Let's Become a REIT

With US companies struggling to create shareholder value in the "old fashioned way" i.e. through steady growth in revenue and income, they are resorting to financial engineering/machination. It is the world where 2+2>4.

No, I am not talking about LBO (leveraged buyout) or MBO (Management buyout). That's so 80s. I am talking about REIT, Real Estate Investment Trust.

Companies left and right are trying to turn themselves into a REIT.

• Just this week, the solar industry got a big boost (FSLR is up 11% in 5 days) from a report that said one of them is trying to get permission from the IRS to set itself up as a REIT. As Bloomberg reported, A San Francisco startup may win approval as soon as this month to become the first firm allowed to raise money for solar-power projects as a REIT, the financing vehicle used in $640 billion of U.S. property ventures. (Full Story).
• Last week, it was waste management companies that caught the fancy of REIT-crowd. Again, as Bloomberg reported, Waste Management Inc. (WM) rose the most in 17 months after analysts at Credit Suisse Group AG said investors would benefit if the biggest U.S. trash hauler was converted into a real estate investment trust. (Full Story).
• Some non-traditional companies have already turned themselves into REITs such as timber companies,  a casino company (PENN), and a retail company (DDS). I am sure there will be more in the next 12 months.

Investors can benefit, sometime mightily, if they can identify a company that could turn into a REIT before the Wall Street crowd do. PENN jumped over 30 percent on November 16, 2012 after it announced plans to split into a REIT. Good luck!

Read Also:

  Clear Channel Outdoor CEO says no current plan to become REIT (Morningstar, Jan 2013)

  The Rise–and Complications–of “the REIT Conversion” (OpEd, Dec 2012)

  REITs Boom As More Industries Discover This Tax-Friendly Structure (Forbes, Nov 2012)

  Here's a Way to Cut Business Taxes: Tech Firms Become Real Estate Trusts (WSJ, Oct 2012)

  Gabelli investors to oppose Gaylord's proposed REIT conversion (Reuters, Sep 2012)

  Crown Castle, A High-Growth Story That Could Convert To A REIT (SeekingAlpha, Sep 2012)

  REITs demonstrate real appeal in more sectors (The Deal, Aug 2012)

  Firms Restructure as REITs (WSJ, Aug 2012)

  The Risks and Rewards of Becoming a REIT (CFO Magazine, June 2012)

  The Lure of Converting to a REIT (Barrons, May 2012)

  Will CyrusOne Become a REIT? (Data Center Knowledge, Feb 2012)

  REIT Renaissance (NYSE Magazine, Jan 2011)

  Firms see REITs as right move (Pension & Investment, Jan 2011)

  More Institutions Barking Up the REIT Tree (National Real Estate Investor, Aug 2010)

  REITs Spread to Timber Industry (Street Sleuth, Nov 2005)

  Host Marriott Finds Trade-Offs In REIT Conversion (Hotel Interactive, July 1999)

  Tax Benefits of Creating a Real Estate Investment Trust (PDF)

  FAQ: REIT (PDF)

 

  Corrections Corporation of America will convert to REIT in 2013 (Feb 2013)

  CBS converting advertising unit to REIT (Jan 2013)

  Equinix Board Approves Plan to Pursue REIT Conversion (Sep 2012)

  Iron Mountain Rips Higher On REIT Conversion Plan (Jun 2012)

  Gaylord to Convert to REIT, Sell Management Business (May 2012)

  Weyerhaeuser declares record $5.6 billion dividend in conversion to REIT (Jul 2010)

  Host Marriott to announce it's a REIT (Dec 1998)

Goldman, the Image Makerover Guru..... uh!

In the US, the reputation of investment banking giant, Goldman Sachs has taken a nose-dive since the financial crisis on the heels of drip-drip revelations of its internal workings/machination, most recently by a mid-level executive by the name of Mr. Smith. Some even blame it for the Greek crisis.

Now the Russian government has asked the same Goldman to soar up its reputation amongst investment community. Is this ironic or what? Goldman, the image makeover guru!!

Goldman Sachs Group has been hired by the Russian government to burnish the nation’s image overseas and attract more institutional investors.

