Financial, industrial and basic material stocks took the brunt of the beating, but on days in which the broad market gets bashed by 6%, even traditional safe havens like consumer staples and utility shares get clocked as well, which occurred.
Yesterday we mentioned how the S&P 500, after moving below the October 27 closing low of 848 intraday, reversed course to rally in the final hour. Obviously, this move was meaningless as we fell through that mark yesterday – 5% below that level in fact. The October 2002 multi-year low of 776 may be the next test in line.
That low was hit on October 9, 2002 – the all-time high of 1565 was hit October 9, 2007, interesting how things match up like this – marked a pretty depressing period, we recall it vividly. The same mood is in play this go around – it took the January 2003 tax proposal (and passage five months later) to bring confidence and sentiment back. Unfortunately, we’re trying everything except a tax-rate response this time.
Market Activity for November 18, 2008
I’ve got to say things have become quite ridiculous. Sure there are concerns, major concerns. We’ve got housing that fails to show any sign of rebound, consumer and financial institutions that are in the process of de-leveraging and global economies moving into recession – reducing the export activity that was helping to offset the economic drag from housing. Oh, and businesses remain extremely cautious, which means business equipment spending won’t provide a catalyst over the next few months.
But let’s face it, valuations on a number of indices reside at the lowest levels in nearly 20 years and an abundance of stocks offer dividend yields above that paid on the 10-year Treasury note. There are concerns about the sustainability of a rally (whenever it occurs) on top of everything else; make no mistake the market is freaked out over the possible direction of future tax and trade policy – not to mention government spending proposals that make the past eight years look like an exercise in frugality. However, we’re going to rally big time from these levels, the market is hugely oversold at this point.
(A possible bright spot on the policy front is the current market action is sending a clear message to all of those on the Hill that desire to take even more money from the private sector as if they know how to allocate it better than those who actually make it. As a result, they may be forced to hold back on their stated agendas and that may just incite a rally that is sustainable. In any event, no matter how stocks behave over the next several months, we’re looking at the greatest buying opportunity since 1974. I know, no one wants to hear that right now, but investing takes patience and this virtue is certainly being tried right now.)
The Economy
On the economic front, the Labor Department reported the consumer price index fell a large 1% in October due to the plunge in energy prices – the largest monthly decline since records began in 1947. The year-over-year figure fell meaningfully, dropping to 3.7% from 4.9% in September.
Again, as we discussed yesterday, this is a result of the Fed-induced jump in commodity prices (particularly energy, which doubled in the eight months that followed August 2007) in the first-half of the year. If not for that surge, the massive decline in energy prices during October would have been highly unlikely. So those thinking deflation here are off base in our view as the situation is not one in which all prices are declining, but rather resultant from the commodity bubble bursting.
While the vast majority of commodity prices have declined in a precipitous manner, it’s the fuels components that pushed CPI down by this degree. Interestingly, CPI ex-energy came in flat last month and would have risen if not for a large 2.3% decline in new vehicle prices and a 5.3% tumble in the price of used vehicles. Vehicles make up 7.2% of the index.
In any event, this is buying the Federal Reserve some time, but when economic activity begins to bounce back they’ll need to take some of their easing and massive liquidity injections back out of the system.
The core rate also declined in October (the first since 1982), which is a nice sign – especially since that producer price core rate showed a surge via Tuesday’s release. It is somewhat disturbing though to see many food component prices continue to rise. Also, the personal care component within CPI jumped 0.4% in October, which reflects the jump in paper and packaging prices in Tuesday’s producer price report. Again, the consensus is concerned about a deflationary environment, but that concern will shift to one of inflation when the economy bounces back. (I recall the Fed was concerned about deflation in 2003, which is what led them to keep rates to low for too long – the preponderant element to the housing bubble and over leverage within the financial sector).
Under normal circumstances, we would not be so hawkish on future rates of inflation (brushing off the large move in headline CPI since records began and the most since 1982 on the core rate) if not for the huge levels of both monetary easing from the Fed. It is difficult to see inflation remaining tame after a multi-month respite from the elevated levels of the past year as M1 money supply has jumped 30% at an annual rate over the past six months. This is a period of disinflation (declines in the rate of growth rather than a sustained period in which all prices actually move negative) due to the plunge in energy prices from extreme elevations and lower demand as global growth contracts.
In a separate report, the Commerce Department reported housing construction starts fell 4.5% in October, which was less than expected but as the chart below shows the pain continues. Starts fell to 791,000 at an annual rate, the lowest since records began in 1959.
This is the first look at starts for the current quarter and indicates the housing sector will weigh heavily on Q4 GDP. We could be in for a real rate of GDP decline that’s closer to 4.0% than the 3.0% that many are currently forecasting – housing’s drag on economic growth will extend to the 11th straight quarter for the current period and this one may be the most significant believe or not.
That said, there has been much progress made in lowering the homes available for sale – I know the word progress seems out of place, but supply needs to be cut – and we should see the bottom here. Surely the housing market will remain weak for several months still, as foreclosures lag and will keep supply (at the current sales rate) elevated, but we’re getting there. (Also, in terms of GDP, based on what we currently know, the fourth-quarter reading will prove to be the worst of it, in my view.)
Building permits dove 12% in October – a much larger than expected drop – to 708,000 units. Single-family permits fell 14.5%, and multi-family units (condos etc) were down 7.1%. This permits data shows things will not get better for current-month activity, so the November reading for housing starts will be just as weak.
Bernanke & