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• March 2014 Investor Letter
  Scott Krisiloff, March 6th, 2014 at 3:02 pm

  Below is a letter that is written monthly for the benefit of Avondale Asset Management’s clients. It is reproduced here for informational purposes for the readers of this blog.  If you are interested in receiving this letter monthly by email, sign up here.

  Dear Investors,

  The S&P 500 was up 4% last month and even though the index is still effectively flat for the year, February’s rise was particularly heartbreaking for bears. Bears endured a horrific rise in 2013 and just as it looked like there was finally going to be a little relief in January, the market turned right back around to reach new heights.

  February’s rise puts the bears under an extreme amount of pressure. The market has risen virtually in a straight line for fifteen and a half months. If the market continues to rise and bears don’t participate, they are risking their careers and credibility. Bears simply cannot afford to miss out on another rally.

  To add to the bear’s anxiety, March and April are historically two of the best months of the year for equities. No doubt bears are looking at this potential advance and panicking. Perversely, this panic is likely what caused February’s rise. Bears are so sensitive that even the slightest possibility of a stable economic environment was enough to force them to come rushing back into the market.

  Although it did come as a surprise, February’s advance is still consistent with the very late innings of a bull market. Equity prices were pushed higher solely because of heightened emotions and the absence of bad news. This kind of reaction suggests that the final bears are capitulating.

  These capitulating bears can continue to push prices higher in the short term, and I would not be surprised if stocks continue to rise in the coming weeks. Eventually, however, the capitulation is what sets a more lasting peak because once the bears are through there isn’t anyone left to buy.

  I wish that I could say we were positioned to take advantage of a potential near term rise, but unfortunately we aren’t and don’t have any plans to be. The only thing that keeps us from getting caught up in emotions like other bears is avoiding the temptation to reposition for a quick gain. Our portfolios are deliberately maneuvered like an aircraft carrier rather than a speedboat in order to mitigate the risk of making capricious decisions. We take a long-term view when investing and a positive outlook for the next couple of weeks does not change the outlook for less calm seas on the horizon. We should be prepared to be frustrated in the near term, but I’d rather be frustrated than abandon our discipline.

  Importantly, I believe that heightened emotions are clouding investors’ ability to see a deteriorating environment. The greatest concern is that stocks have not gotten any cheaper this year. They have only become more expensive. At current levels, the S&P 500 is trading at the exact same PE multiple that it did at the peak of 2007’s bull market. The only time in history that the S&P 500 has traded at a higher multiple on peak earnings is the 1997-2000 period.

  In addition to high prices, earnings growth is slowing while growth expectations are rising. This is best illustrated by analyst expectations for what the S&P 500 will earn in 2014. In 2013, the revenue per share of the S&P 500 grew by just 0.63% while earnings (thanks to margin expansion) managed to grow by a mediocre 5.6%. In 2014 analysts are projecting revenue growth to accelerate to 3.6% and earnings to grow by 8.9% (thanks to even greater margin expansion than 2013).

  In 2014 there is even less slack in the economy than there was last year so it’s difficult to see how revenue will grow significantly faster than it did in 2013. Likewise, it is difficult to make the case for further margin expansion. Corporate profit margins are at or near all-time highs, and have benefitted from weak labor markets and low inflation. If economic activity is really going to continue to pick up in 2014, the outlook will likely have to include higher inflation and tighter labor markets. Both of these would pressure profit margins.

  Another headwind to growth and margins is that productivity growth has slowed and is likely to slow further in 2014. Productivity is the most important driver of real economic growth, and the fundamental source of productivity is innovation, which allows people to do more with less. In the recent cycle, mobile computing has been the single biggest productivity driver for the economy. Today that wave has slowed and is now effectively over. Everyone who needs a smartphone or a tablet in the US already has one. Some investors are currently chasing hot new growth avenues, but there is no category of products on par with the smart phone that is on the precipice of mass adoption. There will be revolutionary products down the line of course, but we are currently in a lull in the innovation cycle.

  Besides productivity, debt accumulation is one other factor that could boost short-term economic growth, but is unlikely to materialize. While corporate borrowing may step up in 2014, consumer borrowing is really what moves the needle on aggregate debt. Specifically, mortgage borrowing is the most important category. The next time there will be real mortgage growth is when Gen Y levers up to buy homes. Gen Y has a tremendous amount of borrowing capacity and will eventually fuel a borrowing boom, but demographically the wave is still a couple years away. The median age of Gen Y is 28 years old, which means that the individuals who will become Gen Y’s mass affluent are just finishing up professional schools and re-entering the workforce. In a couple of years they’ll have the savings to make a big splash in housing, but probably not in 2014.

  Finally, investors are fully aware of one more economic cloud, but seem to be willfully ignoring it. The higher the market climbs, the more likely the Fed is to withdraw monetary stimulus. QE3 is a large part of the reason that stocks have not had a significant pullback in 15 months. And as long as stocks maintain their current position or rise from here, QE will be finished before the end of the year. The Fed is the bull market’s ticking clock. In the past, Fed policy provided a floor for equity markets, but now it provides a ceiling. It is a ceiling that we are rapidly approaching.

  Scott Krisiloff, CFA

  
  
  
  

• Global PMI Data February 2014
  Scott Krisiloff, March 5th, 2014 at 10:50 am

  Global PMI surveys were released this week and overall they continue to show an expanding global economy.

  The manufacturing data was strong across the board.  Of the 22 countries tracked here, only four had readings below 50, implying contraction.  Unfortunately, China, which is arguably the second most important global economy, is one of the economies showing weakness.  HSBC’s manufacturing survey for China fell again last month  to 48.5, which is the lowest reading since last July.

  Services surveys were also strong.  Only two countries out of eleven tracked here indicated contraction.  With the exception of France, which has been perpetually weak, European economies are showing significant strength in the services surveys.  The top four surveys were UK, Germany, Spain and Italy.

  Source: Markit Press Releases

   

  
  
  
  

• S&P 500 Finishes March Positive 2/3 of the Time
  Scott Krisiloff, March 4th, 2014 at 10:34 am

  A couple of weeks ago I mentioned that we were approaching one of the best seasonal periods for equities.  Today’s rebound serves as one confirming data point for that seasonality.

  Since 1957 the S&P 500 is positive in March 67% of the time.  It is also positive in April 70% of the time.  That makes March and April the 2nd and 3rd most frequently positive months of the year.

  If seasonality holds, bears will need to brace themselves for at least two more months of pressure.  I’m not sure there are many left who can last that long though.

  

  
  
  
  

• When Peoples War, Corporations Profit…
  Scott Krisiloff, March 3rd, 2014 at 9:57 am

  “When peoples war, corporations profit. When corporations war, the People profit.”

  –TIME Magazine, 1929

  I think there’s almost no possibility of a global conflict arising out of the situation in Ukraine, but markets are running a fire drill today on how to behave in the event of war, so I decided to take a look at how the economy and markets reacted to global conflict in the past.