The bank has signed a three-year agreement with the Economy Ministry and the Russian Direct Investment Fund to advise on issues such as communicating government decisions and setting up meetings with investors, according to Sergei Arsenyev, Goldman Sachs’s managing director of investment banking in Moscow. >>>

January was Great But....

You can't complain about the performance of the market during January. The S&P500 was up 5% during the month. If one were to extrapolate that growth rate for the rest of the year, the market will be up a whopping 71%. That is clearly very unreasonable.

The market is taking a much overdue breather today. Whether today's move is a just a pause before another leg of the rally or a beginning of a sustained downturn is anyone's guess. If you believe in trend-investing, you're in the former camp. If you believe in mean-reversal, then you're in the latter camp.

The technical pattern in today's move suggests that the market may be heading towards a short/medium-term consolidation. The technical pattern we are referring to is called "island reversal". Whether this thesis is correct or not, time will tell.

The market will not sell-off on its own. It needs a reason, whether valid or not. The reason for today's sell-off was a huge jump (+22bp) in Spanish government bond yield given increased political uncertainty there. There are plenty of others in hibernation, they just need to pop their head - sequestration, oil heading $100, Middle East tension, currency war, disappointing economic data etc.

If the market is looking for excuse to sell, the high fliers of January might be most vulnerable i.e. transportation, energy and retailing. Watch out!!!

Time to Take a Bite of Apple

The mighty AAPL had seen better days. Since the intra-day high of $705 reached on September 21, 2012, the stock has fallen a whopping 36%. Just this year, the stock is down 14.7% while the S&P500 is up 5.0% and the S&P500 technology sector is up 1.3%. The question is whether it is the right time to buy the stock. The answer is "qualified yes".

From the fundamental prospective, it trades at 8.9x 2014 earnings ($51). Sure 2014 estimates have come down from $64 last July but so has the price. Actually, the price has fallen more. At the peak, AAPL traded at 11.0x 2014 EPS. If you take into account the amount of cash AAPL has on its balance sheet, the valuation looks even more compelling. It has $137 billion cash or $146 per share. Ex-cash, AAPL is trading at 6.0x 2014 earnings. Bottom-line, true, the latest earnings and guidance were not impressive, but lot of things have to go wrong for valuation to get extended.

From the technical standpoint, the stock is at a critical juncture from 3 prospectives (1) it is at the long-term trend-line that it established since 2003, (2) it is at the 38.2% retracement from all time high and (3) it is at the level where it "gapped up" above the trading range in January 2012, and started to make a parabolic up-move. It is very critical that APPL holds the $430 level.

AAPL will not just bounce off from current level because there are traders who are betting on it to get even lower, say $380 level. Those bearish traders have to be washed-out before it heads upwards. The only way those guys are going to give-up is for the stock to hold-up against the downward pressures. A catalyst would help. There are several potential ones (1) new product launch, (2) share buyback, (3) dividend increase or (4) stock split (remember CRM last week). Product launch is probably difficult since Tim Cook is no Steve Jobs. But unlike Jobs, Cook takes conventional corporate actions (remember the dividend payment) so #2, #3 and #4 are more likely. Stay tuned.

GDP = C+I+X+G... But Something is Missing

2012 Q4 GDP surprised everyone with a negative print (-0.1%). This was the first negative read since 2009 Q2 (-0.3%), and occurred despite a 2.2% increase in personal consumption expenditure, the largest component of GDP, making up more than 70%.

The culprits for the negative GDP read were "change in private business inventories" and "expenditure on national defense". Inventories peeled off 1.27% from GDP, while defense spending subtracted another 1.28%.

Why inventories were depleted during Q4 is anyone's guess. One can blame Hurricane Sandy, which impacted much of the US north-east during that period. It created logistical nightmares. Businesses had to rely on their stock to satisfy customers. This is kind of counter-intuitive given that retailers like Kohl's and JC Penny had "over-inventory" problem during Q4 because of warmer than expected weather. Be as it may, if it was unintentional withdrawal of inventory, it should boost GDP in Q1. We'll see if that happens.

