October 6, 2008: Morning Call

October 6, 2008: Morning Call


Fair Value: SP500 – 1103.06; NDX: 1482.03; DOW – 10346



Technical Levels:

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

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


Events:

09:00: Former Fed Chairman Volcker speaks on financial supervision
10:00: Lehman CEO Dick Fuld testifies about firm’s collapse
10:30: FWLT presents at Johnson Rice Energy Infrastructure Conference
12:00: Fed’s Evans speaks on the economic outlook.
12:15: MDR presents at Johnson Rice Energy Infrastructure Conference
13:30: Fed’s Fisher speaks on the Fed Policy and the economy
15:30: SGR presents at Johnson Rice Energy Infrastructure Conference
15:30: MA presents at ATM Debit and Prepaid Forum


Foreign Market Summary/Key Macro News/Commentary:

SP futures are trading 24 points below fair value while the NASDAQ futures are trading 36 points below fair value at 7:30am ET. Foreign markets are tumbling with most markets in Asian and Europe down more than 5%. The bailouts for Hypo Real Estate (HRX GR) and Fortis (FORB BB) unraveled over the weekend after their was a run on Fortis bank deposits and the consortium of commercial banks withdrew their support for the government backed bailout of Hypo Real Estate. In response, BNP agreed to buy Fortis operations in Belgium and Luxembourg for EU14.5 billion while the German government provided HRX with a EU35 billion emergency bridge lone. A weekend meeting in Europe also did not produce a coordinated response to the credit crisis as some had hoped (the French President is calling for an international summit while the German President is calling for “individual responsibility” at the national level). The declines are broad and deep with 592 of the 600 components in the Eurostoxx index lower; all of the components in the FTSE-100 are lower. Many financial, mining, and energy stocks are down more than 10% in Europe. Asian markets: All indices traded sharply lower on evidence the financial crisis is spreading after the German government and the country's banks and insurers agreed on a rescue package for commercial property lender Hypo Real Estate (HRX.GR). China resumed trading after a week long bank holiday and was down sharply despite efforts by the Chinese regulators to support the market. Ping An (11.HK) said yesterday it would report an impairment loss of about 15.7B yuan on its existing investment in Fortis. It said the loss would have a material impact on its net profit, but added that its capital position and solvency margin would remain "solid and sufficient". The Nikkei reached its lowest since May 2004 with sectors that derive their revenues from exports leading the index lower.

Impact Research Calls/Market Moving News:

Rumor Mill and Fed News: Equity futures had bounced about 10 points off the lows on speculation that global central banks will announce a coordinated interest rate cut. Some Fed watchers are suggesting that the Fed should cut interest rates 100 basis points. At 8:15, equity futures declined to the session lows after the Fed boosted TAF cash auctions and said they “stand ready to foster liquid money market conditions.” The Fed also announced that they would begin paying interest on bank reserves. Obviously, the initial knee jerk lower suggests that market participants were looking for an interest rate cut. Fed funds futures are currently showing 100% odds of a 50 bp rate cut and 60% odds of a 75 bp rate cut.