  As you might expect, war is a big stimulant to the economy, but not particularly favorable to equity markets or inflation.

  During World War II (1939-1945), real GDP grew at an average rate of 11% per year.  Meanwhile nominal GDP grew at 15% per year as CPI inflation averaged nearly 4% during the time period.  That inflation rate was achieved through strict price controls, which gave way to double digit inflation in the years following the war.

  

  The economy saw strong growth, but equity markets traded sideways for most of both World War I and II.  The strong growth seems to have been offset by risk aversion.

  

  Source: Fed Data

  
  
  
  

• Company Notes Digest 2.28.14
  Scott Krisiloff, February 28th, 2014 at 5:08 pm

  A digest of some of the top insights that I’ve gathered from this week’s earnings calls.  Full notes can be found here.

  The Macro Outlook

  The question on everyone’s mind is whether this is all about the weather:

  “is the U.S. in a pause right now, or did it just have bad weather? I think we come down that it’s not in a pause. It just had bad weather, and that fundamentally, the U.S. recovery is going there, but there is a question on that…my view is I think the United States has got, now got take-off momentum” ($TD)

  Macy’s says January weakness was more than just the weather, but things seem to have picked up after Valentine’s day:

  “There was some weaker business in the non-weather impacted areas, that’s why I said during the call that I don’t think its all weather in January but the good news is starting in Valentines Day our boats are rising and so we’re feeling very good about the trend.” ($M)

  The big test for the economy will be housing’s spring selling season:

  “[mortgage] originations were down 58% year-over-year, and the refi boom has clearly ended. So it’ll be interesting to see what happens in the spring selling season and after the winter weather” ($TD)

  For what it’s worth, Toll Brothers is optimistic:

  “While it is still too early to draw conclusions about the spring selling season, we remain optimistic…during this time traffic has actually been up of 8% per community which is encouraging especially given the weather in many of our markets” ($TOL)

  And the poor weather may have created some pent up demand at Home Depot:

  “I will also note that the extreme winter weather in February hasn’t been our friend, but our February comps are positive and we know firsthand that many homeowners have some major repairs ahead of them, which suggest we should have a great spring selling season.” ($HD)

  But even if the weather thaws, businesses may find it difficult to keep growing the top-line.

  Comps are becoming tougher:

  “I think the premise is we are projecting the 1% to 2% comp. Obviously, we did the 3% last year, but we’re up against 5% comp over the last 5 years on a compound basis. So that presents a challenge…over 5 years, we’ve averaged to 5% comp. I don’t think it’s realistic to expect that we can sustain that kind of comp level.” ($ROST)

  Still no signs of #inflationaccelerating:

  “I don’t think we’re expecting inflation in terms of apparel. We haven’t seen that lately. So that won’t be our expectation for the first quarter.” ($ROST)

  “In 2013, we enjoyed commodity inflation, not thinking that’s going to happen this year. In fact, we are going to have some pressure from commodity price deflation.” ($HD)

  Questions about China are a little more significant than the weather:

  “Can China manage this transition? Because it is often the case in economies like China and emerging markets where you can get to one level of GDP and you find it hard to get to the next level because it requires fairly significant institutional shifts in your economy and in your political structure.” ($TD)

  Hilton says real estate development in China still feels good though:

  “China is clearly been trying to make sure that they don’t end up with a real estate bubble. It’s clearly still generally pretty positive. There was a period of time I would say sort of in the first half of last year where China development really slowed down. It picked up pretty materially, it didn’t get back to the peak levels but it picked up pretty materially in the second half of last year, and what we see so far in China in the beginning of this year…It feels — it still feels pretty good.” ($HLT)

  Financials

  Commercial banking clients up-beat but mortgage origination has slowed:

  “I’ve seen a lot of clients in the last quarter right through our footprint, Maine to Florida, and there is improving sentiment when I talk to commercial and business clients. The one area where I would say there’s obviously a slowdown is mortgages.” ($TD)

  Mortgage standards are loosening up in an effort to generate growth:

  “We thought all along that credit availability was the big driver of the housing recovery and the shape of the recovery curve. We are very encouraged by what we have seen at Wells Fargo. Wells Fargo has announced that they are taking the FICO scores for FHA loans, down from what was 640 to now 600″ ($HD)

  Weak mortgage growth means that even with the taper, the Fed will still soak up net mortgage supply:

  “think when we look at what actual net supply or growth of the agency MBS market will be this year, most estimates have it ranging from about $100 billion to $150 billion in net supply. The Fed even with the taper will absorb that much supply in the first four to five months of this year” ($NLY)

  Auto loan market still hyper-competitive:

  “As far as the auto loan market in the U.S., it is still hypercompetitive. We’ve actually scaled back a little bit on both our numbers of dealers as well as our originations in the last quarter.” ($TD)

  Not a lot of money for hotel development:

  “So at least over the next sort of two to three years we think it’s very muted. We think really in terms of what we see going on, there is quite a bit of discipline in the market. There is money to develop but there’s not a lot and it’s only with the best developers that it’s really getting done and the best brands.” ($HLT)

  Bank branches going from service locations to sales locations:

  “There is no question that the average square footage of a branch will be declining over time, and they will also changed in the nature of the transactions that happen. They’ll move much more to sales transactions versus service transactions.” ($TD)

  Consumer

  Retail will finally get some positive seasonality in Spring with a late Easter:

  “I do think the later Easter is good for retail, so that could be helpful. And I had said earlier, we do expect the second quarter comp to be higher than the first quarter. Beyond that I think that really is all I can say.” ($M)

  Still a promotional environment:

  “I would say, based on how business conditions have been, I would expect it to be fairly promotional.” ($ROST)

  Very hard for an off-price retailer to make money in e-commerce:

  “Our assessment is that it’s very hard for an off-price business to make money in e-commerce at the price points that we operate at.” ($ROST)

  JC Penney claims that it is past the first two phases of its turnaround:

  “We also realized this turnaround would come in three phases, the immediate stabilization phase, followed by a phase rebuilding and then the go forward phase positioned JCPenney for long-term growth. Over the last 10 months, we completed the first two phases of our turnaround in a very tough and highly competitive environment” ($JCP)

  Technology

  AT&T and Verizon are responding to T-Mobile’s aggressive tactics:

  “you’re right, it is a highly competitive environment, players are responding. I would say we haven’t seen much impact to us on the Q4 price changes that AT&T made nor based on their program targeting our users. And then in Q1, we’ve seen both Verizon and AT&T respond.” ($TMUS)

  T-Mobile doesn’t think it’s started a price war though:

  “I think all of the players are trying to protect their base, find their way amongst some of the new — remember the changes in the industry have been as much about structure of how we’re serving customers as it has been about price and flexibility. So no, I don’t feel it is a price war, I don’t believe it will become a price war. I think it’s good, healthy competition and choice for customers, and I think it will continue.” ($TMUS)

