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Mr. Mubarak, Turn On That Internet!

Yesterday, we posted a note about the Jasmine Revolution becoming Tunisia’s top export. Specifically, we wrote:

 

“Over the last three days, there have been massive protests in Egypt against the autocratic regime of President Hosni Mubarak.  These protests are being driven by economic concerns, primarily spiraling costs of living (read: inflation).  As the costs go up, the underemployed and underpaid youthful population naturally vents, and in an autocratic regime they have no outlet other than, at least in their minds, to take to the streets.  No doubt the successful revolution in Tunisian was a catalyst for the Egyptian revolts; the success of overthrowing the Tunisian government has emboldened protestors across the region.”

 

This morning it seems the Egyptian government is combating the spread of the Jasmine Revolution . . . by cutting off almost all internet in the country.  In the chart below (with credit to Arbor Networks), you can see the precipitous drop in internet traffic.  Somehow we don’t think this is going to appease the people of Egypt. 

 

This is a country with more than 2/3rds of its population below 30, a country where 40% of the population lives on under $2 per day, and unemployment is close to 10% (and higher in reality). 

 

If President Mubarak thinks that he is going to stem the rising tide of discontent in Egypt by limiting their ability to communicate, Tweet, and Facebook, he is, in our estimation, misjudging the power of the Jasmine Revolution.  So far, the stock and credit markets in Egypt agree with us, and profoundly so.  Specifically, Egyptian 5-year credit default swaps are hitting two-year highs today at 375 basis points and the EGX 30, the benchmark  equity index in Egypt, closed down (-10%), after a prior three-day drop of 16%.

 

Our advice is simply this : Mr. Mubarak, turn on that internet!

 

Daryl G. Jones
Managing Director

 

Mr. Mubarak, Turn On That Internet! - 1


TALES OF THE TAPE: WEN, COSI, GMCR, CBOU, SBUX, EAT, YUM, DRI, MCD

Notable news items/price action over the past twenty-four hours.

  • WEN held their analyst day yesterday and, as my note published this morning details, I viewed the meeting as positive for the long term prospects of the stock which I continue to view as being undervalued
  • COSI has traded poorly this week but gained 5.4%, albeit on slowing volume.  I continue to like this turnaround story.
  • GMCR and CBOU declined on accelerating volume; coffee prices are posing a significant headwind for coffee companies and SBUX is growing market share.
  • SBUX downgraded at McAdams Wright Ragen.
  • EAT gained on accelerating volume.  This stock has performed strongly of late, even given the slowdown in Q4 for casual dining, and I continue to like the name as management executes on margin enhancing initiatives and sales driving catalysts come through over the next few months.
  • EAT was upgraded by Morgan Stanley this morning from “underweight” to “equal weight”.  Target increased to $26 from $18.
  • YUM’s Taco Bell chain is launching an ad campaign to fight back against a lawsuit over the quality of its beef taco filling.
  • YUM’s CDS spreads have blown out recently and this is due to rising food prices and the resulting riots in developing nations, according to Bloomberg.  General Mills, Darden Restaurants, and Campbell Soup Co. are other names named in the article.
  • MCD promoted Kevin Newell to the global chief brand officer role. 
  • The U.S. cattle herd probably shrunk to the smallest size since 1958 and the drop in beef supplies may boost prices to a record, analysts said. Ranchers held 92.211m head of cattle as of Jan. 1, down 1.6% Y/y, according to average estimate of 7 analysts  That would be the smallest herd in 53 years, said Ron Plain, livestock economist at the University of Missouri in Columbia.

TALES OF THE TAPE: WEN, COSI, GMCR, CBOU, SBUX, EAT, YUM, DRI, MCD - stocks 128

 

Howard Penney

Managing Director


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - January 28, 2011

 

Equity futures are trading mixed to fair value after Thursday's uneventful day.  Overnight, Moody's said on the US 'Aaa' rating: "Although no rating action is contemplated at this time, the time frame for possible future actions appears to be shortening, and the probability of assigning a negative outlook in the coming two years is rising". Today we have the release of Q4 GDP and the final reading of January Michigan Consumer Sentiment.