A sharp reduction in defense spending in Q4 is also puzzling especially given that defense contractors like Lockheed Martin, Boeing and Northrop Grumman reported decent Q4 numbers. I have not heard any plausible reason yet but may be there is.

US stock markets did not react too negatively to Q4 GDP because nobody believed it. A normal reaction to such number would have been Dow opening down 200 points. The market did end the day down and at the lows of the session but that's more to do with the FOMC announcement than GDP ("sell the news" trade).

Private equity gets deeper into debt

Private equity gets deeper into debt

Fortune, 24-Jan-13

By Dan Primack

Leverage multiples on the rise.

Leveraged buyout debt multiples are on the rise, according to S&P Leveraged Commentary & Data.

LCD breaks its numbers out by company size, with "large" being anything with more than $50 million in EBITDA. And, for those deals, leverage multiples rose to 5.3x in 2012. This includes a 5.5x mark for Q4 2012, and represents the fourth straight annual increase since a 4x nadir in 2009. The all-time high mark was 6.2x in 2007, while the 5.3x figure matches what LCD saw in 2005.

For "small" companies of $50 million of less in EBITDA, the LBO debt multiple hit 4.5x in 2012. This included a 5x figure in Q4, and compared to 4.3x in 2011

Overall purchase price multiples for all LBOs fell to 7.9x in 2012, which is the second-lowest mark in the past six years (2009 being the outlier).

Large LBO purchase price multiples fell from 9.1x in 2011 to 8.9x in 2011, although they hit 9.2x in Q4 2012. Similar story in the smaller market, with an 8.9 figure for all of 2012 -- compared to 9.1x in 2011 and 9.2x in Q4 2012.

Equity contributions stayed fairly flat on large deals at around 36%, while smaller deal equity contributions climbed past 40%. The below chart represents equity contributions for all private equity deals:

S&P500 Ripe for a Roll-over

The S&P500 broke the 8-day winning streak and fell just marginally. On a weeekly basis, it is still up for all 4 weeks of the year.

The trend looks like it is topping, not least because it is hitting against psychologically important 1,500 level. The index has tried to break above 1,500 in a meaninful way in the last 3 sessions but has not been able to. Meanwhile, the tops in the relative strength index (RSI) has been lower and lower. This technical divergence along with a jump in VIX support the notion that the S&P500 is ripe for a roll-over.

The index will not just roll-over on its own because so far it has been catching a bid on any weakness. There has to be a catalyst and there are quiet a few this week.
1) ADP Employment on Wednesday
2) FOMC statement also on Wednesday
3) Jobless Claims on Thursday
4) Chicago PMI also on Thursday
5) Payroll on Friday
6) ISM also on Friday.
7) Any weakness (for whatever reason) in the overseas markets.

Byron Wien Expects a Major Sell-Off

Economics & Earnings Calendar This Week

Monday
Earnings:
Caterpillar, Yahoo, Biogen Idec, BMC Software, VMWare, Celanese, Graco, Roper, Illumina, International Rectifier, Seagate, Crane, Olin

0830 am Durable goods
1000 am Pending home sales
1030 am Dallas Fed Survey
0100 pm $35 billion 2-year note auction

Tuesday
Earnings:
Amazon, Ford, Pfizer, Eli Lilly, DR Horton, EMC, Harley Davidson, Illinois Tool Works, Corning, Ashland, Allstate, Valero, Peabody Energy, International Paper, Tyco, Tupperware, Broadcom, Boston Properties, Nucor, CIT Group, AK Steel

2-day FOMC meeting begins
0900 am S&P/Case Shiller home prices
1000 am Consumer confidence
0100 pm $35 billion 5-year note auction

Wednesday
Earnings:
Boeing, Facebook, Qualcomm, Fiat/Chrysler, Hess, Conoco Phillips, Cannon, Marathon Petroleum, L-3 Comm, MeadWestvaco, JDS Uniphase, Northrop Grumman, NTT DoCoMo, Phillips 66, Cannon, ADT, Wisconsin Energy, Booz Allen Hamilton, Manpower Group, Southern Co, Skyworks, Owens-Illinois, Murphy Oil, Duke Realty, Rockwell Automation