  Materials, Industrials, Energy

  Growth of US oil production likely to slow in 2014:

  “it looks like the rate of growth in 2013 slowed compared to 2012 and we expect this trend to continue in subsequent years…We are still bullish regarding U.S. oil process because of slowing domestic oil growth and we are not particularly concerned about a surplus of U.S. light sweet oil.” ($EOG)

  Natural gas prices $4.50 in 2014 and 2015:

  “Regarding North American natural gas prices, our long-term view hasn’t changed. We have obviously seen some relief this year due to the multiple shifts in the polar vortex this winter. We think natural gas prices will stay around the $4.50 level in 2014 and ’15″ ($EOG)

  Miscellaneous Nuggets of Wisdom

  Give your customers what they want:

  “2013 was a transformational year for us as we turned a declining business into a growth one. How did we do it? By listening to customers and then offering them what they told us they really want: A great service on a nationwide, lightning-fast 4G LTE network; devices when and how they want them; and plans that are simple, affordable and without the restrictions the other guys placed on. We changed the way this industry operates and customers responded.” ($TMUS)

  
  
  
  

• Flat Through February
  Scott Krisiloff, February 27th, 2014 at 9:40 am

  We’re almost 1/6 of the way through 2014 and stocks are still pretty much exactly where they started the year.  The S&P 500 is +/- 0.20% depending on where you count the last tick, the Dow is down 2% and the Nasdaq is up about 3%.

  Going back to 1957, there have been seven other years that the S&P 500 finished February in roughly the same place that it began January.  Six out of those seven times the index rose between February and year end.  Three of those times it managed to climb by double digits.

  1994 was the only year that the index fell after it flat-lined in the first two months.  The weakness that year was mostly driven by rising interest rates.  Stocks traded in a narrow range that year though.  At its lowest point the index was 6.6% lower than where it started the year  (we’ve already nearly matched that in 2014).

  1959 is a candidate for the closest analogue to 2014 because that year followed a year that the index gained more than 30%.  The first two months of 1959 may have been flat mostly due to fatigue.  The first two months of 2014 may have been flat for the same reason.

  

  
  
  
  

• At These Prices Stocks are Counting on Growth
  Scott Krisiloff, February 26th, 2014 at 3:42 pm

  91% of S&P 500 companies have reported earnings for the 4th quarter of 2013 so we now have a pretty good sense of how companies performed for the full year.  Last year S&P 500 companies reported earnings per share of $100.78 in aggregate.  ”Operating” earnings, which are earnings that are adjusted for unusual items were $107.13.

  The current level of the S&P 500 index is 1845, which means that the index is trading for 18.3x trailing “reported” earnings and 17.2x trailing “operating” earnings.  These are both relatively high numbers on an absolute basis.  The equivalent earnings yields are 5.5% and 5.8% respectively.  That’s below the hurdle rate of return that I’d ordinarily expect of 8-10% on equities.

  Many bulls argue that stocks are still cheap though because the forward multiple of the S&P 500 is much lower than the trailing numbers.  The forward multiple, which is based on analyst expectations of what companies are going to earn in 2014 is only 15.3x (a 6.5% earnings yield).

  The forward number is low because analysts are expecting earnings to grow by 12.5% to $120.60 in 2014.  This is a lofty number, especially considering that revenues are only expected to grow by 3.4% after growing by 0.63% in 2013.

  I have a hard time justifying why analysts are expecting growth to accelerate in 2014, but judging by the difference in trailing vs. forward multiple, I’d say that stocks are counting on the growth to materialize.  If earnings growth settles at a lower rate than analysts currently expect, stocks will look pretty expensive by year end.  And, at these prices, even if we do see some strong growth in the spring, it’s possible that the growth is already baked into prices.  In other words, stocks may not rise even on strong data.

  

  
  
  
  

• Insights From the Fed’s December 2008 Meeting
  Scott Krisiloff, February 25th, 2014 at 12:25 pm

  Recently I spent some time reading through the transcript of the Fed’s December 2008 meeting.  I focused on that meeting because that was when the Fed Funds target was lowered to the zero bound.  This marked a seminal change in monetary policy.  Below is a condensed summary of how the meeting unfolded.  My full notes can be found here.

  Summary Insights:

  In the Fed’s December 2008 meeting there are two primary issues that are set out for discussion.

  The first philosophical discussion revolves around the merits of quantitative easing.  Very surprisingly, both Ben Bernanke and Janet Yellen seem to oppose outright monetary easing and balance sheet targeting.  Both prefer sticking to the type of credit facilities already in place which they term “asset” policies and they feel are much different from Japanese style QE.  Jeff Lacker is actually the main champion of aggressive balance sheet easing in order to end the threat of deflation.

  The second primary discussion topic surrounds the policy statement.  Specifically the board debates whether or not to suspend targeting the Fed Funds rate entirely.  This proposal came extremely close to being included in the policy statement.  In fact it appears to have taken a unilateral decision from Bernanke to strike the proposal.

  Although QE was not voted on in the December meeting, obviously it was aggressively initiated in March of 2009.  It’s extremely interesting to see that Bernanke and Yellen were each forcefully against the spirit of QE early on.

  Suspending Fed Funds targeting would have been a radical departure from precedent.  Even though it wasn’t included in policy, it’s very informative that it was proposed and had widespread support.  The Fed clearly felt that it was moving to a new policy regime in December of 2008, and many felt that they were leaving Fed Funds behind.  This understanding might influence how we interpret Fed interest rate policy today.  Perhaps we should place even more focus on QE and tapering.

  Two up-front miscellaneous thoughts

  These aren’t really related to the broader discussion, but are too interesting to bury later in the post:

  Members of the Fed are aware that they are purposefully distorting markets:

  Kroszner: “In some sense we are purposefully distorting what the market is doing now, but in some sense we think of the market as being distorted from where it normally would operate. So we have to be at peace with that.”

  The Fed gropes its way to figuring out the right policy:

  Lacker: “I think we would have a great deal of difficulty figuring out a quantitative relationship between the monetary base at the zero bound and our objectives. But we started the way we usually do things—without a serious quantitative understanding of the relationship between the funds rate and growth and inflation, and we groped and groped and found our way. We are going to grope and try to find our way in this new regime, and we are going to have to think hard about it and make some guesses—by trial and error—just the way we learned how to do funds rate targeting.”

  Setting the Scene:

  At the time of the December meeting there were two important background issues to consider.  The first was a brewing debate over Fed governance.  There was a conflict between the FOMC and the Board of governors over control of Fed policy.  

  The second background issue is that while the Fed is debating whether or not to lower the Fed Funds target to zero, the effective market for Fed Funds is already there.  Even though the Fed is paying interest on excess reserves, that is not able to keep the Fed Funds rate at the target rate.

  Governance Issues:

  Before the December meeting the Fed had expanded its balance sheet significantly through temporary credit facilities, which were much different than the QE.

