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New Money Helps Santa Keep Giving – The classic Santa Claus Rally is said to consist of the final five trading sessions of the outgoing year and the first two sessions of the New Year. The first two sessions of any quarter are often benefitted by early funding of pensions, 401Ks and the like.
That tendency was noted in the early sessions of the two preceding years. In 2009, the first trading session saw the S&P rally 3.1%. In 2010, the S&P rose 1.6% on the initial day. So, yesterday’s action was somewhat traditional.
There were some minor oddities within the trading. The ETF sector was far more active than the stock sector.
The Dow rose 93 points but the S&P was up the equivalent of 127 Dow points. The clear winner was Nasdaq which shot up the equivalent of 173 Dow points. The techs may have benefitted from the aggressive valuation put on Facebook after the Goldman investment.
The opening day saw volume rise back above a billion shares for the first time in over a week. That was a touch surprising since markets in London, Tokyo and Shanghai were closed.
The bulls gave back only a mild portion of the rally as the session ended. A few Gann style cycle types had been calling for a sharp afternoon reversal which obviously did not arrive.
And So Say All Of Ye – CNNMoney did a year opening survey of 32 stock “experts”. They look for an average rally in the S&P of 11%. In fact, not one of the 32 thought the S&P might close down on the year. That gives you a little bit of a chill.
Do As I Say Not As I Do – If you were in the stock market as September began last year, you might not have been exactly elated. After a multi-month roller coaster, the averages sat, pretty much, where they had begun the year. But things were in the process of change.
In the final weekend of August, Chairman Ben Bernanke delivered his Jackson Hole speech which outlined a possible QE2 program. The stock market began a rally that would last to yearend (and maybe beyond).
The premise was simple. The Fed would expand its balance sheet in order to buy Treasuries and other debt instruments to make monetary policy easier (lower rates). QE2 would allow the Fed to get around the limitations of traditional policy in a zero interest rate environment.
The announced goal was to ease monetary policy (lower rates) enough to help lift the stock market and other assets promoting a kind of wealth effect.
The “targeted” assets began to rise almost instantly and obediently. At the time of the Jackson Hole speech, the Dow was approximately 10,000 and the S&P was around 1050.
Some non-targeted assets also began to rise. At the time of Jackson Hole, gold was around $1200; copper was near $3.40 and crude was about $78. So, we can see that the proposal and implementation of QE2 has had a dramatic impact on prices. But, what else would you expect from a much easier monetary policy that drove rates lower.
Yet, as Hamlet might say – Aye, there’s the rub. Despite the Fed’s purchases of billions upon billions in treasuries and other debt, rates have moved higher since Jackson Hole. The yield on the 10 year has risen from about 2.50% to near 3.25%.
So, it would appear that it is not the monetary mechanics that are moving markets; rather it is what John Hussman has described as rhetorical impact. Mr. Bernanke appears to have “jaw-bonded” the stock market higher, along with other assets.
So far the pundits are crediting QE2 with beginning to lift the economy (as evidenced by the stock market). We have yet to see what will be the effect on the economy of the unintended consequences (higher prices for oil, food, etc.). This is only the end of Act I.
Investment conclusion: We are reducing agency reps/warranties loss estimates by $1.2b to $10.4b given today’s actions and BAC’s commentary that it’s 70-75% of the way thru GSE claims. Reduced loss est is accretive to eps by 8c/share and worth ~80c to the stock price, which is what we got today with BAC’s 85c uptick.
What the market is not pricing in? Additional upside if reserves are too high against future agency r/w losses. We est agency reserves are ~$1B too high, worth ~6c/share in eps or about 65c to the stock. We model remaining agency loss estimates of $3.1b and estimate that BAC is carrying $4.1B in agency reserves. We do not model reserve bleed, but rather assume it could be used to help fund a more severe bear case private label reps and warranties losses than we are estimating.
Implications for non-agency r/w: We believe our reps and warranty estimate on non-agency exposures is conservative, and today’s announcement supports that view. Clearly, non-agency r/w exposure is very different from agency r/w exposures. However, our non-agency r/w loss estimates of $9.2B ($10.2B including our est excess reserve above) is roughly double the implied 1% loss against FRE’s unpaid principal balance (upb). This is likely too high given lower probability of successful putback.
