Daily Insight

U.S. stocks got clocked again as the broad market posted its largest single-day percentage decline since Black Monday 1987 on an ugly September retail sales report. That economic data possibly kicked off another round of de-leveraging as redemptions caused hedge funds and mutual funds to sell shares.

This latest retail sales report, combined with the negative reading for August, suggests consumer activity may have declined at a 3.0% annual pace in the third-quarter. That would mark the worst consumer retrenchment since the 1981-1982 recession.

I don’t think one should dismiss that the market is also currently pricing in fears of impending regulation, not to mention an Obama/Pelosi/Reid government that has opposed free trade pacts and proposed higher tax rates.

The good news is the market seems to have priced in an awful lot – a significant U.S. recession, possibly a global recession, policy concerns and a credit market freeze up that is making things much worse. (I’m not saying we’ll see the global economy actually contract, certainly very weak growth will occur, just that the market seems to have priced this event in)

This is a bargain-hunters dream, but patience remains and will continue to be the theme for several months. Those with a longer-term view have had to deal with a decade in which stock-market returns have been non-existent for large-cap stocks. Thankfully, a diversified portfolio would have provided some boost as mids and smalls are up at 7%-8% annualized rates over the past 10 years.

These events of stock-market stagnation occur on occasion; the good news is large returns follow – although things may remain sketchy for a while still.

Market Activity for October 15, 2008
Oh, and I’ve got to touch on this de-regulation claim we keep hearing about – you know, the exhortation that de-regulation has caused the current crisis. Someone tell me where net de-regulation has occurred over the past seven years. In fact, the last round of de-regulation occurred in the late 1990s. Have people forgotten about Sarbanes-Oxley and all the regulatory requirements that accompanied that legislation?

While the current crisis results from years of monetary policy mistakes, keeping rates too low for too long, (and all of the leverage, poor risk-management, scurry for yield and overall bad behavior that these policy mistakes encouraged) it has been a regulatory regime that’s sent public offerings to the London and Dubai Exchanges as the comparative cost of going public on the NYSE has risen.

For the record, I am for de-regulation, but it is a specious claim to state that this is what has brought on the current situation.

It appears the credit markets are beginning to unlock. It is really too early to tell, but three-month LIBOR (inter-bank lending rate) has come down a bit – although it remains at an extreme elevation. The overnight LIBOR rate dropped 20 basis points this morning to 1.94% -- the lowest level since late 2004. We’ll need to see that three-month rate come much lower.


On the economic front, the Labor Department reported that producer prices fell 0.4% in September, marking the second month of decline – the August reading fell 0.9%. The core rate, however, accelerated, rising 0.4% on a month-over-month basis and up 4.0% year-over-year – that’s up from the previous reading of 3.6%.


For the overall reading it remains elevated, up 8.7% from the year-ago period, although it has come down from 9.8% in July – not much considering energy price have moved much lower, but the direction is encouraging – oil has come crashing down from $145 per barrel in July to $72.57 this morning, which brings it back to the level just prior to the Fed’s latest aggressive monetary easing (interest-rate cuts).


More specifically, we’ve been watching prices of core intermediate goods – the goods used to produce finished product and excludes energy – which does remain stubbornly high. Although, on a three-month annualized basis we have seen the degree of decline has been substantially up 14.2% vs. 21.7% in the previous reading – this will show up in the year-over-year figure next month.


In a separate report, the Commerce Department stated retail sales fell for the third-straight month, and core retail sales – which exclude gas station receipts (which have put pressure on the overall reading as prices have declined) and auto sales – fell for the second-straight month. So we can’t blame this on weak auto sales and declining gas prices.

Overall retail sales fell 1.2%, core sales fell 0.7% and the figure that funnels directly to the GDP report (sales ex gasoline, autos and building materials) fell 0.6%. That last figure has collapsed on a three-month annualized basis, down 3.8% -- that number was up 4.8% as recently as July.


For nearly three months now we talked how consumer activity was going to decline for a while as the job market remains weak, inflation keeps real income growth flat and an intense level of caution has set in due to falling home and stock prices. Up until the credit markets locked up a month ago business spending was on fire, but that all changed over the past six weeks. The economy will falter so long as capital distribution lanes remains blocked – the length of this situation will determine the duration and severity of the economic downturn. That downturn will begin to show up in the next GDP reading.

The Commerce Department also reported business inventories rose 0.3% in August, following a 1.1% jump July – these figures suggest inventory investment will offset some of the fall off in domestic final demand, and thus temper the decline in GDP.

However, the sales data dropped a significant 1.8% in August. Most of this was expected, after five months of very strong gains, but the September figure will surely mark the second-straight month of decline based on all that has occurred. Thankfully, the inventory-to-sales ratio remains low and the fact that firms have kept things very lean should help to manage this downturn. (Again though, all bets are off the longer credit remains frozen.)

Finally, the Federal Reserve issued its regional economic survey, which stated the following:

• Economic activity weakened across all 12 districts
  
• Consumer spending was weaker in many districts. Boston and New York were the exceptions – that’s interesting with the financial-sector fallout. Many districts stated consumers were more price conscious, shifting to cheaper brands
  
• Several districts reported capital spending decisions were being delayed due to economic uncertainty
  
• Manufacturing declined in most districts; several stating credit conditions were contributing to a high level of caution
  
• Real estate and construction weakened or remained low in all districts. However, the inventory of unsold homes was reported to have declined in Boston, Atlanta, Cleveland and Philly. Cleveland and St. Louis reported commercial construction was steady
  
• Price pressures have eased, but remained sticky and elevated in a number of districts
  

Hang in there and have a great day!


Brent Vondera, Senior Analyst