0700 am Mortgage applications
0815 am ADP employment
0830 am Real GDP fourth quarter final
0100 pm $29 billion 7-year note auction
0215 pm FOMC statement

Thursday
Earnings:
Deutsche Bank, Royal Dutch Shell, Aetna, Blackstone, Altria, Hershey, Time Warner Cable, Viacom, Dow Chemical, UPS, Chubb, McKesson, PerkinElmer, Reinsurance Group of America, Manitowoc, Thermo Fisher Scientific, MasterCard, Colgate-Palmolive, Dominion Resources, Occidental Petroleum, Ericsson, Potash, Pulte Group, Bemis, Corinthian Colleges, Meritage Homes, Ryder Systems, Eastman Chemical, CR Bard

0830 am Initial claims
0830 am Personal income
0830 am Employment cost index
0945 am Chicago PMI

Friday
Earnings:
Exxon Mobil, Chevron, Merck, Tyson Foods, Beam, Ingersoll-Rand, Mattel, Newell Rubbermaid, Lear, Aon
Monthly vehicle sales
0830 am Employment report
0955 am Consumer sentiment
1000 am ISM manufacturing
1000 am Construction spending

Cramer's Game Plan for Week of January 28, 2013

Citi Economic Surprise Indicator Portends a Surprise for the S&P500

The Economic Surprise Indicator (ESI) from Citigroup is quite popular amongst analysts/traders that want to track how actual economic data compare to expectations. In a way, it measures relative optimism and pessimism amongst professional forecasters regarding the economy, which is a very useful tool for investors.

ESI is constructed daily by taking a weighted average “surprises” (actual release sversus Bloomberg survey median forecasts) observed over the past three months. Older surprises are discounted relative to more recent surprises to prevent the index from becoming stale.  A value greater (less) than zero denotes stronger- (weaker)- than-expected data, whereas a value near zero indicates that the data have been coming in as expected. As the Fed paper, points out, (1) there is a high degree of auto-correlation, which suggests that there is stickiness to economists' forecast. The Fed paper doubts such to be the case but we think it is the case (people don't change their views day-to-day), and (2) the weights are based on the historical impact of each data surprise on the U.S. market i.e. payrolls and ISMs have higher weights that others. Such weighting may not be appropriate for the Fed policymakers but it is definitely relevant for investors.

As the chart show, the ESI tends to lead the S&P500 variance with its 200-day moving average by about 3-6 months. If this relationship were to hold, then we should see pull-back in the S&P500 towards its 200-day moving average.

Cramer's Game Plan for Week of January 21 2013

A Full Circle for the S&P500

The S&P500 has made a full circle since its April 2, 2012 peak. The index closed at 1,419 on that day, but then steadily lost steam as Q1 earnings poured in. Disappointing earnings pressured the index, and by the end of the earnings season, the S&P500 had lost ~10%. The standout performers during downtrun were Telecom Services, Utilities, and Food and Staples Retailing. Not a surprise there.

The S&P500 troughed on June 1, 2012 at 1,278. It was the day May non-farm payroll surprised to the downside by a big chunk (+69K vs +150K consensus and downward revision for the prior months). The S&P500 traded lower the next day but snapped back above the 200-day moving average the day after. Thereafter it grinded higher on combination of favorable comments from the Fed and the ECB members, and on better than expected US macro data. The start of the Q2 earnings season on July 9th meant that investor focus shifted to corporate news from macro headlines. From June 1 to August 21, when the S&P500 touched 4-year high on the intra-day basis (1,426), it gained ~10%. Energy and Tech led the rallies but their outperformance was relatively muted. Telecom Services and Pharma lagged but only slightly.

The bottom line is that the defensive sectors (Telecom Services, Pharma, Food & Staples Retailing and Software and Services) have acted much better both in the downturn as well as the upturn. Cyclical sectors (Autos, Semis and Consumer Durables and Apparel) have fared the worst.

The S&P500 is hitting against important resistance levels. If it were to make a next leg up, I would bet that the cyclicals will have to do the heavy lifting. That means, if you are bullish, buy Semis, Materials, Diversified Financials and Tech Hardware.

