Markets Get Relief From the Worst GDP Report in 27 Years - Could Have Been Worse

January 29, 2009 – The futures were indicating lower openings this morning as the Street continues to digest downbeat earnings reports, profit warnings and job cuts. However, futures reversed on the GDP data. Traders were preparing for a really ugly GDP number, but breathed a sigh of relief when it came in showing a contraction of only 3.8%. Expectations were for a decline by 5.4%. For all of 2008, GDP expanded by 1.3%.

Other economic news: business investment has dropped by 19% in the last quarter, the most since 1975. Purchases of equipment and software declined by 28%, while home construction contracted by 24%.  Inventories grew at a $6.2 billion pace in Q4.

The dollar is stronger against the euro this morning, which continues to be surprising to us. The euro is at 1.2852. We continue to forecast the euro to climb back over 1.40 against the dollar this year, as the U.S. piles on debt and unemployment expands. Our forecasts have been a bit more on target lately about gold prices, which are up this morning another $16.40 to $921.50. We are targeting $1,000 prices this year.

The fact that the dollar is stronger and gold is strengthening concurrently is a head-scratcher. The two typically trade opposite to one another as they exchange ‘safe haven’ status. The fact that gold has been surging lately is an indication that traders are increasingly getting bearish on the global economy, but that the dollar has maintained relative strength can only be explained, we think, as a short-term phenomenon while peer currencies underperform amidst respective economic erosion. We just happen to think that the ditch the U.S. has dug for itself is deeper, and the outlook for the dollar is really bad in light of the fact that the government has chosen to commit trillions in more debt to try and stimulate, or shock, the economy back into shape. It remains questionable whether this will ultimately work. All of the uncertainty, nonetheless, helps explain gold’s strength.

And oil prices are up slightly by $0.51 this morning to $41.95. Look for OPEC to wade back in with more production cuts sooner than later in further efforts to buoy prices. We think with or without further production that oil is way oversold.

In international markets, the jobless rate in the euro zone climbed to 8% in December, while inflation fell to 1.1% in January for countries using the euro. Over the entire 27 country European union, unemployment was 7.4% in December. Spain’s rate hit 14.4% in December. Japan’s industrial production fell 9.6% in November, the largest decline since it began reporting on this back in 1953, and its unemployment rate rose to 4.4% (it is going to rise further – see Hitachi and NEC below) from 3.9% in December. Household spending in Japan fell 4.6% in December, marking the tenth consecutive month.

Norway’s government said this morning it is allocating 1.35 billion kroner ($200 million) in stimulus to its national industrial development fund. Russia is bracing for a heavy budget shortfall, about 40% lower than previously planned on. It is planning on taking 2 trillion rubles ($56 billion) from its reserve fund to deal with it. Much of Russia’s problem is being caused by the declines in oil prices. Its initial budgets were based on $90+ prices of oil.

On the corporate front,

·         Auto Sector – Honda (NYSE:HMC) said Q3 net profit was ¥20.24 billion yen ($224.9 million) on a 17% decline in revenue to ¥2.53 trillion. It cut its profit target this year by 57%. Porsche’s six month sales since August 1. Fell 14% to €3 billion ($3.9 billion). Our Outlook is negative.

·         Electronics Sector – NEC Electronics (NEN.DE) reported a Q3 net loss of ¥130 billion ($1.46 billion), up from ¥5.2 billion in the same period last year. Revenue was down to ¥948 billion from ¥1.05 trillion. It is shutting down its UK plant for 4 months. Hitachi (NYSE:HIT) is forecasting a net loss for the current fiscal year of ¥700 billion yen ($7.7 billion). Our outlook is neutral – inventories and commoditization will be an issue near-term.

·         Oil Sector – Despite posting a 60% Y/Y decline in profit in Q4 to $7.8 billion, or $1.55 per share on revenue which fell 27% Y/Y to $84.7 billion, Exxon Mobile (NYSE:XOM) reported a $45.2 billion profit for FY08. Chevron reported Q4 earnings of $4.9 billion, or $2.44 per share despite a 23% decline in revenues on a Y/Y basis to $43.1 billion. For the FY08, it earned $23.9 billion, or $11.67 per share compared to earnings of $18.69 billion, or $8.77 per share in 2007. Our Outlook: Positive – and we think the sector should be helping underwrite some of Detroit’s losses along with the rest of U.S. taxpayers.

·         Consumer Products – Procter & Gamble (NYSE:PG) reported a 53% Y/Y increase in Q2 profit to $5 billion, or $1.58 per share on a 3.2% Y/Y decline in sales to $20.37 billion. Profit was boosted by its sale of Folgers. Our outlook is neutral. Defensive consumables should continue to do all right but discretionary consumables will continue to struggle.

·         Solar Sector – SunPower (Nasdaq:SPWRA) reported Q4 revenue of $401 million, up 79% Y/Y and net income of $29.5 million, or $0.70 per share (beating Street). Gross margin rose to 29.9%. FY08 revenue came in at $1.43 billion, an 85% Y/Y increase, and FY net income of $92.2 million. For FY09 it expects revenue of $1.6 billion to $2 billion and net income per diluted share of $2.20 to $2.80 with production capacity of more than 450MW. Our outlook is positive with some headwinds coming from tight credit markets which may make larger scale project financing tougher.

·         Job Cuts – NEC is cutting 20,000 jobs, Hitachi is cutting 7,000 jobs. Honda is laying off 4,200 workers.

The DJIA closed down 226 points yesterday to 8,149. An important note to make here is that while the selloff was ugly, volume was anemic at only 5 billion shares traded, an 18% decline in volume on a day-over-day basis. We have been commenting regularly on the lack of conviction out there. While stocks are set to open lower this morning, it would nonetheless be a positive signal if volume stays relatively low. That stocks will trade lower in today’s session heading into the weekend shouldn’t be too surprising.

Traders are also positioning portfolios for next week’s economic session, which includes a lot of key data: personal spending and income for December, construction spending for December, pending home sales for December, auto/truck sales for January, ADP employment for January, weekly jobless claims, productivity for Q1 (preliminary number), factory orders for December, nonfarm payrolls for January, the unemployment rate for January, and consumer credit for December.

We fully expect that stocks will touch November lows in the near-term in the midst of all of this news – which is all expected to be really ugly. Against this backdrop, we would be recommending to position accordingly for some near term downside volatility. As for today, the markets will get some lift initially because the GDP number came in better than expected. But sooner than later traders will snap out of it and remember that the number was still really bad – the worst in 27 years. We expect even more confusion amongst traders, but the disposition will be bearish heading into the close as traders brace for next week’s data.