Daily Insight

U.S. stocks fell for the third day in four as it didn’t appear traders found reason to get in front of Bernanke’s testimony to Congress on Wednesday. The Fed Chairman will lay out the strategy for exiting the unprecedented level of monetary easing that is currently in place. To be sure, there are other concerns affecting the market right here but you never know what may be stated, or more importantly how the markets interpret Bernanke’s statements.

The broad market was actually holding in there pretty well -- up in the morning and hovering around the opening price level into the afternoon session – until sliding a bit in the final hour. For what it is worth, the Dow closed below the 10K mark for the first time since early February – it has crossed this mark 57 times now since 1999.

Some comments from former Fed Chairman Greenspan on Sunday morning’s Meet the Press may have also had an effect on trading. Greenspan stated that the economic recovery will be “slow and trudging.” He also explained that he’d be very concerned if stock prices continue to fall, more on that below.

Commodity prices rebounded a bit. It’s been a pretty good pullback, down 12% over the past month after hitting post-crisis highs. A move of 12% over this length of time isn’t saying a lot as these prices can swing violently, but it’s the most significant move since June and all about sovereign default concerns – European banks hold a lot of the public debt that’s in question and that gets the market concerned about future credit contraction.

Financials led the broad market lower, followed by basic material and industrial shares. All major industry groups closed lower.

Market Activity for February 8, 2010

Central Bankers and the Risk Trade

Central bankers are keeping a close eye on stock prices, as Greenspan signaled this weekend and we’ve talked about several times now. A key objective of the ZIRP (zero interest rate policy, for new readers) was to get traders and investors back into risky assets – they were running from anything other than cash and Treasury securities early in 2009. When you completely erase returns on cash holdings, as the Fed has done, you will get people hunting, desperately in some cases, for yield and returns – that means a rush of money into stocks, and higher-yielding corporate bonds.

Boosting stock prices is really the only quick way with which the Fed could begin to repair household balance sheets; they can’t do it from the perspective of income as that takes job growth, which takes a considerable amount of time. They have certainly accomplished this goal to some degree as household net worth has bounced $5 trillion since last March. The crushing 57% plunge in stock prices (from the Oct. 9, 2007 high to the 13-year low on Mar. 9, 2009) and the roughly 30% decline in home prices (from the July 2006 peak to the cycle low hit in Jan. 2009) stole more than $17 trillion from household net worth. It hit $66 trillion in 2007 and currently sits at $53.4 trillion.

But the perils behind this strategy are not fully being considering in my view, or maybe they have been recently. When your strategy is to push people into riskier assets, traders push aside their consideration of risk as they myopically hone in on the yield – it’s like throwing chum to sharks, a frenzy results. What these yield/return seekers have forgotten, is that there is another side to this trade – prices can move lower. It is utterly amazing to me how so many have forgotten this just 10 months removed from largest collapse in riskier-assets since the 1930s, but that’s what ZIRP does. We’ve recouped a lot by way of stock prices, half of the losses before this 8% pull back. Yet one gets this sense that too many people expected this substantial rally to continue without abatement. We simply face too many headwinds, and it takes time to forge through these challenges.

Anyway, Greenspan made it clear and for sure Bernanke is keeping a close watch on stock prices in particular. If the market endures a decent sized correction here -- which I think is likely as the market begins to consider weaker prospects for growth in the back half of 2010 and into 2011, the cost of very deep deficit spending, the sovereign debt realities that ensue, and a housing market that very likely has to get past another round of downside – we may not yet fully appreciate the extent to which both Congress and the Fed will accelerate easing strategies over the coming months. That means a return to quantitative easing from the Fed and additional spending from Congress, both of which will cause market distortions and new problems that will have to be worked off over the next couple of years.

I do not wish for this to occur, which is why this letter keeps harping on the need for the Fed to gently raise rates and Congress to slash tax rates across the board. Even mild rate hikes will cause problems for this economy, but the slashing of tax rates will offset that pressure – I can’t emphasize this enough. At some point, you’ve got to rein in some of the things we’ve done and force the market to stand on its own. If we don’t, I’m sure additional problems will arise – at which point the Fed won’t have to worry about a short-term correction to this rally from the March lows, but a mired stock market for a longer period of time.