Fun Stuff - Shhhhh

Earl Long, the colorful late former Governor of Louisiana once offered this advice on Louisiana politics: "Don't write anything you can phone. Don't phone anything you can talk. Don't talk anything you can whisper. Don't whisper anything you can smile. Don't smile anything you can nod. Don't nod anything you can wink."
That advice is equally applicable to Wall Street but with a caveat "Don't e-mail anything, you can write on paper. Don't write anything on paper, you can phone....."  

Source: hereisthecity.com

1. 'You f.cking Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians'.
In October 2006, the head of the Standard Chartered’s American operations allegedly sent a panicked message to a Group Executive Director in London, saying that the bank’s handling of Iranian clients could cause 'catastrophic reputational damage'. The above is said to be the reply the American got for his troubles.

2. 'Dude. I owe you big time! Come over one day after work and I'm opening a bottle of Bollinger'.
External trader to a Barclays trader who allegedly asked for a low LIBOR submission.

3. 'Just made it to the country of your favourite clients (Belgians)!!! I have managed to sell a few Abacus bonds to widows and orphans that I ran into at the airport, apparently these Belgians love synthetic ABS CDO2!!!!'.
Fabrice Tourre, an Executive Director in Goldman's Structured Products, Group Trading unit, messaging a girlfriend.

4. Many of the 'e-mails they'd like you to forget' were sent by equity analysts. Here are some other gems which appeared in the press a few years back:

'If I so much as hear one more f.....g peep out of them, we will put the proper rating...on the stock'. (Citigroup)

'If you can't say something positive, don't say anything at all'. (CSFB)

'Question 'What's so interesting about GoTo except investment banking fees ?' Answer - 'Nothin'' (Merrill Lynch)

'Triangle is a very important client. We could not go out with a big research call trashing their lead product'. (UBS)

'For the record, I have attempted to downgrade RSL THREE times over the last year but have been held off for banking reasons each time'. (Lehman)

'I can't believe what a POS that thing is. Shame on me/us for giving them any benefit of the doubt'. (Merrill)

While on the subject of stock analysts, it would be remiss not to mention former Citigroup man Jack Grubman. Former New York State Attorney General Eliot Spitzer released 'report cards' on Grubman. These were compiled by some of Citigroup's own brokers and investment bankers.
Here's a selection of what Grubman's colleagues allegedly said about him:

'Not all four letter words are bad ones. Perhaps some of the analysts, like Grubman, should consider this one: SELL'.

'A monkey could pick better stocks than he could'.

'Please do not fire Jack. He is my No.1 indicator - I do exactly what he says not to'.

5. 'Ratings agencies continue to create an even bigger monster - the CDO market. Let's hope we are all retired by the time this house of cards falters'.

'Screwing with criteria to 'get the deal' is putting the entire S&P franchise at risk - it's a bad idea'.

6. Bear hedge fund manager Matthew Tannin sent the e-mail below to his boss, Ralph Cioffi, in April 2007- months before two Bear hedge funds collapsed. Prosecutors used it to bolster their case that the two men had committed fraud.

'The supbrime market looks pretty damn ugly ... If we believe the (report) is ANYWHERE CLOSE to accurate I think we should close the funds now....the reason for this is that if (the report) is correct then the entire subprime market is toast'.

The matter ended up in court, and all over the front pages. In the end, and after a lot of aggro, both fund managers were found not guilty by a New York jury.

Bond King versus Stock Guru

In his monthly Investment Outlook, Mr. Bill Gross, the Bond King had not so nice things to say about Mr. Jeremy Siegel, the Stock Guru. Basically, Gross said Siegel's argument that "Stocks are for the Long Run" does not make economic sense. Both are clearly the leaders in their respective fields and their fiesty debate on CNBC is an interesting side-show.

Cult Figures

Pimco, August 2012

By Bill Gross

• ​The long-term history of inflation adjusted returns from stocks shows a persistent but recently fading 6.6% real return since 1912. 
• The legitimate question that market analysts, government forecasters and pension consultants should answer is how that return can be duplicated in the future.
• Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades.