  Bernanke: “You are all aware of the lending facilities for banks and dealers, the swaps with foreign central banks, the promised purchases of MBS, the various credit facilities for which even I do not know all the acronyms anymore…”

  Some members of the FOMC seemed to resent these policies because they were established under section 13(3) of the Federal Reserve Act.  That section gives the Federal Reserve Board the power to act in “unusual and exigent” circumstances. The Federal Reserve Board is a distinct entity from the FOMC, so some FOMC members are concerned that the Board of Governors is taking authority away from the FOMC.

  Bernanke: “The law provides a kind of odd co-dependence, if you will, between the Board and the FOMC with respect to the balance sheet. Both the Board and the FOMC are enjoined by the Federal Reserve Act to pursue the dual mandate, and both the Board and the FOMC have powers that affect the size and composition of the balance sheet. In particular, the FOMC has authority over Treasuries, agency purchases, and swaps, whereas the Board has, in particular, the 13(3) authority, which has been utilized a lot lately for credit programs”

  Jeffrey Lacker appears to be the most vocally concerned about governance:

  Lacker: “legislation of the 1930s that created the Federal Open Market Committee…surely, the guiding principle there was that they wanted one single governance body in the Federal Reserve System to be responsible for the monetary conditions in our country, and I take that to be the guiding spirit of the FOMC as well. This is the only body in the Federal Reserve System in which we all come together as one and subject ourselves to the discipline of listening to each other’s different views and forming a workable consensus on the way forward.”

  Plosser is also very concerned that credit policies are being substituted for monetary policies: 

  Plosser: “On the governance side, I continue to believe that the FOMC is the appropriate body for making monetary policy decisions and that replacing monetary policy with credit policies that are unconstrained by this Committee is to violate both good governance and the spirit of the operating understanding of the FOMC”

  Bernanke urges the council not to take too “legalistic” of an approach

  Bernanke: “If we work together and keep each other apprised of developments and our views, we will be able to make this work. If we take too narrow an approach, too legalistic an approach, I think it will be much more difficult”

  The Fed backed into a corner:

  Up until November of 2008, the Fed had made efforts to “sterilize” its balance sheet expansion by soaking up excess reserves in the system:

  Kohn: “At first we sterilized that by selling Treasury securities. Then we sterilized it by the Treasury selling Treasury securities.”

  By December, the Fed had lost the ability to sterilize excess reserves:

  Kohn: “Our inability to sterilize and the huge increase in our balance sheet raise very difficult questions about how the Board and the Reserve Banks together carry out their shared responsibility for achieving the objectives of the Federal Reserve Act”

  Most seem to agree that growing the balance sheet expansion is a natural extension:

  Kohn: “I don’t think we have crossed a sudden barrier in the last month or two. It is true that the base has begun to rise because we have run out of the other sterilization options. But I do think it is a natural extension of where we have been for a while.”

  The Debate Over QE

  The two background issues above naturally flow to a debate over QE.  The Fed is operating at zero interest rates and will have to respond with unsterilized monetary expansion.  The current strategy of “credit policy” gives all the power to the Board of Governors through section 13(3).  On the other hand direct balance sheet targeting is monetary policy and would be controlled by the FOMC.

  Very surprisingly, neither Ben Bernanke nor Janet Yellen appear to support QE.  Both want to stick to an “asset” approach like the credit facilities already in place.  Neither sees much value to expanding the balance sheet for the sake of expanding the balance sheet.  It’s Jeff Lacker who pushes for aggressive easing.  This stance may be influenced by his concern over FOMC governance of monetary policy.

  Bernanke defines Quantitative easing:

  Bernanke: “The theory behind quantitative easing was that providing enormous amounts of very cheap liquidity to banks, as Steve discussed, would encourage them to lend and that lending, in turn, would increase the broader measures of the money supply, which in turn would raise prices and stimulate asset prices, and so on, and that would suffice to stimulate the economy”

  Very surprisingly, Ben Bernanke is not on the side of Quantitative Easing:

  Bernanke: “I think that the verdict on quantitative easing is fairly negative. It didn’t seem to have a great deal of effect, mostly because banks would not lend out the reserves that they were holding. The one thing that it did seem to do was affect expectations of policy rates because everyone understood it would take some time to unwind the quantitative easing. Therefore, that pushed out into the future the increase in the policy rate.”

  He is “very strongly” against trying to describe monetary policy by the size of the balance sheet:

  Bernanke: “I do not think—and I feel this quite strongly—that it makes any sense for us to have or try to describe monetary policy with a single number, which is the size of the balance sheet or the size of our liabilities, as the Japanese did”

  Bernanke feels that what they are currently doing is different from QE because it is focused on the asset side of the balance sheet.  

  Bernanke: “I would argue that what we are doing is different from quantitative easing because,
  unlike the Japanese focus on the liability side of the balance sheet, we are focused on the asset side of the balance sheet.”

  Bernanke’s distinction of “asset side” policies is extremely important because up until this point the Fed’s policies were primarily credit focused policies with specific objectives.  Bernanke would like to keep it that way:

  Bernanke: “Rather than looking at this as a single number, as a measure of the liability side of the balance sheet, I think we ought to think about it as a portfolio of assets, a combination of things that we are doing on the asset side of our balance sheet, that have specific purposes and that may or may not be effective; but we can look at them individually”

  Yellen is also on Bernanke’s side regarding balance sheet targeting.

  She argues that purchasing conventional assets will have no effect on the behavior of banks and asset prices:

  “Theory suggests that when the monetary base is increased by purchasing conventional SOMA assets, its expansion should have little or no effect on the behavior of banks or asset prices more generally after the zero bound has been reached. Abstracting from expectational effects, the evidence generally supports this view. While the quantity of money is surely linked to the price level in the very long run, most evidence suggests that variations in the base have only insignificant economic effects in the short or medium term under liquidity trap conditions.”

  She calls it an inappropriate instrument with no discernible economic effects beyond communicating the intention to commit to a ZIRP:

  Yellen: “This makes the base an inappropriate operating instrument for monetary policy in a zero bound regime.As Japan found during its quantitative easing program, increasing the size of the monetary base above levels needed to provide ample liquidity to the banking system had no discernible economic effects aside from those associated with communicating the Bank of Japan’s commitment to the zero interest rate policy. I think my views on this mirror those that you expressed in your opening comments, Mr. Chairman”

  Interestingly though she supports mortgage and treasury purchases, ostensibly because they push borrowing costs down.

  Yellen: “Going forward, I support both the purchase of agency debt and MBS by the System Open Market Account and purchases of long-term Treasury debt. Both existing evidence and the market response we just saw to the recent announcements and comments concerning such programs suggest to me that such purchases can push longer-term borrowing rates down.”

