October 3, 2008: Morning Call

October 3, 2008: Morning Call


Fair Value: SP500 – 1118.47; NDX: 1502.71; DOW – 10507


Technical Levels:


SPX: 1063, 1090 support/1142, 1250, 1298-1300, 1337 resistance

NASDAQ: 1890, 1921 support /2020, 2210, 2264 resistance


Events:

Pre-market EPS: FDO (.34/1.76B)

05:00: Euro-zone Retail Sales (August): 0.1% MoM; -2.4% YoY (stronger: 0.3% MoM; -1.8% YoY)

08:30: AIG Business Update Call
08:30: Change in Non-Farm Payrolls (Sep): -105,000; Unemployment Rate: 6.1%
08:30: Change in Manufacturing Payrolls (Sep): -57,000
08:30: Average Hourly Earnings (Sep): 0.3% MoM; 3.6% YoY
08:30: Average Weekly Hours (Sep): 50.0



Foreign Market Summary/Key Macro News/Commentary:


SP futures are trading 8 points above fair value while the NASDAQ futures are trading 12 points above fair value at 8am ahead of the September Employment data. Sep ISM Non-Manufacturing to be reported at 10 ET. European markets are up 0.50% on very light volume. Better-than-expected Eurozone Aug Retail Sales data helped sentiment with major indices rallying to currently stand in positive territory. Decliners on the FTSE 100 lead advancers 2-1. Bank and Insurance sector share volumes are tracking well below the average over the last month. European investment banks (UBS and CS) are outperforming on positive comments by Deutsche Bank and Goldman Sachs. Best sectors in Europe include: Banks +1.8%, Basic Resources +1.0%, Autos +0.62%. Worst sectors include: Consumer Discretionary –2.0%, Industrials –1.55%, and Tech –1.45%. Asian markets traded lower ahead of today's financial rescue package vote in Congress. Markets in China, South Korea, Indonesia and Pakistan were shut for holidays today. Mining and Oil stocks were down after a fall in metals and oil amid concerns over slowing demand. Financials were lower with Hang Seng Bank (11.HK) lower again on persistent fears over Wahington Mutual (WM) exposure. Car makers extended their losses with Toyota Motor (7203.JP) hitting a three-year low following weak car sales for Sept in the US.




Impact Research Calls/Market Moving News:

WB (3.91): Wells Fargo (WFC) and Wachovia agree to merge in stock-for-stock transaction valuing WB shares at 7 dollars: The companies say they have signed a definitive merger agreement. Wachovia shareholders will get 0.1991 shares of WFC common stock for each share owned. Based on prior close, the transaction values WB common shares at $7 in a total transaction value of appx $15.1B. Citibank is trading down 2 dollars to 20.25. The transaction will require no financial assistance from the FDIC or any other government agency. Obviously, this is good news because the private sector is stepping in here and the FDIC is no longer on the hook for losses in excess of 42 billion.

C (22.50); JPM (49.85); BAC (36.37): Deutsche Bank’s Mike Mayo Comments on proposed TARP legislation impact and says that the money center banks (C, BAC, JPM) are “less a safe haven than implied by the share prices.” “Plan Should Help, but Only Mitigates Weakness: The government's proposed program can help reduce systemic risk, aid capital markets, and prevent worst case scenarios but is not a panacea. Resolving problem loans seems difficult, especially given increases in new problem areas. Capital markets can be helped but headwinds remain, as reflected by unusual systemic risk that remains at levels far from normal. Participants will not have a free lunch and, in some cases, will have punitive costs. We maintain our underweight stance on banks and would move more so. Consumer Lending Not Likely Coming Back Much Soon: U.S. consumer debt to GDP increased from 25% in the early 1950s to 50% in 1985 to 70% in 2000 to 100% at 2Q08. If for no other reason, we expect this trend to change because banks are likely to keep stricter consumer lending standards to avoid similar mistakes that led to the possible $700B government plan. If this ratio declined simply to the level at the start of the decade, total industry loan growth would get hurt by 12%, or an amount that could keep loan growth sluggish for a few years. Thus, while likely higher loan losses remain an issue, another concern is that revenues may be weaker than expected. Money Center Banks Less of a Safe Haven Than Implied by Stock Prices: We recently lowered expectations for third quarter earnings given higher credit card losses, slower growth in the U.S. and outside, and weaker capital markets. In other words, the extent of problems seems more broad based and severe than in prior quarters. Moreover, for the past two weeks, (9/22-10/2), stocks increased meaningfully even while risk has increased as measured by CDS spreads for each Citigroup (stock from $20 to $22; CDS from 185 to 302), Bank of America (stock from $34 to $38; CDS from 134 to 170), and JP Morgan (stock from $41 to $50; CDS from 132 to 144).”