​The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well. I “tweeted” last month that the souring attitude might be a generational thing: “Boomers can’t take risk. Gen X and Y believe in Facebook but not its stock. Gen Z has no money.” True enough, but my tweetering 95-character message still didn’t answer the question as to where the love or the aspen-like green went, and why it seemed to disappear so quickly. Several generations were weaned and in fact grew wealthier believing that pieces of paper representing “shares” of future profits were something more than a conditional IOU that came with risk. Hadn’t history confirmed it? Jeremy Siegel’s rather ill-timed book affirming the equity cult, published in the late 1990s, allowed for brief cyclical bear markets, but showered scorn on any heretic willing to question the inevitability of a decade-long period of upside stock market performance compared to the alternatives. Now in 2012, however, an investor can periodically compare the return of stocks for the past 10, 20 and 30 years, and find that long-term Treasury bonds have been the higher returning and obviously “safer” investment than a diversified portfolio of equities. In turn it would show that higher risk is usually, but not always, rewarded with excess return >>>

The Story from July Employment Report

Last Friday's July employment report surprised to the upside. The upside came from a robust growth in private payroll. There was some hint of such outcome earlier in the week in the form of the ADP report. But be as it may, markets rallied on the back of this report.

While the report was better than what could have been, some economists raised the issue of"seasonality". July is a tough month for calculating seasonal factor because teachers are off for the summer break and auto workers stay home as plants stay idle. Even ignoring this issue, the report was not great.

Private payroll peaked in January 2008 at 138 million and troughed in February 2010 at 129 million. The latest release showed 133 million workers suggesting 130K a month job growth since the bottom. At this growth rate, job level will not reach January 2008 peak until early 2015.

We calculate monthly job growth required to get unemployment rate back to 6% by January 2015 on different population growth and participation rate assumptions. The bottom-line is that 160K is the minimum required.

From January 2008 to February 2010, 8.7 million jobs were lost. Since February 2010, 4 million jobs have been re-gained, meaning there are still 4.7 million jobs missing. Those 4.7 million jobs still missing are in manufacturing, construction and retail trade. Other interesting facts from the report, (1) since February 2010, 230K teachers have lost their jobs (2) manufacturing renaissance is a myth. Only 500K jobs have been re-gained since February 2010, while job loss between January 2008 and February 2010 was 2.2 million, meaning a net loss of 1.7 million jobs since the recession.

A Picture's Worth Thousand Words

Mario Draghi "Overpromised on July 26 and under-delivered on August 2". Markets reacted accordingly. With the earnings season in the US tapering off, macro factors, more specifically around euro survivability, will start to dominate again. Expect volatility to trend higher.

On July 26, Draghi said, "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough". Investors were caught off-guard by such unexpected comments. That caused an instant rally in the euro, the Spanish 10-year, Dax and the S&P500 future.

On August 2, Draghi could not even deliver a rate cut (benchmark rate stayed at 0.75%) let alone convince policymakers at the ECB and the wider Europe to pursue aggressive policies like Securities Market Purchase, ECM banking license etc. Not surprisingly, all the asset classes fell in unison as soon as Draghi opened his mouth at the bi-weekly post-ECB meeting press conference.

The charts on the left (click on it to enlarge) show the schizophrenic reaction of different asset classes to Draghi's comments.

Forget the Fed, Focus on ISM

Stock markets were pretty sanguine today despite being hit by trifecta of major economic data, the ADP employment pre-market, the ISM during the early morning trade and the FOMC decision before the close. The most significant and the most waited of all was the 2:15PM EST Fed announcement. Investors were anxiously waiting for Bernanke’s team to give hints of QE3. Surprisingly, they didn’t although there was a slight change in the language. Equity investors shrugged off the “bad” news. May be they are expecting “Super Mario to Save the Market” tomorrow.