 

 MACRO DATA POINTS:

  • 8 a.m.: Fed’s Joseph Tracy speaks in Orangeburg, New York
  • 8:30 a.m.: Employment cost index, 4Q, est. 0.5%, prior 0.4%
  • 8:30 a.m.: GDP, 4Q, est. 3.5%, prior 2.6%
  • 8:30 a.m.: Core PCE, 4Q, est. 0.4%, prior 0.5%
  • 9:55 a.m.: Uni. of Michigan confidence, Jan., F, est. 73.3, prior 72.7
  • 1 p.m.: Baker Hughes rig count, Jan. 28  

TODAY’S WHAT TO WATCH:

  • Amazon.com (AMZN) forecast 1Q oper profit $260m-$385m vs est. $474.4m
  • Boston Scientific (BSX) got sued by U.S. for selling certain defective cardiac devices
  • Chubb (CB) forecast 2011 oper. EPS $5.35-$5.75 vs est. $5.82
  • Digital River (DRIV) forecast 2011 non-GAAP EPS $1.13 vs est. $1.35
  • MarkWest Energy Partners (MWE) boosted quarterly div to 65c from 64c; first increase since Oct. 2008
  • Microchip Technology (MCHP) forecast 4Q adj. EPS 56c-57c vs est. 57c, posted 3Q rev. $367.8m vs est. $362.9m
  • Microsoft (MSFT) reported 2Q adj. EPS 77c vs est. 68c, unearned rev. $13.42b vs est. $14.1b, according to data compiled by Bloomberg
  • Monster Worldwide (MWW) forecast 1Q adj. EPS 1c-4c vs est. 4c
  • QLogic (QLGC) reported 3Q adj. EPS 53c vs est. 42c
  • SanDisk (SNDK) forecast 1Q rev. $1.2b-$1.28b vs est. $1.16b
  • Tessera Technologies (TSRA) said it sees 1Q charge $2.5m-$3m, cites job cuts
  • Thoratec (THOR) reported 4Q adj. EPS 28c vs est. 29c
  • VeriSign (VRSN) says on conf. call sees 2011 rev. $750m-$780m vs est. $772.2m
  • Timothy F. Geithner gives address in Davos today; agenda for his trip also includes meetings with ECB President Jean- Claude Trichet, U.K. Chancellor of the Exchequer George Osborne and Belgian Prime Minister Yves Leterme
  • BankUnited raised $783m in IPO yesterday; sold 29m shares at $27 apiece after offering 26.3m shares at $23-$25 each
  • Sara Lee holds conf. call at 10 a.m. to give update on “strategic initiatives.” JBS gave up efforts to raise financing for takeover bid, making a spinoff of SLE coffee unit more likely, person with knowledge of the matter said yesterday
  • Kraft is re-assessing its brand portfolio and may look to sell slower-growth units such as Oscar Mayer meats business, NY Post says, citing unidentified source 
  • 69% of investors in Bloomberg global poll say Facebook is overvalued after Goldman invested $450m in a deal that put co. worth at $50b

EARNINGS:

  • American Electric Power (AEP) 6:57 a.m., $0.39 
  • Dover (DOV) 7 a.m., $0.82 
  • Ford Motor (F) 7 a.m., $0.48 
  • Honeywell International (HON) 7 a.m., $0.86 
  • Idexx Laboratories (IDXX) 7 a.m., $0.55 
  • Oshkosh (OSK) 7 a.m., $0.91 
  • AirTran Holdings (AAI) 7 a.m., $0.05 
  • Alliance Holdings GP (AHGP) 7 a.m., $0.71 
  • Alliance Resource Partners (ARLP) 7 a.m., $1.60 
  • Amcol International (ACO) 7 a.m., $0.41 
  • Scotts Miracle-Gro Co/The (SMG) 7 a.m., $(0.91)
  • Dominion Resources /VA (D) 7:30 a.m., $0.66 
  • *T Rowe Price Group (TROW) 7:32 a.m., $0.68
  • AGF Management Ltd (AGF/B CN) 8 a.m., $0.34 
  • Arch Coal (ACI) 8 a.m., $0.41 
  • Chevron (CVX) 8:30 a.m., $2.40 
  • Synovus Financial (SNV) Pre-mkt, $(0.20)
  • Enbridge Energy Partners (EEP) 4:01 p.m., $0.70 