Goldman Sachs lowers US GDP forecast and raises unemployment rate forecast: “We are marking down our forecasts for growth and interest rates substantially. The recession that we have been forecasting now looks likely to be deeper and longer, taking the unemployment rate to 8% by late 2009 and pushing the Fed to cut interest rates to 1% or lower. I. A Mild Recession Becomes More Severe: With the boost from fiscal stimulus gone and the impact of tighter credit conditions working its way into the real economy, US economic activity has decelerated sharply in recent weeks. The intense distress in financial markets-which seems unlikely to dissipate quickly-further darkens the outlook. As a result, we are marking down our forecasts for growth and interest rates substantially. The recession that we have been forecasting now looks likely to be deeper and longer, taking the unemployment rate to 8% by late 2009 and pushing the Fed to cut interest rates to 1% or lower. A More Severe Downturn: Although many economic indicators looked recessionary in the first half of the year, the pace of decline has steepened in the last few weeks. Amid a torrent of even-weaker-than-expected data points, a few specific themes are worth mentioning: 1. An outright downturn in consumer spending. Real spending is on track to post its first quarterly decline since 1991, and a large one at that. The data in hand through August suggest it is contracting at a 2½% pace. Early readings for September offer no comfort: light vehicle sales declined to only a 12.5 million seasonally adjusted annual rate, and discretionary retail sales are cratering (the Redbook survey showed that same-store sales for department stores are down 6.2% year-over-year, from roughly flat in the springtime). 2. A slump in manufacturing activity. The ISM manufacturing index plummeted to 43.5 in September, its worst result since the aftermath of the September 11 terrorist attacks (Exhibit 2). Although part of the month's decline might be attributable to shut-in production in the Gulf Coast due to Hurricanes Gustav and Ike, other manufacturing data had been looking softer as well. For example, durable goods orders were down significantly in August, and the ratio of shipments to inventories-a useful leading indicator of future activity-continues to deteriorate.3. More rapid contraction in the labor market. September's employment report revealed across-the-board deterioration in employment. Payrolls dropped by 159,000, with almost all sectors losing jobs. Hours worked and wages were weaker than expected. The unemployment rate held steady at 6.1%, but a closer look suggested deterioration here as well-the rate slid from 6.06% to 6.13% on an unrounded basis as the household employment figure used for the calculation slid by 222,000. More strikingly, broader measures of the unemployment rate all worsened-with the broadest ("U-6", which includes marginally attached workers as well as part-timers who would prefer a full-time job) rising to 11%, a 14-year high. An Even Weaker Economic Outlook: Because economic indicators have deteriorated even more sharply than we expected in recent weeks, and because financial market stresses have intensified even further, we are marking down our US economic forecast substantially. Real GDP growth is likely to stall this quarter, as the effects of fiscal stimulus faded earlier than we had anticipated. We look for outright contraction in real GDP in the fourth quarter and in the first quarter of 2009, with growth below trend into 2010. Exhibit 4 compares our new growth forecasts to the previous outlook. Consumer spending contracts for three consecutive quarters and likewise remains below trend through next year. The unemployment rate rises to 8% by the end of 2009. Policymakers will remain active in the coming year. We expect the Fed to cut the funds rate to 1%-lower if it can avoid further disruption to the money markets-with a 50 basis point cut coming before end of year and possibly even before the next scheduled meeting. Further expansion of liquidity facilities looks likely as commercial paper issuance dries up. A more radical intervention would be to guarantee bank transactions, as the Irish government did earlier this week. Meanwhile, Treasury officials will be working furiously to ramp up asset purchases, now that they have been given the authority to do so. Additional interventions are conceivable if the $700 billion of purchases still leaves banks saddled with a substantial amount of bad assets, or if private sector funds for bank recapitalization are not quickly forthcoming. In short, the recession we forecasted back in January now looks to be a deeper downturn. Judged by the change in the unemployment rate, our forecast now implies that it will be somewhat more severe than the average postwar recession”