  Yellen, like Bernanke seems to support focusing on the asset side of the balance sheet with clear objectives:

  Yellen: “the current Bluebook specifies the types and amounts of mortgage-related assets that the Desk should buy and the objective of these purchases—namely, to boost activity in the mortgage and housing markets.Language of this type is consistent with the policy approach I support, in which each credit facility program and asset purchase decision is judged on its own merits, according to whether it improves the availability of credit or lowers its cost, thus stimulating the economy”

  She argues that if one program ends because the economy is getting better, we shouldn’t feel the need to replace it with a new one just to keep the balance sheet at the same level:

  Yellen: “Imagine, however, that the commercial paper market were to revive, allowing us to terminate the CPFF. Excess reserves would decline, but that decline would have no negative effect on economic activity, so there should be no presumption that some other program should be expanded to restore the monetary base to its previous level”

  Yellen and Bernanke also each at different points seem to reference the long term inflationary trade off of QE:

  Yellen: “In theory, by committing to more inflation than we actually want later on, we could generate extra stimulus now.  I do understand the attractions of such a strategy in theory, but I am not at all convinced that the benefits would exceed the costs in practice. It would be enormously difficult to explain and could harm the Fed’s overall credibility as an institution. Moreover, it is not only real rates but also nominal rates that influence housing demand, and any increase in longer-term nominal rates triggered by higher inflation expectations could adversely affect this key sector”

  Bernanke: “All of these strategies are time-inconsistent, of course. So we have to be willing as a Committee to sit here and accept higher-than-normal inflation ex post. I just point that out. We have to ask ourselves if we would be willing and if the public would be willing to accept that.“

  It’s not Bernanke or Yellen, but actually Jeff Lacker who pushes for aggressive monetary easing:

  Lacker: “we prevent deflation by convincing the public that future base growth will be inconsistent with a falling price level.“

  Lacker argues that pushing the growth of the base is vital to preventing deflation:

  Lacker: “imagine that we commit to keeping interest rates at the zero bound for an extremely long time period, say infinitely. If we do that—this is a clear result from the literature—it does not prevent a deflationary equilibrium. But if we can commit to keeping the monetary base at a finite level, not falling, then that does rule out a deflationary equilibrium. So it is key that expectations about the base, not just nominal interest rates, are vital for our ability to prevent a deflationary equilibrium.

  He argues that people understand that a rising monetary base=inflation.  In his opinion this is an elegant form of communication and worked in the 80s:

  Lacker: “I think that focusing on the monetary base is going to help communication, and the reason…in almost everyone’s mind is the phrase “too much money chasing too few goods.” It provides, for a lot of people, an intuitive link between money and inflation…I think we—for all the warts of our policy in the early 1980s under Chairman Volcker—exploited that well, to convey to the public that we were committed to bringing inflation down in a simple, intuitive way.“

  Lacker argues that this is about convincing the public that they can control deflation:

  Lacker: “I think that can help us now, analogously, in convincing the public that we are going to be able to prevent deflation because we control money.”

  Part of Lacker’s disagreement surely stems from the rift between the Board of Governors and the FOMC.  Lacker is a member of the FOMC and is clearly arguing against “credit policies” (which were set by the board) and in favor of “monetary policies” (which are controlled by the FOMC):

  Lacker: “Credit market programs may have macroeconomic effects. Indeed, that is their intended effect—to have beneficial macroeconomic effects on growth and inflation. It is the same as other fiscal policy initiatives that also may have macroeconomic effects. But they are not monetary policy, and I think that is fairly clear”

  Lacker: “This Committee, I take it as given, is responsible for monetary policy. At the end of the day, monetary policy is about controlling the monetary base or bank reserves. From the point of view of FOMC policy, what is important about the nonstandard tools and credit market programs is their effect on the monetary base.”

  Lacker: “Again, to make this contrast stark, a policymaker controlling spreads cannot prevent deflation. A monetary policy maker controlling the base can.”

  Lacker asks directly for outright QE:

  Lacker: “What we should communicate is that we are targeting a quantity of the monetary base or bank reserves, and this communication should be made in a way that is broadly similar to the way we talk about interest rate policy, stating that our goals are for growth in the monetary base that supports the achievement of sustainable real growth and our medium-term goal for inflation.”

  From a policy standpoint, outright QE doesn’t make it into the December 2008 FOMC statement.  Bernanke considers it too radical a step and shelves the discussion.    

  Bernanke: “With respect to the use of, say, the base as a measure of monetary policy, I would say that for tomorrow we’re pretty far from being able to feel comfortable doing that. We haven’t done the work. We haven’t done the analysis of the transmission mechanisms. We haven’t looked at what monitoring ranges and how they might work. So it would be a radical step to take in one meeting. I leave that open as we continue to think about what the right indicators of policy are.

  The discussion on QE is mostly shelved.

  The Debate over suspending Fed Funds targeting

  Instead of QE, the watershed development of the December 2008 meeting was that the Fed lowered interest rates to the zero bound.  Amazingly there was a more radical shift that was debated: whether or not to suspend Fed Funds targeting entirely.

  The reason to suspend Fed Funds is that the Fed Funds market was already effectively at zero:

  Fisher: “the effective funds rate we all know is trading at 1/16″

  Many are concerned that interest on excess reserves is supposed to be keeping the Fed Funds market above a floor but it isn’t working:

  Plosser: “We still do not understand why having interest rates on reserves isn’t working to keep the funds rate at its target”

  The other concern is that lowering rates to zero will kill bank profitability:

  Duke: “the plea was unanimous: Please don’t lower the rates. The reason for that really goes to the prime rate, not the fed funds rate. If the prime rate moves down, I do believe that dollar for dollar it’s going to reduce bank profitability. If we were to go to zero, if prime were to go to 3 percent, I think it would take our entire banking system on an operating basis to an unprofitable level.“

  So, it is proposed that Fed Funds guidance be suspended 1) to demonstrate a clear break in monetary policy regime and 2) to let other interest rates float away from the Fed Funds peg.

  Duke: “I think suspending the fed funds target as a policy tool rather than lowering it might be the safer course because it would let prime find its own level and the banks might not necessarily feel pushed to lower prime if we did not change our target.”

  The staff drafts two policy statements

  Alternative A suspends Fed Funds targeting:

  Staff: “Alternative A represents the sharpest departure…The third paragraph would indicate that the Committee judges that it is not useful to set a specific target for the funds rate. It would explain that judgment by noting that, as a result of the large volume of reserves provided through liquidity programs, the federal funds rate has already declined to very low levels. It would also note that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time, avoiding the use of the “near zero” phrase”

  Alternative B lowers Fed Funds to a zero range:

  Staff: “alternative B differs from alternative A by explicitly setting a target range for the federal funds rate of 0 to ¼ percent”

  The FOMC voices its opinions on the options

  Nine of Sixteen speakers support Alternative A

  Bullard: “I like the language “not useful to set a specific target for the federal funds rate” in alternative A because I think this will begin the process of getting the private sector to think in alternative terms about monetary policy.”