PERFORMANCE:

 

Yesterday, the XLP broke the Hedgeye TRADE line as the earnings calendar seemed to be the big headwind for the staples - 8 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.

  • One day: Dow +0.04%, S&P +0.22%, Nasdaq +0.58%, Russell 2000 +0.22%
  • Month/Quarter/Year-to-date: Dow +3.56%, S&P +3.33%, Nasdaq +3.86%, Russell +1.50%
  • Sector Performance - (6 sectors up and 3 down): - Financials +0.88%, Consumer Disc +0.79%, Industrials +0.37%, Tech +0.34%, Utilities +0.38%, Healthcare +0.25%, Energy (0.58%), Materials (0.83%), Consumer Spls (1.01%)  

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 338 (-823)  
  • VOLUME: NYSE 990.18 (+8.95%)
  • VIX:  16.15 -2.94% YTD PERFORMANCE: -9.01%
  • SPX PUT/CALL RATIO: 2.66 from 1.06 (+151.57%)

CREDIT/ECONOMIC MARKET LOOK:

 

Treasuries were higher with help from another well-received auction

  • TED SPREAD: 17.35 +0.913 (5.555%)
  • 3-MONTH T-BILL YIELD: 0.15% -0.01%     
  • YIELD CURVE: 2.83 from 2.83

COMMODITY/GROWTH EXPECTATION:

  • CRB: 331.39 -0.43%  
  • Oil: 85.64 -1.94% - trading +0.12% in the AM
  • COPPER: 433.85 +1.68% - trading +0.27% in the AM
  • GOLD: 1,322.20 -0.65% - trading -0.47% in the AM

OTHER COMMODITY NEWS:

  • Oil’s link to U.S. equities has unraveled from its strongest level in at least 20 years as increasing inventories reduce the price of crude in New York. The 30-day correlation between these two benchmarks was at 0.28 yesterday compared with 0.82 on Nov. 16, the highest level since at least March 1991.
  • Natural gas dropped to a four-week low on speculation that a stockpile decline last week wasn’t enough to keep supplies from reaching a record by November.  Gas fell 3.9 percent after the Energy Department said inventories dropped 174 billion cubic feet to 2.542 trillion.
  • Copper rose the most in two weeks on speculation that low U.S. borrowing costs will buoy demand for industrial metals.
  • Better-than-expected US home sales data turned the sentiment positive in entire base metals at LME, and zinc future traded higher at $2,276 per ton on London Metal Exchange (LME).
  • Argentine rains in recent days were not enough to help corn crops recover from earlier dry weather, the Buenos Aires Cereals Exchange said.  The crop, which is about 99 percent planted, is forecast to reach 19.5 million metric tons, the same as a week earlier, the exchange said today in an e-mailed statement.
  • Bangladesh, South Asia’s biggest rice buyer, doubled its import target for this year to cool domestic prices that surged to a record in December as consumers and farmers hoarded supplies, a government official said.
  • Wheat fluctuated in Chicago as some investors liquidated contracts after prices reached a five-month high on demand from North Africa, where riots broke out this month over rising food costs.  The grain gained 9.1 percent in the past two weeks as rioting in Algeria, Tunisia and Egypt sparked demand for food commodities.
  • Cocoa prices capped the longest rally in more than three years, touching a one-year on increased speculation that supplies will be disrupted from the Ivory Coast, the world’s largest producer. 
  • Cotton futures in New York jumped to a record as growers struggled to meet surging demand from China, the world’s biggest consumer.  Prices have more than doubled in the past year as China’s imports climbed to the highest level since 2006 and adverse weather slashed global crops.
  • The total U.S. cattle herd at the start of this year shrank to the smallest size since the Eisenhower Administration, reflecting high feed costs, aging producers and drought that hurt pasture conditions.  As of Jan. 1, the nation’s inventory of all types of cattle and calves fell to 92.1 million head, down 1.7 percent from the same date in 2010, according to a survey of analysts. That would be the smallest herd for that date since 1958, according to government data. 