Coming Data

We were without an economic release yesterday but get back to it today with the NFIB Small Business Optimism Index and wholesale inventories (December).

On Wednesday, we receive Mortgage Applications (week ended February 5), the trade balance (December) and the monthly budget statement (size of the budget deficit during January)

On Thursday, and I’ll be out off the office the final two days of the week, we get retail sales (January) and jobless claims.

The retail sales and jobless claims figures will get most of the attention, but NFIB and mortgage apps will be important to watch as well.

Next week things get very interesting with the following releases:
Housing starts, industrial production, Philly Fed and CPI. The market will want to see some bounce back in housing starts after December’s 16% plunge (we’ll see how weather-related that drop was) and industrial production will need to post a good reading (December’s results were all on cold weather as the utility component accounted for the entire increase).

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks spent most of the session in negative territory, hitting the day’s nadir shortly after lunch (Dow at 9834 and 1044 on the S&P 500), but turned higher about an hour before the closing bell. The Federal Reserve’s latest report on consumer credit provided the impetus for the market’s turnaround as it showed the smallest drop since the record consecutive months of decline began in February.

There was also talk that the market was helped by speculation the EU would come up with a plan for Greece’s budget this weekend at the G7, this should be interesting. But it seemed to be more on the consumer credit news as the market’s about face occurred directly after that release. Now that the meeting has come and gone, we see it was more talk than anything else, as is usual. The sovereign debt story is not over; there will be a default or two and plenty of close calls. This is the nature of things coming out of such a deep global contraction, government spends like mad to combat the problem and that combines with a slide in tax revenues to widen budget gaps to levels that cause additional problems.

Total consumer credit fell just $1.7 billion in December after a record $21.8 billion decline in November – records go back to 1943. Revolving credit (credit card accounts) continued to decline, extending the record streak to 15 months – this is likely to continue for a while as credit lines run off of delinquency models. What helped the figure was the non-revolving segment, basically car loans. With loan terms averaging 3.26% during the month and maturity at 64 months…and loan-to-value at 92% -- giddy up!

Commodity prices continue to get hit pretty hard. Oil got slammed down to $70/barrel before recovering to $71.19 on Friday, down 8% in three sessions; gold was back to $1,052/oz. before jumping this morning; copper is down 7.5% since Wednesday and 18% from its recent high.

As the flight to safety has returned, the dollar is the beneficiary – up above 80 on the Dollar Index (DXY) for the first time since July as it was coming off of its crisis high of 89 on the DXY. Treasury securities are back in vogue as well. Man, anyone who went short Treasuries thinking it was a no-brainer has gotten crushed thus for in 2010.

Market Activity for February 5, 2010
January Jobs Report

The January jobs report printed numbers that set up an environment for very contentious analysis. Those who believe this recovery is normal in nature viewed the report with an optimistic hue, while those who understand that recoveries following credit/balance sheet-driven recessions are not at all normal viewed the report with skepticism.

For me, and I’m undoubtedly in the latter camp, I don’t look askance at the report, but would rather wait and see the subsequent months confirm what I think is going on – a large divergence between the household and payroll surveys due at least partially to a lot of people who were working in the construction sector now venturing out on their own, adding to the roles of the self-employed. Many of the nearly two million jobs that have been lost in that sector are not coming back, not anytime soon – for all intent and purpose they have been structurally eliminated and those formerly in the sector are beginning to realize this. The household survey picks up these self-employed, the payroll survey does not.

So let’s get to the specifics, and we’ll begin with what is more familiar to most people: the payroll survey. The Labor Department reported that 20,000 payroll positions were cut in January (economists had expected a 15K increase). Whether, 20K up or down, it doesn’t matter because this is a statistically insignificant level. What is statistically relevant is the downward revision to the December reading, which showed 150K jobs were lost; it was initially reported as decline of 85K last month.