  Lacker: “I support alternative A. I think it makes sense to deemphasize the funds rate target. For reasons that were illuminated by Brian earlier and reasons that Governor Duke alluded to as well, I don’t think a target range is useful”

  Kohn: “I guess I have a slight preference for alternative A as a better recognition that we are not really controlling the federal funds rate in here.”

  Hoenig: “going with A, in which you don’t set a fed funds rate or talk about it, is probably preferred.”

  Pinalto: “What I like about alternative A is its straightforward characterization of the policy situation and how we plan to respond to it. I support leaving in the language that is bracketed in alternative A.”

  Plosser: “I think it’s time that we publicly convey that we have entered a new monetary policy regime…alternative A, does help indicate that we are moving to a new regime. That’s important, and therefore, I lean in that direction.

  Fisher: “I like alternative A…It does indicate a regime change, and as President Bullard pointed out, I think we have to be forceful in doing so…I am quite worried that stating zero to 25 basis points will bring down upon us the wrath of bankers. I do think it’s important that community banks be profitable and that they be healthy“

  Cumming: “I see the circumstances as requiring the most action we can take. Therefore, I would favor alternative A somewhat over alternative B, but I could live with either. I think that alternative A has the advantage, which President Bullard described and others have referred to, that it does signal a significant change in what we’re doing and draws attention to it.”

  Duke: “I do favor alternative A. In terms of what will happen with the prime rate, I frankly don’t know, but I think it will leave the banks to determine their own prime rate and floors as they wish”

  Six support Alternative B

  Rosengren: “The bleak outlook calls for aggressive action…I am comfortable with alternative B and would reduce the interest rates on required and excess reserves to 25 basis points.”

  Evans: “as I understood Bill Dudley, there is no operational difference in these two options. It really comes down to how we want to communicate with ourselves and also the public. I tend to favor alternative B”

  Lockhart: “I actually lean toward alternative B. I think it is the clearest, and with the inclusion of the language related to deflation, it is also internally more consistent.”

  Stern: “as several people have observed—and I agree—I don’t think there’s any significant policy difference between A and B. That’s certainly where I am. From a communication point of view, I have a mild preference for B”

  Krozsner: “Going to no target at all is extremely newsworthy, maybe too newsworthy to include with all these other things…So I would actually say that, given all of the moving parts and all of the changes, talking about a range either “between” or “of” zero to ¼ percent would make a lot of sense”

  Yellen: “on communication grounds, my own strong preference would be for B. I think it is important at this juncture for the FOMC to state very clearly what it wants the federal funds rate to be, that we want it to remain close to zero, and I think we best do that by specifying explicitly a rate or, as it is, a range.”

  One kind of abstains:

  Warsh: “Alternative C is a sort of way station. It is our last chance to describe the old regime and to pivot to a new regime, whether the new targeted rate was 25 or 50 basis points. But seeing that there doesn’t seem to be much interest in that, I won’t try to reconcile the music and lyrics of C”

  Yellen’s Plea

  Yellen is strongly opposed to option A (suspending targeting) because she feels it risks the perception that the Fed has lost control of Fed Funds:

  Yellen: “In contrast, it seems to me that A is saying that the Committee is all but helpless to affect the funds rate, so, after all, it would be a charade to set a target. Then it kind of acknowledges, well, but, you know, the funds rate trading near zero is really not such a bad thing”

  She argues that the Fed could push the Fed Funds rate higher if it wanted to:

  Yellen: “ If the Board and the FOMC really wanted to push the effective funds rate up above zero, say to 50 or to 100 basis points, the Board could choose to raise the rates paid on reserves and the discount rate, and we could get it up, even though we have all of this enormous quantity of excess reserves and even though interest on reserves isn’t working in quite the way we expected.”

  Bernanke’s Judgement

  Bernanke, who has not spoken about Alternative A vs. B at this point, unilaterally shelves alternative A:

  Bernanke: “So in the spirit of trying to move gradually and not just overwhelm the market, I would like, as I say, to move halfway to where we want to be. There was a slight majority in favor of alternative A, but I’m very concerned that, if we don’t say anything about the funds rate, there is just going to be confusion“

  Bernanke sides with Yellen about the risk of confusion:

  Bernanke: “I am also concerned about the view that President Yellen, Governor Kroszner, and others raised if we sort of say that we’re not targeting it anymore. It suggests that we’re indifferent to the rate or that we have no ability to raise it.”

  And dismisses concerns over bank profitability:

  Bernanke: “I understand the concerns about community banks. I do think that’s not a reason that should control our policy, and they certainly can change their pricing policy.”

  Bernanke apologizes that the document is imperfect, but this is his judgement:

  Bernanke: “Again, I apologize that this is an imperfect document. Given the many moving parts, as I said, I wanted to try to keep it from being too overwhelming. This is going to be a big enough step as it is.”

  Fisher strongly dissents and actually threatens to vote against the proposal:

  Fisher: “Mr. Chairman, I can’t support that, and I’ll tell you why. I do feel that we had an elegant solution in alternative A. I firmly believe that if we target 0 to 25 basis points—the effective funds rate we all know is trading at 1/16—it is going to create enormous backlash. It is unacceptable to me to say that the bankers will figure out how to deal with this. They can’t.”

  Fisher: “I just want to state it myself straightforwardly and honestly—I may be the only person at this table, but I’ll vote against that. If you give us alternative A, I’ll vote for it. I know I’m one of 17 at this table—there are more than 17 people at this table. I apologize, but I don’t think it’s necessary to make the funds rate clear. It’s implied in what we’re doing, but alternative A gives people enough ambiguity to steer around it, and that’s my opinion. I apologize”

  Hoenig also steps in to argue with Fisher on behalf of Alternative A

  Hoenig: “ I think it was easier when we had alternative A and we were going to a new regime than when we’re saying, “Well, okay, we’re going to end this regime here.”…I guess in your opinion it’s easier to explain going from “Here’s the old regime; we’re going to stick to it for a little while longer and then . . .”

  Bernanke shuts down the conversation emphatically.  This is clearly a new regime:

  Bernanke: “No. Today is the end of the old regime. We have hit zero. We can’t go further. Going forward, this is what we’re going to do. I think that’s clearer. Again, I’m just concerned about not saying what we’re doing with the funds rate. Are we going to let it do whatever it wants to do from today? I think that’s just going to create volatility.Again, I’m sorry for those who are in disagreement”

  Fisher pushes back that a majority was in favor of option A.  Bernanke acknowledges but says it was close and pushes a vote:

  Bernanke: “Most of them said it was pretty close, and it’s a matter of communication. It’s my judgment that we are just going to cause a lot of criticism and a lot of concern and confusion if we do it now. I also agree that it’s fairly close. But my feeling is that the concern of clarity is more important to me. Others? Would you call the roll, please?”

  In the vote 9 vote yes, Plosser votes yes reluctantly.  Fisher is the only one who votes no.  Amazingly only three out of the 10 voting members had argued for option B (the one that is approved) in the comments period.