CURRENCIES:

  • EURO: 1.3703 +0.15% - trading +0.19% in the AM
  • DOLLAR: 77.727 -0.22% - trading +0.04% in the AM

EUROPEAN MARKETS:

  • FTSE 100: (0.78%); DAX: +0.11%; CAC 40: (0.05%) (AS OF 5:30 AM EST)
  • European markets trade mixed with peripheral European indices generally outperforming the region.
  • Indices opened lower before paring losses, an exception being the FTSE100 that remained near session lows. Declining sectors lead advancers 12-6 with healthcare (1.8%) and food & beverage (1%) leading fallers.
  • Financials lead gainers, banks +1% and insurers +0.8%, building on yesterday's advance, aided by optimistic comments from Bank of America's CEO in Davos.
  • The Irish Taoiseach says he will dissolve the Dáil on 1-Feb and announce a date for the General Election.
  • Spain's unemployment rate in Q4 rose to 20.3% from prior quarters 19.8%. US futures trade lower
  • UK Jan GfK consumer confidence survey (29) vs consensus (22) and prior (21)
  • The pound was pressured by the weak UK consumer confidence data and comments by Chancellor Osborne that the UK faced particularly acute challenges with the recovery likely to be slower than some other European countries
  • U.K. Jan. consumer confidence plunged most since 1994; fell 8 points from Dec. to minus 29: respondents have become more cautious on housing decisions, are worried about interest rate increases

ASIAN MARKTES:

  • Nikkei -1.13%; Hang Seng (0.68%); Shanghai Composite +0.13%
  • Most Asian markets fell today, with india down the most (1.54%)
  • China finished flat as new real-estate taxes in Chongqing and Shanghai harmed sentiment. Gains in small caps balanced weakness in property and financial shares.
  • South Korea fell (0.34%), but Samsung Electronics  rose 2% on results, and Hynix Semiconductor gained 5% on its outlook.
  • CNOOC dropped 7% to lead energy shares down in Hong Kong, and property counters fell on developments in China.
  • Energy Resources of Australia plunged 13% after canceling its dividend and reporting a 2010 net at the bottom end of guidance.  Australia treaded down (0.65%).
  • Megabanks fell on S&P’s ratings downgrade for Japan.
  • Japan December household spending (3.3%) y/y vs cons (0.6%). December retail sales (2.0%) y/y. December jobless rate 4.9% vs prior 5.1%. December core CPI (0.4%) y/y vs (0.5%) cons.

 


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THE M3: CASINO SMOKING AREA; SJM PAY RAISE; CHINA CAP RATIO; HENGQIN BORDER

The Macau Metro Monitor, January 28, 2011


NEW DRAFT ANTI-SMOKING LAW ALLOWS CASINOS TO HAVE SMOKING AREAS
macaubusiness.com

A new draft of the government’s proposal to revise Macau’s smoking law, but allow smoking areas in casinos, has already been submitted to the Legislative Assembly.  Casinos can create smoking areas covering a maximum of half of the casino floor and must be physically separated from the non-smoking areas.  If passed, casinos will have one year after the new law is enacted to set up such smoking areas.


SJM ANNOUNCES PAY RAISE macaubusiness.com

SJM has announced a 5% salary increase for its entire staff, starting February 1.

