Today's Tidbits

Bond Sell-Off Based on Fundamentals
From Lehman: “To understand the implications of the sell-off, it is important to understand the cause. Most of the increase in rates has been “real”—with interest rates on inflation-protected bonds rising almost as much as nominal yields. The rise seems to be mostly the result of stronger economic news, including reduced risk of a U.S. recession and signs of global inflation pressure. Of course, this has helped change policy expectations, and some of the sharper moves seem to have been sparked by “capitulation” by dovish investors hoping for Fed rate cuts. Finally, the more recent sell-off has been concentrated in the long end, suggesting a small rise in term premia, perhaps on expectations of asset rebalancing by Asian central banks. So far, the contagion effects have been limited…At this stage, the sell-off is a relatively minor event for both the economy and policymakers. Interest rates remain low relative to inflation. The feed-through into other capital markets has been limited. And in typical model simulations, a 50 bp rise in bond yields slices only a few tenths off of GDP growth. In other words, the bond shock probably only “cancels out” some of the recent good growth news. Policymakers have probably been surprised by the speed of the sell-off but will likely
view most of the move as warranted by fundamentals. Many officials have warned that the current low risk premiums—including term premia—are unsustainable. Fed officials have puzzled in public over why markets were insisting that rate cuts were coming. With its repeated warnings of “strong vigilance,” the ECB cannot be too surprised by the weak
bond market. The BOJ has made clear that it is at the beginning of a long tightening cycle.
A number of other central banks are either hiking rates or warning of hikes to come.”

Comparing Current Declines to Past Housing Busts in the U.S.
From The New York Times: “During the 1930s, housing prices fell sharply across the nation. According to the S.& P./Case-Shiller home price index, a measure of national housing prices, the average price of a home fell 24 percent from 1929 to 1933. More recently, there have been severe price declines in regional markets. The most severe was in the so-called oil patch during the 1980s. In the late 1970s, as global oil prices soared, oil-producing areas of Texas, Oklahoma, Louisiana, Colorado, Wyoming and Alaska experienced an economic boom. As oil prices collapsed in the early 1980s, those economies crashed, and housing along with them. In the worst cases, nominal home prices fell 40 percent in Lafayette, La., and 33 percent in Casper, Wyo., from 1983 to 1988, according to the Office of Federal Housing Enterprise Oversight. In Houston, prices fell 22 percent. Then there were the sharp price declines in housing on both coasts during the early 1990s. At that time, a series of events including the recession of 1990-91, the military downsizing after the cold war and a commercial real estate collapse led to a housing downturn. For instance, in Los Angeles, Long Beach and Santa Ana areas of California, the average price of a home tumbled 19 percent from 1993 to 1998, while on the other side of the country, in the Hartford area, the average home price dropped 17 percent over the same period…So how far have prices actually fallen? The median price of an existing home has declined 4 percent, on average, since the peak in October 2005, according to the National Association of Realtors…In the 12 months that ended in March, for example, the median price of an existing single-family home in the Sarasota-Bradenton- Venice area of Florida fell by 12.4 percent, according to the National Association of Realtors. In Louisiana, in the area of New Orleans, Metairie and Kenner, the average price fell by 11 percent. And in the Reno-Sparks area of Nevada, the average decline was 8.8 percent…”

Bernanke Worried Falling House Prices Hurt Consumption of Poor More than Rich
From The Financial Times: “Changes in house prices could have a bigger effect on consumption than the traditional “wealth effect” suggests, Ben Bernanke said on Friday in comments that offer some insight into how the Federal Reserve may think about the continuing problems in the US housing market. The Federal Reserve chairman told a conference hosted by the Atlanta Fed that, in addition to making homeowners richer or poorer, changes in house prices might influence the cost and availability of credit to consumers. This is because people with equity in their homes have more at stake in avoiding default…If this theory is correct, Mr Bernanke said, “changes in home values may affect household borrowing and spending by somewhat more than suggested by the conventional wealth effect”. The Fed chief notes that this argument also indicates that the distribution of home price gains or losses matters for consumption. …This suggests the Fed may be relatively relaxed about declines in segments of the housing market where wealthy homeowners have a large stock of home equity, but more concerned about price falls in areas where people have little home equity. This is typically the segment with a high proportion of subprime loans….The Fed chief said he did not know whether the so-called “financial accelerator effect” on household spending via access to credit was big enough to affect the overall economy.”