  After a lunch break, Fisher decides to change his vote for the sake of solidarity:

  Bernanke: “On consideration, in order to maintain a united front with the Committee, President Fisher changed his vote to vote “yes” on the resolution.”

  That’s how close we came to the Fed suspending a target for Fed Funds.  It’s impossible to know whether this change would have made a difference, but five years removed, there is the possibility that it would have.  If the Fed had explicitly stopped targeting Fed Funds it’s possible that the rest of the interest rate curve could have a significantly different shape than it does today.  Perhaps credit markets would have felt more comfortable drifting away from Fed Funds.  It’s impossible to know, but we also might not be so concerned about when the Fed is going to raise rates because we may have shifted away from that paradigm.

  Topics for further discussion

  Towards the end of the meeting, Bernanke highlights a couple of issues for further discussion:

  1) Inflation targeting:

  Bernanke: “I think there are two promising directions. One is to have an inflation target or something close to an inflation target, depending on how the Committee decides, what we think is feasible, and so on.”

  2) Balance sheet targeting (seems to put this forth purely as a governance concession)

  Bernanke: “The other would be to develop a more formalized structure for discussing the integrated responsibilities we have with respect to the balance sheet, and that could involve quantitative ranges, for example. I didn’t quite like your ceiling because I think in some cases you might want to have a floor. But I don’t think, as I said yesterday, that we can describe our policies in a single number, and I don’t think that a target for the overall size of the balance sheet is a sufficient statistic for what we’re doing. But I do think that, for governance and other reasons, we can talk about ranges, consultation, and so on, about the size of the balance sheet. Okay?”

  
  
  
  

• Company Notes Digest 2.21.14
  Scott Krisiloff, February 21st, 2014 at 6:37 pm

  A digest of some of the top insights that I’ve gathered from this week’s earnings calls.  Full notes can be found here.

  The Macro Outlook

  David Einhorn’s goal for 2014 is just to protect capital:

  “During the month of January our net exposure decreased about 10 points to 45% as we reduced our exposure on both long and short sides. We continue to hold macro positions in gold and in short sovereign debt. Our goal in 2014 remains to protect capital in an uncertain environment and define investment opportunities that will generate alpha on both our long and short portfolios.” ($GLRE)

  2013 was primarily driven by multiple expansion. This can’t last forever (Did I mention how much I like David Einhorn?):

  “The market ended the year on a strong note after a huge move that was supported mostly by multiple expansion as earnings growth was lack luster. In 2013 the market rewarded many companies repeating [ph] earnings after they had lower guidance. This trend is not likely to continue indefinitely.” ($GLRE)

  Meanwhile in the economy…

  Nordstrom says sales remained soft in January:

  “Q1 looks like it’s roughly flat to 2% comp overall, the way we’ve calendarized that out. And in terms of the holiday period, we definitely had, I would say, better than trend sales in the month of November and in the first half of December. Sales started to soften up around the holiday and it continued soft post Holiday and through January.” ($JWN)

  BHP Billiton’s CEO is emphatic that we’re not operating at the top of the cycle though:

  “Can I just jump in? We’re not actually at the top of the cycle. Andrew, this result that you’ve seen is primarily driven by our own self-help and our own productivity…we certainly don’t feel that as things sit at the moment, we’re finished with our productivity gains and — or that we’re operating at the top of the cycle.” ($BHP)

  Coke says the US is the best in the West:

  “in terms of our flagship market in the United States, clearly the best right now as far as we can see, the best western developed economy in the world we think we will see slightly improved mobility in the United States in 2014 versus 2013.” ($KO)

  Cummins agrees. North America is the best of the bunch, and China is turning the corner:

  “North America is definitely feeling more positive than I think any other region of the world just now. China is turning the corner. China I think over the last year and a half we were maybe a little bit flat on it. We had a good year last year – some of that was artificial with the pre-buy ahead of NS4. This year we’re projecting record revenues in China including our joint ventures” ($CMI)

  Which is good, because let’s be honest, we’re not worried about Turkey or Argentina, we’re worried about China:

  “the main risk to growth will not come from instability in countries such as Argentina and Turkey but from…the size of the unofficial banking sector in China which appears to be responsible for just under $3 trillion in loans and debt obligations, and which accounted for 30% of all such debt obligations at the end of 2013.” ($DSX)

  Financials

  Someday the Fed will raise rates, even if it doesn’t feel like it will ever happen:

  “When short-term rates increase and they will even though today it feels like they never will, just like a year ago or two years we thought loan rates would never increase and they did, but at some point they will. That would be a big benefit for us because our loan book is going to re-price faster than our deposit book.” ($WFC)

  Deposit growth likely to slow:

  “our best guess is that the rate of deposit growth in the industry will probably be slow a little bit because of the tapering that the Fed will do.” ($WFC)

  Wells Fargo now overcapitalized:

  “we’ve made a big point a couple of years ago saying that we thought we needed about 9% [tier 1 common ratio] and now we’re above that…We would like to get down to a 9%. We think that’s sufficient for the company. So we’re going to work toward that.”

  Consumer

  The promotional retail environment is still a problem:

  “I think it’s fair to say that the increased promotional activity that happened in December was more than we had expected and an area of concern for us going forward.” ($JWN)

  E-commerce makes the promotional environment worse:

  “with the way that Direct works now and all the information available to customers, if something is online and it’s marked down and it’s available to everybody, then we got to be competitive everywhere, too, particularly given the fact that we’ve got a completely aligned and synergistic merchandise strategy between Direct and in-store.” ($JWN)

  Coca Cola says that consumers’ belief that Diet Coke is unhealthy is a “misperception” and will defend its position with “meaningful facts”:

  “Sparkling beverage volume fell 2%, largely due to softer diet coke volume. We have implemented a multi-faceted approach to address category headwinds and the various misperceptions that fuel them. This effort is targeting both obesity and ingredient concerns and increase aggressive sweetener innovation, transparent consumer communications, continued packaging evolution and new partnerships with credible third parties around the world who will use meaningful facts to defend and protect the sparkling category.” ($KO)

  One analyst had harsh and direct criticism for Coke:

  “I am hearing from many investors and a lot of questions on this call, is that there is a feeling that the Company isn’t doing enough to change itself despite that the world around it has really changed…should investors expect bigger bolder change that pay out to meet this truly different world and so what specifically should we be looking for to just kind of sharing your confidence about the story or should we just expect kind of same status quo going forward?” ($KO)

  The potential Comcast/Time Warner merger is a big time consolidation:

  “we’re still assessing some of the competitive implications. But certainly, if the deal is approved as proposed, it clearly represents an unprecedented media concentration in 1 company. I guess, I think the challenge in terms of what posture we take in Washington, D.C. we haven’t decided yet. But I think one of the challenges is to try and ensure that it is appropriately scrutinized in some kind of unique ways than you might traditionally look at. And I think it’s particularly around the effective broadband monopoly they might have in as much as 2/3 of the country and the implications of that” ($DTV)