In fact, February brings with it annual labor market revisions and those new readings showed that 8.4 million payroll jobs were slashed offer the past two years, it was previously believed that 7.2 million payrolls were lost. BTW, the Bureau of Labor Statistics “birth/death” model estimated that more businesses open than closed in 2009 for a net 1.79 million jobs. I’ve never questioned this B/D model, but it is a little hard to believe that the worst recession in the postwar era saw more businesses open than close, so it’s not out of the question to wonder if well more jobs were lost than even 8.4 million. I’ll leave it at that.

These numbers are obviously backward looking, they are in the past, so one shouldn’t dwell on them. What it does inform us of is that the repair that’s needed within the job market will take even longer to accomplish than previously expected. If a meaningful degree of repair in going to occur within the next two years then we are going to have to see even stronger monthly job growth and GDP figures than it normally takes. Normally, it takes at least 120K in monthly job gains to keep the jobless rates steady and something closer to 200K/month over a period of time to bring it lower. Those number may have to be greater now, possibly 150k/month to keep it from rising and 300K/month to get the jobless rate back down to 8% in 18 months time.

Anyway, back to the monthly numbers. In terms of industry, goods-producing industries shed 60,000 payrolls last month. Manufacturing actually added 11,000 jobs (first time in more than two years and much better than the three-month average of -23K). Construction cut 75,000 jobs (considerably worse than the three-month average of
-47K). I don’t believe one can blame this on the weather as was the valid case in December. It is more a function of the accelerating pace of commercial construction deterioration. But, we’ll see over the next couple of months which view is correct– if it was the weather, construction employment should bounce with vigor in the coming months and vice a versa.

The service-providing industries added 48,000 jobs in January after a downwardly revised -69k in December, which was initially reported as a 4K decline. Business services added 44,000 jobs (in line with the three-month average of +45K). Retail trade added 42,000 jobs (much improved from the -8K on the three-month average). Trade and transport added 15,000 (nice improvement as the three-month average is -18K). The financial sector cut 16,000 jobs (about in line with the -10K monthly average over the past three months).

Temporary positions rose 52,000, probably mostly within the business services sector, and are up 247,000 since September. This is good news as it usually indicates more permanent employment is on the horizon. This is the expectation, but the looming question remains to be seen; Will the gains be strong enough and durable enough to bring the jobless rate lower in a reasonable amount of time? Further, as I’ve suggested on more than one occasion, the reliability of indicators that have proven accurate in the past may not be so true this time. Temp. employment has risen very nicely, but in this environment one has to be cautious of firms’ willingness to turn these workers into permanent employees (and thus take on the benefit expenses that accompany a permanent worker) like has occurred in the past.

The government cut 8,000 jobs. The Federal government added 33K, but states and local cuts offset this increase.

So now we get to the household survey. This is the survey that is used to calculate the unemployment rates. For newer readers, the payroll survey (which calculates the number of payroll jobs gained or lost) is the monthly jobs number you read in the headlines. The household survey is used to calculate the unemployment rate and it captures the self-employed.

The unemployment rate fell to 9.7% from 10% in December. Economists had expected the rate to hit 10.1%.

The household survey showed a gain of 541,000 jobs last month, after the December decline in 589,000. This is a volatile measure (as the prior sentence illustrates) and has bounced all over the map over the past few months. This pick up for January is why the unemployment rate fell to 9.7% from 10% even as 111,000 people came back into the labor force – meaning they had looked for work in the four weeks that this monthly survey captures.

There is no way of knowing just yet whether this bounce in household employment is the beginning of something. I’ll repeat, it will take several months of a trend to be established to confirm whether we’ll muddle around at low levels of jobs growth or something more substantial will take place. I think what occurred via the large pick up in household employment is that enough of those out of work in the construction sector decided to become self-employed – one man shops of carpenter, electricians, etc. Thus, as they stated via the survey that they were out of work in December, they now stated they were working in January. Again, we’ll need some consistency in the readings over the next few months to confirm what is going on.