 

CHINA SAID TO PLAN TO RAISE BANK CAPITAL RATIOS WHENEVER CREDIT EXCESSIVE Bloomberg

According to sources, China may order its biggest lenders, including Industrial Commercial Bank of China and China Construction Bank Corp. to raise capital ratios to as high as 14% when credit growth is judged excessive.  In normal conditions, lenders deemed systemically important will need to have a minimum 11.5% ratio, unchanged from the current requirement for China’s biggest banks, said the person.

 

ROUND THE CLOCK CONTROL SERVICES AT HENGQIN BORDER PENDING FOR APPROVAL Macau Daily News

The Macau Government's final approval for the Hengqin Border crossing between Macau and Zhuhai to open 24/7 is still pending, although approval is expected.

 

 


 


The Last Entitlement

This note was originally published at 8am on January 25, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“When a milestone is conquered, the subtle erosion called entitlement begins its consuming grind.”

-Pat Riley

 

It’s Game Time. And tonight, America’s currency needs a big win. So, as a little pre-game prep for President Barack Obama’s State of the Union speech, I thought I’d toss him a little love from 5-time NBA Championship Coach, Pat Riley.

 

On the pre-game wire (US Dollar Index trading $78.16 as of 7AM EST), across durations, world currency markets are betting against America’s credibility and fiscal resolve:

  1. US Dollar Index immediate-term TRADE line resistance remains overhead at $80.05
  2. US Dollar Index intermediate-term TREND line of support ($78.66) is broken
  3. US Dollar Index long-term TAIL line of resistance remains firmly entrenched up at $81.62

Sure, some privileged Americans are willing to turn a blind eye to their sovereign currency, employment, and inflation levels. Some, like The Ber-nank, still fundamentally believe that America’s stock market is the barometer of her long-term health. All the while some “Wall Street Bankers”, according to the #1 headline on Bloomberg this morning, are “partying in Davos.” Ah, the storytelling about the depression and the deflation – nice.

 

The only problem with all of this is the other HALF of Americans who have $2,000 or less in some form of a stock and bond market account. For them, America’s leadership needs to stand ready to sacrifice tonight or else their team, to borrow another thought from Pat Riley, will continue to regard their “former greatness as a trait and a right.” Then, “half hearted effort becomes habit” … and “the champion is sapped.”

 

The world’s history of great Empires sides with me on this. From the Roman and British Empires of political entitlements past, I can only hope we’ve learned something. We’ve already crossed the proverbial Rubicon of senatorial deficit and debt spending. Time is no longer on this entitled state’s side.

 

The Last Entitlement in this country isn’t Social Security or Medicare – it’s cheap capital. And if the US Dollar is abused any further, “subtle erosion” of America’s global economic power will continue its “consuming grind.”

 

If there’s one picture that shows this most obviously (see the chart below), it’s the series of lower-highs and lower-lows that Presidents Bush and Obama have chosen to oversee with their Big Government Intervention, Spending, and Dollar Devaluation policies.

 

Yes, inflation is a policy. And no, it doesn’t have to be this way. It wasn’t this way under Reagan; it wasn’t this way under Clinton either. Both of these Presidents had an explicit strong US Dollar policy that led to two of the most productive decades of job growth in US history. Whereas, under Presidents Bush and Obama, America witnessed a decade (2000-2010) of net ZERO American jobs created and now we’re staring down the pike of American style Jobless Stagflation that we haven’t seen since Jimmy Carter blessed the Fed’s Arthur Burns “monetization” of US debt.

 

The Last Entitlement is perpetuated by a completely politicized US Federal Reserve. It prints the moneys. It prints the asset inflation. It justifies its actions with politicized fear mongering that permeates the American psyche.

 

It also shortens economic cycles. It amplifies asset price volatility. And, if you haven’t noticed, it doesn’t work.

 

All of this can be conquered if America holding the world’s reserve currency in the palm of her hand is respected again. We also need to respect the cost of capital or continue to run the risk of handing it out to these Bankers of America who continue to hoard it and destroy it via the Piggy Banker Spread.