Merrill Causes Bear Stearns’ Mortgage Hedge Fund Auction to be Postponed
From Dow Jones: “Merrill Lynch & Co. Monday morning postponed its planned auction of $400 million worth of collateral assets from a troubled Bear Stearns Cos. hedge fund, giving the fund’s managers more time to present a plan for salvaging it, say two people familiar with the matter. Worried that the Bear fund, called the High-Grade
Structured Credit Strategies Enhanced Leverage Fund, would be unable to make a margin call Merrill on Friday moved to seize the assets and prepared to auction them off at noon
Monday. But over the weekend the fund’s managers, led by Bear veteran Ralph Cioffi, cobbled together an 11th-hour plan to garner new investment capital and a short-term loan to meet the most immediate margin calls, said another person familiar with the
matter.”

Robust Chinese Economy Offsets Slowdown in European Manufacturing Growth
From JP Morgan: “China’s May activity indicators, including retail sales, fixed investment, exports, and industrial production, portray an economy that is firing on all cylinders, raising the possibility that current-quarter growth could be even faster than the
12.4% pace (q/q, saar) posted in 1Q. Although nonfood inflation remains dormant, the brisk pace of activity growth is raising concern among officials. An export surge in the first five months of 2007 boosted the overall trade surplus 84% above the same period last year, increasing the risk of political problems with the US. Renewed strength of fixed investment spending and a buoyant stock market have prompted Premier Wen Jiabao to state that policy needs “moderate tightening” to prevent the economy from overheating… The latest surge in manufacturing output in China contrasts with a sudden slowing in the Euro area. Despite these mixed signals, we remain comfortable with our view that global manufacturing activity is accelerating from the trend-like 3% growth pace averaged during 4Q06-1Q07. China’s central role in the global production cycle means that it is increasingly a bellwether for global demand and production. Indeed, the acceleration in China is being mirrored in the rest of EM Asia and in the United States. With Japan poised to join the rebound, global IP growth will gain speed despite a moderation in the Euro area. The sharp contraction in Euro area manufacturing output in April was a reminder that industry within the region is coming back down to earth, after almost two years of strong growth.”

Web Retail Growth Slows as Market Penetration Reaches 5%
From The New York Times: “Since the inception of the Web, online commerce has enjoyed hypergrowth, with annual sales increasing more than 25 percent over all, and far more rapidly in many categories. But in the last year, growth has slowed sharply in major sectors like books, tickets and office supplies. Growth in online sales has also dropped dramatically in diverse categories like health and beauty products, computer peripherals and pet supplies. Analysts say it is a turning point and growth will continue to slow through the decade… Sales on the Internet are expected to reach $116 billion this year, or 5 percent of all retail sales, making it harder to maintain the same high growth rates. At the same time, consumers seem to be experiencing Internet fatigue and are changing their buying habits… The retailers that have started in-store pickup programs… have found that customers who choose the hybrid model are more likely to buy additional products when they pick up their items...Consumers are generally not committed to one form of buying over the other.”

Caution Warranted for Prescription Drugs Made in Asia
From The Washington Post: “India and China, countries where the Food and Drug Administration rarely conducts quality-control inspections, have become major suppliers of low-cost drugs and drug ingredients to American consumers. Analysts say their products are becoming pervasive in the generic and over-the-counter marketplace… After the pet food scandal that triggered fears over the safety of human and animal foods imported from China, experts say medicines from that country and from India pose a similar risk of being contaminated, counterfeit or simply understrength and ineffective… FDA officials say that they are not aware of any health problems caused by drugs imported from India or China and that the American companies that import them usually do their own quality and safety testing. But the agency acknowledges that it is virtually impossible for it to know whether poor-quality or contaminated drugs from lightly regulated Asian plants have caused patients to get sicker or remain ill, especially because patients and doctors are unlikely to suspect poorly manufactured drugs as a problem… Analysts estimate that as much as 20 percent of finished generic and over-the-counter drugs, and more than 40 percent of the active ingredients for pills made here, come from India and China… a former FDA associate commissioner, called the situation dire and deteriorating. ”


Underinvestment in Electrical Grid Increases Likelihood of Disruption this Summer
From Reuters: “Most people in the United States only think about where electricity comes from when the lights go out suddenly. But unless the antiquated transmission grid is fixed, expensive blackouts that bring modern life to a grinding halt will become ever more common…Before the 1980s, power generating companies were responsible for the entire chain of supply, from securing fuel to transmitting power to homes. Deregulation, meant to increase competition, has busted that chain apart and left the wires and substations that deliver electricity as a "neglected stepchild," …As demand for electricity rises, especially in the hot summer months when air conditioners are humming, the result is an overstretched grid, exploding transformers, brownouts and blackouts. Transmission only accounts for about 10 percent of the industry's assets, and for decades utilities and regulators have focused on more expensive parts of the system. Now, even electricity generated in ultramodern plants is dependent on the brittle transmission grid. "Imagine driving a Maserati over a road littered with potholes," …”