The U6 unemployment rate, which captures the officially unemployed plus “discouraged” workers (those that didn’t look for a job during the survey period because they believed their chances of finding one was low) and those working part-time because they couldn’t find full-time work, fell for just the second time in two years. U6 came in at 16.5%, meaningfully lower than the 17.3% in December as those who want full time work but are working part-time for economic reasons fell to 8.3 million from 9.2 million in December.

Unfortunately, the long-term jobless rose to a new record as the percentage of those unemployed for at least 27 weeks rose to 41.2% from 39.8% in December. More than four out of 10 unemployed persons out of work for more than 27 weeks.

In addition, the average duration of unemployment extended to a new record of 30.2 weeks from 29.1 weeks in December.

The average hours of production per week ticked up to 33.3 in January from 33.2 after hitting the all-time low of 33.0 in October. This number will have to rise to 33.8-34.0 before any meaningful hiring takes place. The 10-year average is 33.7.

So again, this report is quite conflicting. There were positives, such as the unemployment rate decline even as the participation rate rose, the rise in temporary employment, the continued easing in payroll losses (three-month avg. is just -35K/month, that was -220K/month just three months back) and the tick higher in hours of production.

Yet, we’ll need to see the jump in household employment be confirmed in the coming months, large questions remain as to whether this economic environment can produce the job growth needed to repair a meaningful portion of the 8.5 million payroll jobs lost over the past two years, and the long-term unemployment situation continues to deteriorate.

I think this report leaves more questions than anything and it doesn’t tell us much in terms of new information. Remember that we’ll have 700,000 2010 census workers (a two-month gig) being hired by early summer. This is going to cause distortions and make analyzing the data even more contentious among economists.

Have a great day!

Brent Vondera, Senior Analyst

Fixed Income Weekly

Sovereign Debt
Concerns over government debt levels are building across the globe, and the effects have been felt beyond the sovereign debt universe. Stocks, commodities and foreign currencies all suffered in the back half of the week, as risky assets were shed in favor of US Treasury and Agency bonds. It was nice to see Dollar hold up in the face of all this, considering the budget and debt issues we face domestically. The dollar index rose 1.68% during the last 3 days of the week, and gold fell 4.62% over the same period.

Several dealers sighted heavy buying on the longer end, an obvious safety trade, while yields on bills were actually higher for the week, as investors sought duration to gain from the rally in bonds.

To try and put the sovereign credit issues into perspective I built this table comparing CDS of some major countries with some more familiar US companies. There are some large discrepancies between credit ratings and CDS cost (BB- Venezuela at 1,055 basis points vs. BB- Turkey at 214 bps.). This should explain pretty clearly how little credit ratings are worth these days.


Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks took a pretty good beating along with commodity prices as an ugly jobless claims report fostered concerns that even mild job growth will be delayed and hence that feeds into concern about final demand.

Financials, energy and basic material shares led the declines. People who have been late to the inflation trade, rushing in after commodity-related stocks were already up 85% from the March lows, have to be a bit annoyed to say the least. We cautioned against myopically moving into this trade after these runs – you had to begin a position 10 months back when few were thinking about it. Now these stocks are getting hammered. I think commodity-related stocks are a place to be over the next two years, but renewed economic issues are inciting a pullback – you’ve got to pick your spots in this market.

A renewed concern about sovereign debt default risks, which appeared to have been allayed for a couple of days, also worked as a cudgel on the riskier assets (stocks, commodities, high-yield corporates).

Better-than-expected factory orders (December) and same-store sales results (January) were not enough to offset the aforementioned issues. Same-store sales looked quite good, expanding on solid figures for December, after fifteen months of getting absolutely crushed. Apparel-store sales were up 6.4% from the year-ago period; luxury was up 10.9%; discount rose 2.9%; and wholesale clubs up 2.1%.

But the jobless claims figures and government debt problems took center stage.

On claims, the initial claims number moved farther away from the 400K level as it is back to 480K. The 400K number is key because it almost always accompanied by some level of job growth.