From the economic standpoint, the more relevant data was July ISM. It missed economists’ estimates and was the second consecutive month of sub-50 reading. More ominously, the gap between New Orders and Inventory indices was negative for the first time since September last year. A negative reading is usually a precursor for a downturn in ISM. Last year’s negative readings (July and August) were exception mainly because the Fed embarked on QE2. Everyone is expecting the Fed to do again (QE3) in September. Bernanke may prep the market in his Jackson Hole speech like last year. If the Fed does not do QE3, for whatever reason, or even if it does but is ineffective, then the downward momentum in ISM may be unstoppable.

Corn Climaxes

Corn futures have jumped massively in recent weeks. It made fresh new high today. A record high price for corn is caused by fears of supply shock owing to (1) harsh weather condition and (2) very low inventory.

The USDA tracks the weather condition during the growing season on a weekly basis. According to the USDA, "excellent condition" has plunged to the lowest level ever.

Inventory has been plunging since 2009, thanks to a jump in usage of corn to make ethanol. In 2002, 10% of domestic corn production was used to make ethanol. In 2011, it has reached 40%, and it the amount was more than used for feedstock.

Much Ado About GDP Revision

The annual revision to GDP last Friday was a non-event. The annual revision, which goes back 3 years (from 2009-Q1 through 2012-Q1), the BEA revised the growth profile marginally (2009 +0.4%, 2010 -0.6%, 2011 +0.1). The net result was that real GDP level in 2012-Q1 was 0.1% higher than before the revision.

Last year, the BEA revised down the growth profile massively (2008 -0.3%, 2009 -0.9%, 2010 +0.1%. The net result was that real GDP level in 2011-Q1 was lower by a whopping 1.6% versus before the revision.

Following the “out of the left field” annual revision last year, market started to price in QE. It eventually got one when Chairman Bernanke give hints of QE2 in a speech at the Jackson Hole Meeting. Looks like market was expecting, or more appropriately, protecting against a similar surprise.

When the annual revision came in as a “non-event”, treasuries sold-off. Last Friday, yield on treasury rose from 1.40% to 1.60% before settling at 1.55% - 20bp move in 10Y treasury is a huge move.

Mario (Draghi) Saves the Market

European equities rallied, euro/$ rate jumped over a percent and Spanish 10-year fell by 45bp. All thanks to comments by Draghi at a pre-Olyimpics Global Investment Conference in London this morning.

What did Draghi say? Two things, (1) “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough” and (2) “To the extent that the size of the sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate”.

While the timing of Draghi’s comments came as a surprise, the fact that he talked about euro and sovereign premia did not. In fact, investors were expecting it to come imminently. The simple reason is that every time Spanish yield rose above 6%, there had been some form of reaction from European policymaker, verbally or otherwise, to push the yield back to below 6%. The only difference has been that the pain threshold leading to the reaction has steadily increased over time.

The first time Spanish yield rose over 6% was in July 2011, just a year ago. It rose steadily going into the European Banking Authority (EBA) stress tests results on July 15, 2011. When the results came in, only 8 banks failed and a mere €2.5bn of new capital was required. That along with positive comments on Greece rescue plans ahead of the July 21^st EU Summit started to push Spanish yield lower. As such, the auction of Spain’s 18-month T-bill on July 19^th was over-subscribed. The EU Summit confirmed investors’ expectations. At the Summit the leaders attempted to prevent Greek contagion from spreading to other peripheral European countries by providing additional help to Greece (extending the maturity of new EFSF loans and significantly lowering interest rates) and allowing the EFSF to buy bonds in secondary markets.

The second time Spanish yield rose over 6% was in November 2011. Again, concerns over the European project rose and reached a peak when the German bond  auction was under-subscribed on November 23^rd. Again, policymakers started to make noise going into the December 9^th EU Summit, which helped push Spanish yield lower. Essentially, the debate started to move towards a fiscal union.  The summit confirmed the rumors. They agreed on principal on a fiscal union but did not flush out the details.

This time Spanish bond yield jumped over 7% on concerns that regional governments are seeking financial aid from the central government. On July 22, Bloomberg reported that, “Catalonia May Follow Valencia in Bailout Request”. As the pressure kept building on Spanish bond, the market was waiting for some form of reaction from policymakers and they got one today.

The rally in risky assets is likely to be short-lived because it is short-covering.