore, depending on the situation a defaulting homeowner can have their credit score damaged by hundreds of points, which will not do much to increase consumer spending, especially if this happens to a significant part of the population. As some of the consequences about defaulting become more known (every state has different rules and some are trying to prevent the “strategic default”), homeowners may avoid defaulting if they can, but may have to reduce discretionary spending in other areas.

More Links of Note

20 Reasons Global Debt Time Bomb Explodes Soon – MarketWatch

Can China Save the Global Economy? – MSN

Resources: the Power Bill Arrives – Financial Times

Never Short a Country with $2 trillion in Reserves? – China Financial Markets

A Few Thoughts on the Burlington Acquisition – Contrarian Edge

Hedge Fund Perry Partners’ Annual Letter – MarketFolly

Raymond James’ Jeff Saut – MarketFolly