Market Wrap-up: markets react negatively to monetary tightening in China

2010-01-20

The markets were on pace for their worst day this year, but recouped some of the losses in the afternoon.  Morning weakness was driven by worries on the global economic impact of monetary tightening in China, which drove commodities stocks lower (Alcoa – AA was down 2.5% and Chevron lost almost 2%).  China ordered banks to put the brakes on their lending.  Investors interpreted this forced economic slowdown as a looming decline in demand for materials.  In addition, earnings of some of the most prominent financial companies weighed on the market in the morning.  Bank of America – BAC (missed consensus), Wells Fargo – WFC (beat), and US Bancorp – USB (met estimates) reported today. 

The general conclusion from bank earnings is that capital markets were particularly weak in 4Q, but credit quality showed improvement.  Some earnings misses confused the market, but investors eventually focused on stronger-than-expected and consistent credit trends.  Unfortunately, the signal is not clear due to the impact of government and banks’ restructuring efforts, which can obfuscate the underlying credit quality of a portfolio.

On domestic economic news, the Mortgage Bankers’ Association released its purchase applications index, which measures homebuyers’ applications at mortgage lenders and is a leading indicator for home sales and construction.  This is a weekly number and can be particularly volatile, so its readings are not always that meaningful.  Still, a 4.4% growth from last week was welcome news, though it primarily reflected artificially low interest rates, subsidized by the government rather than sustainable strength in the underlying fundamentals.  The International Council of Shopping Centers also released a positive number of retailers’ same store sales, which were up 2.0% from the prior week and 2.6% from the year-ago period, primarily driven by better sales at discounters.  The Producer Price Index was pretty much in line with expectations, easing inflationary pressures from a rising index in November, when it jumped by 1.8% vs. a much more benign increase of 0.2% in December.

Bill Ackman explained that he bought Kraft – KFT because the stock was cheap, trading at <15x EPS and >4% div yield.  The company has a very economically resilient business and there is minimal risk of trade-down in its core products.  After Buffett said Kraft’s stock was cheap currency, he got comfortable that they wouldn't issue too much stock for the Cadbury deal.  In contrast to Buffett, Ackman is ok with the price and really likes the deal, because it expands Kraft’s global distribution and gives it an incredible collection of brands.  The mispricing or the upside potential comes from the fact that both Kraft and Cadbury are under-earning, i.e., not achieving what they should be in terms of margins, so there's a big cost-cutting as well as cross-selling opportunity (utilizing each other's distribution channels).  [Video link: http://bit.ly/8mHo3z]

Warren Buffett expects to soon start looking at the next big acquisition after Burlington Northern – BNI is done.  He believes that Berkshire Hathaway – BRK stock is undervalued, so the deal will cost shareholders more than the stated $100 per share, since he has to give BNI shareholders BRK shares trading at a price significantly below what he thinks is the shares’ intrinsic value.  Regardless, the deal made sense even after taking the assumption that BRK has a cheap currency into account.  Buffett disagrees with Ackman on the Kraft-Cadbury deal by calling the acquisition too expensive and a mistake (on Kraft’s part).  Still, he's holding on to shares because KFT shares are still undervalued (though less so after the deal).  [Video link: http://bit.ly/5VwhFq]

User Comments