POT (93.51); AGU (41.61): CIBC defends POT and AGU this morning and comments on the steep drop in the Fertilizer stocks: “Thoughts On Recent Fertilizer Stock Sell Off. Dooms Day Scenario Analysis: - Over the past two months, the sell off in the fertilizer sector has been dramatic, reflecting concerns about the sustainability of the agriculture cycle and in turn, the appropriate value to assign at this point in the cycle. Over the past two months, POT's and AGU's share price have declined ~52%. During the last bear fertilizer market ('98), forward PE multiples were 10-12x actual earnings. With N. American fertilizer producers trading at 3.2x '09 consensus EPS estimates, either there is some deep-value in the fertilizer sector or earnings estimates need to be adjusted lower. In worst case scenario (at $50 oil and sub $3 corn), fertilizer prices drop to US$300/t for N, US$400/t for P and US$500/t for K, AGU would still earn US$6.75/sh and POT US$13.65/sh. Applying a peak multiple would imply that both companies are still attractive using a doomsday outlook. We believe it is unlikely that '09 is the peak year for agriculture and fertilizers. Grain inventory remains at historic lows and it will require years to rebuild. Also, for potash, the market is short with no significant supply response for 3 years. We would be buyers of both AGU and POT.”


AGU (41.61): Agrium downgraded to hold from buy at Canaccord Adams


UNP (62.10); NSC (56.64); BNI (83.00); CSX (47.21): Morgan Keegan downgrades the railroads: “We are downgrading shares of Burlington Northern Santa Fe, Norfolk Southern and Union Pacific Corporation based on a less attractive risk-reward scenario going forward, taking into account our expectations for pricing growth to moderate in 2009 and flat volumes given the weakening economy. We are lowering earnings estimates for 2009 across the Class 1 rail group, including estimates for BNI, CSX, KSU, NSC, and UNP. • We are maintaining our Maintaining our Market Perform rating on CSX. We are also maintaining our Outperform rating on shares of KSU based on the company's new business opportunities and potential growth at the Port of Lazaro Cardenas.” Burlington Northern (BNI), CSX Corp (CSX) upgraded to overweight from neutral at JPMorgan

ADBE (35.22); INTU (29.93); CRM (44.19): Adobe Systems (ADBE), Intuit (INTU), Salesforce.com (CRM) downgraded at UBS: Firm notes macro uncertainty, disappearing F/X tailwinds, and extremely mixed field checks in the U.S. and Europe. ADBE downgraded to sell from neutral; price target decreased to $34 from $46. INTU downgraded to sell from neutral; price target decreased to $30 from $31. CRM downgraded to sell from buy; price target decreased to $44 from $82.


COST (61.92): Costco upgraded to buy from neutral at Goldman SachsThe stock is also added to the Conviction Buy List. Target is increased to $72

MER (27.40): Merrill Lynch downgraded to hold from buy at Citi

STLD (13.01): NUE (34.30); CENX (22.55): Merrill Lynch downgrades STLD, NUE, and CENX: STLD and CENX are downgraded to underperform from buy. NUE is downgraded to neutral from buy.

CMI (38.14): Cummins downgraded to market perform from outperform at Wachovia: “We are decreasing expectations for a variety of reasons. This stock remains one of the best earnings growth ideas in our universe given its exposure to beaten down cyclical markets in N America (truck, Dodge Ram and RV) that could begin to recover late 2009. However, we expect yr/yr earnings growth to be flattish in H1 2009. Combining this with the general market multiple compression, we view the stock as having limited upside in the near-term. Downgrading to Market Perform. Decreasing estimates for 2008 (to $4.92 from $4.95), 2009 (to $5.40 from $6.15),and 2010 (to $6.30 from prior $7.10) due to steeper than previously expected
European truck engine demand drops, delayed and more muted N American truck
and Dodge Ram volume recovery and expected flattening of power generation and
other later cycle demand in H2 09 with declines in 2010. The stock has realized a significant multiple compression due to various factors (both fundamental and non-fundamental). With concerns about a global recession taking shape and a potentially more muted recovery than initially expected, we now expect upside to be relatively limited and are stepping to the sidelines.”

TEX (26.11): Terex downgraded to market perform from outperform at Wachovia: “Our prior earnings growth thesis has hit a wall, and we now expect 2008 to be peak earnings in a potentially deep global recession. We had been expecting H2 2009 earnings growth reacceleration after four consecutive quarters of yr/yr earnings declines (as cranes and mining equipment remained strong and Aerial Work Platforms searched for easier H2 2009 comparisons). TEX is a cheap stock, but is that enough? Downgrading to Market Perform. In our machinery channel checks, European crane dealers reported weakening conditions for mobile hydraulic cranes and significantly decreased tower crane inquiry activity. With the current long backlog, the industry may enjoy peak demand conditions in the short-term through most of 2009. We had originally been modeling continued strength through 2010, but now we are expecting demand contraction in 201”

Safe-haven banks still have risks - WSJ: In a "Heard on the Street" column, the Journal reports that both Wells Fargo (WFC) and US Bancorp (USB), which have rallied to lofty valuations on the back of the bifurcation trade in the banking sector, still hold large amounts of loans that could post higher-than-expected losses due to the spillover effects of the credit crisis to the broader economy. The paper adds that Wells Fargo (WFC) is particularly vulnerable to the paralysis in the credit markets, having increased its exposure to short-term borrowings earlier this year. The column also points out that both banks trade at multiples that would seem excessive even in good times. Wells Fargo trades at 3.9x tangible book, while the multiple for US Bancorp is 7x. Of interest, JPMorgan (JPM) trades at a much more modest 2.63x tangible book. The Journal goes on to discuss the significant potential credit losses in both banks' balance sheets, particularly in the form of restructured loans and HELOCs.