On the government debt issues, the problems are spreading and when it was just Greece the market could see a European Union bailout as not a huge deal. But the Europeans also have problems in Spain, which raised its budget deficit forecasts through 2012, and Portugal, which endured a failed bond auction yesterday (which means bids fell short of what they were offering). The European banks hold a lot of government debt and if these securities continue to erode then they’ve got another capital adequacy problem on their hands.

The European Central Bank (ECB) left its benchmark interest rate at 1%, a record low, and has indicated they’ll hold off from beginning to gently raise rates until they get more information on the economy and inflation – early indications for first-quarter growth in Europe is looking weak. The government debt problems are surely also a topic of conversation within the ECB.

The Bank of England left their rate unchanged at 0.50%, also a record low. The BofE did vote against extending its quantitative easing program (the bond purchases). Economists had expected them to pause. And that’s a key word: pause. I think we could find that the halt of QE is more temporary than permanent.

Market Activity for February 4, 2010
Jobless Claims

The Labor Department reported that initial jobless claims rose 8,000 to 480,000 in the week ended January 30 – economists were expecting a move down to 455,000. Initial claims remain sticky and that’s a concern. It was just a month ago in which it appeared the figure was headed to the 400K level – a level that is needed to offer a good confidence that monthly job growth is upon us. (I’ve been expecting some mild gains in payrolls to begin over the next couple of months, but this claims data is eroding the conviction of this call.)

The four-week average of initial claims rose 11,750 to 468,750.

Continuing claims also continue to rise. The standard claims (those traditional level of benefits that last 26 weeks) rose 2,000 to 4.602 million. The Emergency Unemployment Compensation (EUC) claims jumped 242,000 to 5.632 million – these are the claims that extend out to as long as additional 73 weeks. EUC claims have jumped 600K over the past three weeks.

So the jobless claims data have taken a turn for the worse. Prior to this deterioration that’s occurred over the past three weeks at least we had initials improving even if continuing claims kept moving higher. Now with both on the rise it does suggest that firms will hold off a bit longer before they begin to even mildly increase payrolls.

I will be very interested to see the long-term unemployment data in the employment release this morning. That number hit a new record of 29.1 weeks on average via the December jobs report. I was thinking that figure to begin a slow decline in tomorrow’s report; that’s looking increasingly unlikely.

Factory Orders

Factory orders rose 1.0% in December, following the same increase for November – the December increase was twice what was expected. This data includes both durable and non-durable manufacturing orders.

The orders for durable goods was up 1.0%, which is a significant improvement from the durable goods orders we received last week – that report showed orders rose just 0.3%. Orders for non-durable goods (those meant to last less than three years) also rose 1.0%.

Orders for non-defense capital goods ex-aircraft rose 2.2%, which followed a strong 3.2% increase in November. This figure is the proxy for business spending and we’ve seen a nice bounce over the past two readings.

As we talked about yesterday, what you watch for is this trend to extend through the first quarter. Firms spend unused annual budgets at year end, and this was very true last year as firms were especially chary with their cash for most of 2009. The likelihood that firms are going to go on a spending binge must be confirmed by a continuation of the trend. If it is, it will be very helpful for growth over the next few quarters as the economy will need all the boost it can get from the business side of things as high household debt levels and 10-17% unemployment/underemployment will dampen personal consumption.

Productivity

U.S. worker productivity rose at a 6.2% annual rate in the fourth-quarter, as estimated by the Labor Department’s initial look at the figure. This is a jobs-slashing productivity environment as output rose 7.2% (as firms do a little inventory rebuilding after cutting stockpiles at a record pace during the first half of 2009) and employees’ hours rose just 1.0%.

This is a great number that shows firms are going to be able to absorb higher input costs. Firms will enjoy very high margins and increasing profits for a spell. However, productivity improvements that are purely led by job slashing means trouble for end demand (where is incremental consumer demand going to come from in this environment?) and top line growth for businesses. Thus a durable profit growth story remains very much in question.

Everyone wants higher productivity levels, but the test is to get it when payrolls are on the rise. It’s a short-lived event when it occurs simply because of labor-market erosion.


Have a great weekend!


Brent Vondera, Senior Analyst