 

Respect, unlike entitlements, is earned. And God help us all if we don’t have it within us to recognize this after the last 3 years.

 

In case you didn’t get the message from China’s President last week, the rest of the world is starting to bet against America’s currency too:

  1.  President Hu called the US Dollar reserve system “a product of the past”
  2.  President Hu warned that Americans need to keep the USD at “stable levels given implications to global liquidity and capital flows”

What he meant by that, Mr. Ber-nank, is global inflation being priced in US Dollars.

 

This morning you are seeing Global Inflation Accelerating continue to have its impact on major Emerging Markets:

  1. China was down another -0.68% overnight, taking it to -4.7% already for the YTD
  2. India was down another -0.95% overnight, taking it to -7.5% already for the YTD
  3. Brazil remains flat for the YTD and broken from an intermediate term TREND perspective.

Meanwhile, it’s not just emerging stock and bond markets telling you that US government sponsored Dollar Debauchery perpetuates inflation. India’s central bank Governor Subbarao just said at a ceremony in Mumbai that he is quote-un-quote “desperate” to cool inflation.

 

All the while, just to highlight the divide between our myopic Keynesian Consensus (that’s somehow patting itself on the back in Washington for “saving” us again) and Free Market Libertarians who are getting ready to move to Canada, consider these 2 American quotes from the last few days:

 

1.  “A more active government also attracts opportunists, who perceive that a national emergency can serve as a useful pretext for achieving their own objective.” –Steve Hanke (“On Democracy versus Liberty, GlobeAsia, February 2011)

 

2.  “Oh, and what evidence is there that the economy’s capacity is damaged during booms?” –Paul Krugman

 

Sadly, the unaccountable Big Government Intervention Bubble Making Machine of the Krugman camp dominates both the President and the Chairman of the US Federal Reserve’s craws. Before you know it, they’ll be asking to regulate food inflation in commodity markets. At least that’s what France’s Nicolas Sarkozy said he wants to do this morning. C’est la regulated socialist market vie!

 

Dear Mr. President, it’s Game Time, and this Burning Buck stops with you.

 

My immediate term support and resistance lines for the SP500 are now 1285 and 1295, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Last Entitlement - respect


Munis: Flurry, Blizzard or Avalanche?

“No snowflake ever falls in the wrong place.”

- Ancient Zen Proverb

 

Both the title of this morning’s Early Look and the quote above are very apropos for the current weather gripping New Haven, CT and much of the northeastern United States. Though the mounds of snow which line our streets are several feet high, it’s “business as usual” for those of us who refuse to blame our disappointments on things like “the weather”.

 

Addressing the quotation specifically, the saying above traces its origins to Zen, a school of Mahayana Buddhism. Per our friends at Wikipedia, what distinguishes Zen from other schools of Buddhism is its search for enlightenment through self-realization in Dharma practice and meditation rather than a reliance on text and intellectual reasoning.

 

In the asset and risk management industry, an overreliance on intellectual reasoning can get us into trouble, as we often lean towards the conviction we receive from our data analysis and channel checks versus what may or may not be blatantly obvious. In fact, we’ve all been trained to fade the obvious – even sometimes to a fault.

 

This brings up an interesting topic that is gathering momentum in the marketplace: Muni Bonds. The divergence in sentiment between retail investors and institutional investors seems to get wider by the day, as one group (retail) rushes to avoid what is perceived by some to be a pending crisis while the other (institutional) finds current valuations as a definite reason to “fade the obvious”:

  • Yesterday, it was reported that retail investors withdrew an additional $1.9B out of muni bond mutual funds. Though down from last week’s record $4B redemption, the trailing four-week average increased slightly to $2.3B. All told, the last eleven weeks saw a cumulative outflow of $22.5B, according to Lipper FMI. That’s ~22.5% of the roughly $100B poured into the funds from January 2009 – October 2010. Yes, there’s another side to the Bush Tax Cut extension trade…
  • Amidst the selling by retail investors, asset managers have used the latest backup in yields as a buying opportunity to lock in exceptional tax-adjusted rates, sending average yields on G.O. muni bonds down (-16bps) wk/wk, as measured by the Bond Buyer 20 Index. To a lesser extent, revenue bonds were bid up as well, with yields falling (-5bps). This was the first weekly decline in muni bond yields in four weeks.