Analysts Improve Track Record Since No Longer Required to be Bullish
From Bloomberg: “Never in the history of Wall Street have analysts been so bearish. The good news is they're also getting it right more often, helping make investors richer by betting against corporate America. Thank the regulatory hammer of former New York Attorney General Eliot Spitzer. In 2003 he forced 10 big firms to separate investment banking from research to avoid the conflicts of interest that tempted analysts to keep their reports upbeat. ``The industry has changed: you're not anathematized if you
come out with a negative opinion,'' said Robert Stovall, whose work on Wall Street the past five decades included stints as a strategist at the securities unit of Newark, New Jersey-based Prudential Financial Inc. and research director at Nuveen Corp. in New York. ``It used to be that sell recommendations were frowned upon. I even worked at firms where the CEO said, `I never want to see a bearish word on my stationery.''' That transformation has helped investors following analysts' advice to beat the market. Nine of those 10 firms have been accurate the past two years, according to Investars, which tracks
analysts' performance.”


MISC

From Dow Jones: “U.S. Treasurys were [slightly higher in price with yields falling 2bp]…The dollar was weaker [dollar index down 13 to 82.72]… Stocks were little changed [Dow down 26.5]…Crude oil futures rose more than $1 Monday, climbing…[to the highest level] since last September after fresh militant attacks on Nigerian oil installations and separate plans by Nigerian and Brazilian workers to strike.”
From USA Today: “Because food is an item that people cannot do without, higher food costs mean consumers have less money to spend in other parts of the economy. And because consumer spending accounts for more than two-thirds of all U.S. economic activity, reduced spending in non-food segments of the economy could lead to slower growth in those areas... food prices could have a far more detrimental impact on the economy than higher gasoline costs. U.S. consumers on average spend 15% of their budgets on food and beverages, vs. 4% on gasoline. “

From UBS: “10-year Treasury yields are now more than 300bp above the y/y pace in core PCE prices, up from around 200bp at the time of Mr. Greenspan’s comments [on the bond rate conundrum in early 2005] and in line with the long-term average (330bp from 1960-2005).”

From Credit-Suisse: “After some volatile moves, the forward real yield spread between the US and Europe remains in the low end of the historical range.”

From Bear Stearns: “While industrial production was unchanged in May from April, the level of output in the second quarter is expanding from the first, which in turn expanded from the fourth quarter of 2006. This points to the winding down of the inventory correction which dragged on the economy in late 2006 and early 2007. Based on the continuing low level of initial and continuing jobless claims and other employment indicators, we expect the unemployment rate to decline further in June or July.”

From Merrill Lynch: “…at no point in the past 60 years did core inflation manage to go below 1% without there being a recession involved.”
From JP Morgan: “…the [Chinese] government is likely to cut or remove the 20% tax on interest income to try and limit the flow of funds from bank deposits to the equity market.”

From Merrill Lynch: “Pakistan, Singapore, Korea (moved above 1800) and the Hang Seng (a huge 565 point or 2.7% surge) all hit new record highs today. The snapback in emerging Asian stocks is occurring in tandem, as one would expect, with a sharp recovery in the CRB index as the commodity complex has been on fire of late and the gains broadly based.”

From JP Morgan: “…fear of higher bond yields is likely to cause the traditional dividend yield [equity] sectors to keep giving up market leadership (in the case of utilities) and for financials to underperform the broader market…”

From Barclays: “…commodities are increasingly bid, with WTI crude resuming its uptrend, while base and precious metals hold against key support. The most impressive, however, has been the grain complex…It is a similar story for global equity markets, as they continue their upside march. Japanese equities are on the verge of breaking key resistance, while the DAX futures have registered all-time highs, warning that the cash markets are not far behind.”

From Dow Jones: “Airbus appears to be catching up on its U.S. rival and shaking off its image as a lame-duck company beset by governance issues and industrial hiccups that will keep it in the red for the second straight year in 2007. Including deals announced Monday, Airbus has now taken firm orders this year for about 420 planes compared with 435 at Boeing…”