JPM (45.90): Fox-Pitt previews JPM Q3 Earnings: “• We believe J. P. Morgan significantly reduced its $50 bil. in exposure to legacy leveraged loans and problem mortgage assets during 3Q08. • Overall, we expect net marks of $4.3 bil. comprising: (a) $2.0 bil. On lvgd. loans; (b) $1.0 bil. on mortgage assets (CMBS/Alt-A/Prime/Sub- Prime); (c) $1.2 bil. loss on GSE securities; and (d) $400 mil. on ARS; mitigated by (e) $300 mil. of liability gains. The company is also expected to report a $700 mil. tax benefit. • We expect credit costs to increase 62% sequentially, mainly due to a $1.7 bil. reserve build associated with the Washington Mutual (WM, $0.12, Not Rated) deal. Our pre-WM-deal ests. for 3Q08/4Q08/2009 were $0.51/$0.69/$3.36, respectively, while our initial-take ests. After the WM-acquisition announcement were $0.32/$0.79/$3.82. • After fully digesting the WM-acquisition details and recent disclosures by JPM mgmt, we are revising our 3Q08 est. from +$0.32 to -$0.10 to reflect: (a) addl. marks on lvgd loans & mortgage assets (-$0.28); (b) losses on GSE securities. (-$0.21); (c) ARS costs (-$0.07); and (d) a WM-related credit reserve build (-$0.31); mitigated by (e) higher
revenue in Inv Banking (+$0.07); and (f) tax benefits (+$0.20).• We are increasing our 4Q08 est. to $0.86 from $0.79 to reflect: (a) +$0.22 in net income contribution from WM (post one-time merger costs) and; (b) -$0.05 in dilution from the common offering.• Finally, our 2009 est. increases from $3.82 to $3.91 to reflect: (a) a +$0.74 net income contribution from WM (post merger costs); and (b) -$0.19 in dilution from the common offering. We expect the WM transaction to be 16% accretive to 2009 EPS. • We believe JPM may eventually record reversal gains in the future from assets that were conservatively marked during the Bear Stearns and WM acquisitions. Thus, upward EPS revisions are likely. • While the weakening consumer credit cycle hurts in the near term, we expect JPM to be a major mkt share beneficiary across its traditional banking and its securities units, given the demise of some peers.• We continue to rate the stock Outperform with a $56 target price.”

FORB BB (5.41): Paribas to take control of remaining Fortis (FORB.BB) assets reports the FT: The deal is all stock and will make BNP the biggest bank in the eurozone by deposits. According to Belgium media, the Belgian government will keep a blocking minority of 25% in Fortis Bank and the subprime and related assets will be moved into a special vehicle. FORB shares are halted.

BHP (47.10): Top Chinese executive speaks out against BHP / Rio Tinto deal reports the FT: Zhang Xiaogang, chairman of the China Iron and Steel Association and of Ansteel, called the proposed merger between BHP Billiton (BHP) and Rio Tinto (RTP) terrible for global competition and said it should be rejected by regulators. The deal was approved last week by the Australian anti-trust regulator, which leaves the EU competition authority as the final regulator to decide. It has until January to do so.

CME (362.30); ICE (78.21): CNBC reports that Fed to meet with CME, ICE regarding CDS marketplace: CNBC reports that it has learned that Federal Reserve officials plan to meet with top executives from the CME and ICE in an effort to create a new marketplace for credit default swaps. The meeting will be held as early as Tuesday at the NY Fed, and is expected to clear the way for the creation of a new CDS exchange. People close to the talks told CNBC that the new exchange could be up and running in a matter of weeks.

RIMM (60.96): Research In Motion target reduced to $50 from $70 at Deutsche Bank: The firm notes concerns the Bold will not ship on time at AT&T, potentially leading to a miss for the quarter. Pricing and margins are seen remaining volatile. Shares remain sell rated.

MT (44.62): ArcelorMittal downgraded to hold from buy at Deutsche Bank (pre-Europe open)

MON (83.26): Monsanto upgraded to overweight from neutral at JPMorgan

KO (52.57): Coca-Cola downgraded to hold from buy at Deutsche Bank: The firm cites impact to earnings from global economic weakness and a rising dollar.


NCC (3.51): National City long term IDR rating cut to BBB+ from A by Fitch: Fitch has downgraded NCC and its subsidiary, National City Bank's, long and short-term Issuer Default Ratings. NCC long-term IDR has been lowered to 'BBB+' from 'A' while NCB's long-term IDR has been lowered one-notch to 'A-' from 'A'. The bank and the holding company's Individual rating has been lowered to 'C' from 'B' and the short-term IDR was lowered to 'F2' from 'F1'. Additionally, Fitch has placed all ratings on Negative Rating Watch