To state it bluntly, we don’t see current prices for muni bonds as an investable opportunity to “fade the obvious”. We’re neither brave nor smart enough to get in the way of a potential wave of defaults, restructurings and credit downgrades (emphasis on potential, as we disagree with Whitney that $50-$100B worth of defaults is a foregone conclusion).  You don’t need defaults for the price of a bond to go down.

 

Even for those brave investors who possess the analytical firepower to find value in the muni market at current yields – including the highly-regarded Lyle Fitterer – we think many of them may actually be using faulty data in their analysis. Fitterer, the top muni bond fund manager of the last decade, remarks, “The baby has been thrown out with the bathwater”; as such, he’s using the current back up in yields as a buying opportunity for specific revenue bonds.“If a State were to file bankruptcy, I have a bond with a dedicated revenue stream,” he says.

 

Fitterer’s comments beg the question, “What’s a revenue bond worth when it doesn’t meet its revenue target?” Probably the same as an equity that misses estimates amid bullish sentiment: less. While we’re not yet calling for a spate of “misses” across the nation, we do think the confluence of slowing domestic growth, rising interest rates and a rapidly deteriorating housing market will weigh heavily on the finances of States, municipalities and municipal authorities alike in 2011:

  1. Consistent with our Consumption Cannonball theme, we expect consumer spending to roll over in 1H11. Sales and income tax receipts combine for ~55-60% of State and local government revenues. Deteriorating fundamentals = bad for muni bonds.
  2. Consistent with our Trashing Treasuries theme, accelerating inflation on the strength of a Debauched US Dollar continues to support rising US Treasury bond yields. The Ber-nank may not see inflation, but the global bond market sure does. A rising interest rate environment = bad for muni bonds.
  3. Consistent with our Housing Headwinds Part II theme, we think US housing prices could end up down (15-20%) by the time the July 2011 Case-Shiller data rolls in (early fall). Property tax receipts make up roughly 26% of local government revenues, though they are typically assessed on a 2-3 year lag. Regardless, municipalities across the nation are running out of headway to finagle with their accounting. US housing wasn’t exactly robust over the last 2-4 years. The oncoming wave of lower property tax receipts = bad for muni bonds.

Speaking of borderline accounting fraud, a very alarming trend has emerged over the course of the most recent economic downturn. Rather than lie about their deteriorating finances, a growing number of municipalities have opted to hide them instead.

 

A recent study done by DPC DATA Inc. revealed that over 56% of municipal issuers did not file a financial statement in any given year between 2005 and 2009. Over 33% of them skipped filing in three or more of the past five years. In the latest year (2009), the percentage of non-filers jumped +360bps to 40.2%. An additional 30% filed “extraordinarily late” that year, according to the analysis.

 

It’s tough to analyze what you can’t see. Moody’s Managing Director of Public Finance, Robert Kurtter, agrees, saying on CNBC’s Squawk Box that 2/3rds of all muni issuers are unrated (1/14). And even if they we’re “rated”, we’re not buyers in blind faith of America’s ratings agencies!

 

Regardless of your perception of the fundamentals, the “snow” is falling in the muni bond market and the thick coat of snow accumulating serves as a metaphor for the opacity that’s associated with issuer finances. When the ice melts in the coming months, will you be holding a bag full of “unforeseen” risk because you bought the first dip after a 30-year bull market in muni bonds? We definitely won’t be – that’s for sure.

 

Remember, no snowflake ever falls in the wrong place.

 

Darius Dale

Analyst

 

Munis: Flurry, Blizzard or Avalanche? - red


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