What does BAC’s settlement suggest for lc bank universe? Implies agency loss severities decline by 14% or $4.4b for lc banks including reduced r/w losses of $1b for WFC, $840m for JPM and $600m for Citi, worth ~$1.35, $1.40, and 13c to the shares respectively.
Investment thesis: We are OW BAC as we expect falling credit losses, stabilizing PPoP, rising dividends and higher EPS and BVPS. At 0.7x PB and 1.1x PTB with growing earnings, BAC is cheap, in our view. Fundamental catalysts of stabilizing NIM, improving loan growth, and rising divi are coalescing around 2q-3q11 with credit improvements continuing throughout 2011+.
Macau revenues grew +66% in December to ~MOP18.9B According to DICJ, Macau gaming revenues grew +66% to MOP18.88B, a new monthly record vs. the prior record of MOP18.87B set in October ’10. December’s strong results were above mid-month expectations (revenues were tracking +50% through the first three weeks of December). This indicates a big acceleration in the last two weeks of the year and was overall better than the three-year historical trend of coming in at least 10% lower than October. On a 2-year basis, Dec’s +113% was ahead of Nov’s +102% and 3Q’s +71%. FY2010 revenues of ~MOP188B set a new record, growing +58%.
WYNN and LVS pick up market share in December
According to Macau Business, there were some market share shifts in December, with WYNN and LVS the main beneficiaries. LVS gained ~170bps of market share to 16.7% (19% share in 2010) and WYNN picked up ~60bps of share to 17% (15% in 2010). Notably, WYNN rose to capture the 2nd greatest market share in Dec. There should be upside to 4Q Street estimates for WYNN; we are reviewing our model. SJM was the greatest share donor in Dec, dropping ~200bps to 30% (32% share in 2010) and Galaxy’s share dropped ~50bps to 10% (11% share in 2010). MGM’s share was 11.7% (9% in 2010) and MPEL’s share was 14.5% (~14% share in 2010).
Expect stocks to be strong on Dec revs, China PMI offset
December’s revenue outperformance relative to market expectations is clearly impressive and we expect strong stock performance as a result. That said, the Macau gaming names are highly levered to any macro headwinds in China and the slowdown in China’s PMI could be a bit of an offset to strong revenue performance in Macau. We remain bullish on the Macau market with continued signs of strong demand from junkets and the Chinese high-end consumer, favorable liquidity conditions in China and a strong base of underlying gaming volume the market is carrying into 2011. LVS ($45.95, Buy) and WYNN ($103.84, Buy) remain our top picks given their Asia exposures.
January 3, 2011
Setup and Resolution
John P. Hussman, Ph.D.
Happy New Year. I’d like to begin this week’s update with some investment comments specific to the Strategic Growth fund, and then move on to conditions that we expect to influence the markets in 2011.
Through mid-September of 2010, the stock market was essentially a roller-coaster with no net gains for the year, but the final months saw a speculative burst that was heavily skewed toward cyclicals, small-caps, commodities, and shares characterized by low stability of earnings and high sensitivity to market risk. The Strategic Growth Fund finished the year with a slight loss of 3.62%. The loss resulted from our defense against an overvalued, overbought, overbullish, rising-yields condition coupled with a runup in risk assets that was still uncorrected as the year came to a close. While the decline was minor from a long-term perspective, it felt excruciating in the final weeks of 2010, as stocks characterized by low-quality, low yield and high risk persistently outperformed those ranked higher in quality, yield and stability. The result was a series of small but relentless day-to-day pullbacks in the Fund, while the major indices registered a series of marginal new highs for the year.
We enter 2011 at a point where investors have pushed risk assets to a speculative extreme, on the belief that the Fed has provided a “backstop” against losses. While there’s no assurance that we won’t see a further extension of this over the short-term, we’ve found more often than not that speculative setups in the financial markets are followed by a striking degree of subsequent resolution in the opposite direction.