  4K TV may be a little bit slower to be adopted. Content companies have huge investments in HD equipment that they’re not going to walk away from:

  “I don’t yet get a sense in my discussions that there’s some wholesale move to throw out all their HD equipment and get ready to start investing in 4K equipment. I think they’re all kind of looking at it, going to try some things and test and learn and we’ll see how differentiated the consumer experience is and how fast 4K TV takes off.” ($DTV)

  Technology

  Facebook isn’t going to worry about how to monetize WhatsApp until it has a billion or three users:

  “Our explicit strategy is for the next several years to focus on growing and connecting everyone in the world. And then we believe that once we get to being a service that has billion, two billion, maybe even three billion people one day, that there are many clear ways that we can monetize” ($FB)

  Zuckerberg doesn’t think that ads are the best way to monetize it:

  “I don’t personally think that ads are the right way of monetized messaging services. And I know, Jan, shares this philosophy” ($FB)

  Facebook’s explanation for how they came up with the valuation:

  “In terms of valuation, as we discussed in the remarks, the primary thing that we focused on was just how healthy this network is and how well it’s growing. And our confidence that if you have a network of this size with people who are as highly engaged as customers are with WhatsApp, that they are really on a path to get to a network of a billion people or more in a relatively short period of time. So we looked at other networks that have achieved that kind of size and scale and what kind of value that they’ve created and what they are worth and that helps give us a framework for thinking through what might make sense here.” ($FB)

  They make a good point–SMS is a $100 B business for carriers:

  “And they are already at a place now where the messaging volume running through WhatsApp is nearly the same as the scale of the entire telecom SMS messaging volume. And that’s a $100 billion business for carriers in terms of direct messaging piece. So it’s a really valuable service that people are willing to pay for.” ($FB)

  It sounds like Elon Musk may be getting ready to raise capital:

  “Yes, I think [raising capital] is a good idea. I agree with that. I think that would be the smart move. We can talk more about that next week with — and also discuss the Gigafactory plans. Unfortunately, I can’t say anything right now, except that I agree. I think your advice is good” ($TSLA)

  The PC is showing signs of life in the commercial segment:

  “Overall the PC market contraction is slowing and we see signs of stabilization particularly in the commercial segment…I do think there’s also some net momentum in the long overdue PC refresh, and what I think commercial customers are understanding from their employees is well employees may want a tablet. They actually also need more traditional compute devices to do their real work in the everyday environment in their company, so that is helpful.” ($HPQ)

  Businesses still trying to decide on the architecture of their cloud:

  “There is movement around which are they going to make a bet on HP’s hybrid cloud or they are going to make a bet on someone else’s cloud, so there is a battle going on for architectural control in the enterprise” ($HPQ)

  HP believes that they have the right answer–companies want a hybrid cloud:

  “This hybrid cloud offering that we crafted well over a-year-and-half ago, it’s the right answer. I can tell you every single day customers say that is exactly what I want.” ($HPQ)

  DirecTV is building a hybrid satellite/cloud

  “our highway in the sky with 12 satellites, on a marginal basis, is a low-cost highway to provide a high — the highest quality signal out there. But with that said, we are embracing a hybrid satellite cloud infrastructure for our core business, which will give us greater variety and greater ability to move content through the cloud seamlessly for consumers’ own devices in the home.” ($DTV)

  Materials, Industrials, Energy

  BHP Billiton sees falling iron ore prices long term:

  “in iron ore, we expect significant growth in low-cost supply that will exceed increases in demand from China and elsewhere. The cost curve, as you see, will flatten, as higher-cost margin supply is displaced, and this will lead to lower prices and lower volatility.” ($BHP)

  Copper actually has strong fundamentals though:

  “In the near term, copper inventories are expected to remain at reasonable levels. But in contrast to iron ore, the long-term fundamentals are attractive. Rising strip ratios and grade decline and the lack of high-quality opportunities ready for development now will steepen the cost curve.” ($BHP)

  There may be a glimmer of hope on the horizon for Met Coal:

  “There has been a lot of recovery in the market — or in the production I should say, from Australia because of the recovery from things like floods. That’s coming to an end. And as we look forward, there’s less growth in the next few periods. We’ve seen some announcements just overnight about some of the cost challenges that we’ve faced from competition in North America. Some evidence of that slowing. The pickup in markets, particularly in the developed economies and the growth in their demand for steel will almost certainly benefit metallurgical coal. And we started to see some quite good steel numbers coming out of India, which in the long term has no metallurgical coal and will have to import.” ($BHP)

  That said, BHP not investing any more money in Met Coal:

  “as you’ve heard me talking about it, because of the margins in coking coal and the returns, we’re unlikely to invest in further increases in production, but we’ll complete those underway, and we’ll ramp them up to the maximum extent possible.” ($BHP)

  Diana Shipping still doesn’t see a recovery in the Dry Bulk market in 2014:

  “the bottom line of what we have said is that we do not share the same view with most of the others. We are not so enthusiastic about the prospect of 2014.”($DSX)

  The marketplace is not that excited about natural gas truck engines:

  “The market wasn’t feeling it, and I think it’s going to come eventually but I don’t think it’s going to be this kind of light switch event that some people are going to want to promote. But we continue to make investments both on-highway and off-highway for natural gas products and we’ll continue to do so. We think it’s a good market over time. I would just caution that it’s not going to explode and be a terrific market tomorrow or early next year, 2016.” ($CMI)

  Duke’s renewable portfolio will incrementally be invested in solar:

  “We see opportunities to continue to grow our renewables platform over the two years and expect a greater mix of solar in our capital deployment.” ($DUK)

  Miscellaneous Nuggets of Wisdom

  Debt is cheaper than equity for a reason:

  “We have to compare apples with apples here Mike and you know very well that a bank debt is not the same as preferred equity. You have different covenants, you have covenants, you have mortgages, you have amortization of debt and you have the loss. You have something which is not perpetual, you don’t have an option as a company does try to deem it after year, five or not. So basically comparing the two the 9% will be 3% or 2.5% of the bank loan is not the same.” ($DSX)

  Think holistically about good customer service:

  “On the customer service side, Frank, look, we think of it much more broadly than just purely service although service is an element. We think of the whole customer experience. We’ve got a simplified bill that we’re planning to launch later this year that we think will be more transparent and easier for customers to understand. We’ve added chat capability and self-care. We’ve got further enhancements in our self-care capability, we’ve benchmarked Zappos and Amazon, and I think that’s an area that we can do better with our customers. We continue to strive to even be better in terms of on-time performance, on-time arrival in the way we service our customers.” ($DTV)

  In a competitive environment, focus on keeping the customers you already have:

  “as the market gets competitive, it’s really important that we hang on to our customers…I’m probably a little more sober about the challenges of raising prices and the impact that, that has on the total churn metric in any given year.” ($DTV)