WB (6.21): WSJ looks at the current situation concerning Citi, Wachovia and Wells Fargo: The Wells Fargo deal creates a large number of legal issues since Citigroup never signed a definitive merger agreement with Wachovia. There is language in the bailout bill that could be used to support either the Citi deal or the Wells Fargo deal and will likely need to be decided in court. But a Citi deal would need to be approved by Wachovia shareholders who are unlikely to vote for the deal in light of the Wells Fargo offer unless Citi significantly improves its offer, something the WSJ says Citi executives were considering on Friday. Citing a source close to the matter, the WSJ says Wells Fargo never withdrew its offer on Sunday and continued with due diligence even after the Citi deal was announced. After 5 days of due diligence, the board of Wells Fargo was much more comfortable with the situation and made its offer after alerting the FDIC and Office of the Comptroller of the Currency. Wachovia's advisors concluded that any exclusivity agreement with Citi was trumped by the fiduciary duties of the board to its shareholders.

AAPL (97.07): Securities and Exchange Commission to investigate false report of Apple CEO heart attack reports the NY Times: The SEC is investigating the origin of the report on a CNN citizen journalist website to try and determine if the report was meant to push down the stock price. CNN is cooperating with the inquiry.


Barron’s Summary:

Cover: The bailout bill is needed but not enough to get credit flowing again. Special Report: Mutual Fund Quarterly: Some financial stocks that fund managers believe are good values include TCB, CLFC, HBAN, others...; Established names in the ETF sector offer suggestions; Suggestions for closed-end funds including JSN, IQM, DCS, EDF, ADF, DHF, IMT, MUE, NDD and LBC; Suggestions for tax-loss selling among funds by selling out before year end and distributions; A review of performance for the quarter. Interview: Peter Fisher, Blackrock executive and former U.S. Treasury Undersecretary thinks the U.S. banking system has to consolidate and that Brazil and China have a better chance than other countries of engineering a soft landing. Lead Articles: Barron's believes that Berkshire's next big investment might be in American Express (AXP); MetLife (MET) has lots going for it, especially an undervalued stock, stock could go to $70 within a year; Streetwise suggests, if you need equity exposure, closed-end funds hit by arbitrage-fund liquidation and the credit squeeze including BDT, BDJ and ETG or just a order to buy the market if the Dow trades down 10%; Barron's suggests companies that generate a lot of cash for these credit constrained times; Junk bonds could return 25% or more over the next year if the economy bottoms and credit markets begin functioning, possibilities include JNK, HIX, BLW, DHF, GPM, GOM and others; Economic Beat says GDP could stay positive if the bailout restores the credit markets to normal functioning and positive economic forces prevent an outright contraction; Wells Fargo's (WFC) move for Wachovia (WB) may engender confidence in other investors willing to bargain hunt; Editorial that the bailout bill should have been voted down and inflation may be the result of the attempts to support home prices. Columns: The Trader is positive on Marvel Entertainment (MVL), cautiously positive on AIG; Asia Trader notes the extremely poor performance of Asian equities but that anticipated rate cuts may offer some hope; Euro Trader suggests some European banks; The Striking Price notes the high level of the VIX and suggests tax strategies for stocks that have fallen; Current Yield says the bonds of Fannie and Freddie are easy money given their spreads from Treasuries and points to bargains among munis; Commodities Corner is positive on gold though short term volatility is likely to persist; Preview mentions the stock picking skill of Tulane finance professor including picks like AMSF, IBKC and EPL; Follow Up is cautious on casino stocks, notes the continuing problems at Fannie and Freddie; Up and Down Wall Street discusses the bailout bill, Buffett's investments and believes that the Fed will cut rates sooner because of the unemployment numbers; D.C. Current notes the lead Obama has in the polls and says McCain miscalculated over the bailout bill and suspending his campaign; Technology Trader is cautious on the upcoming earnings season and while GOOG, MSFT and AAPL are all starting to look cheap, this is probably a good time to sit on the sidelines for a while, notes some caution for the solar sector, ICOG could thrive or struggle depending on a coming jury verdict; Plugged In suggests defensive tech names like IBM (IBM), HP (HPQ) and Oracle (ORCL) but not Dell (DELL).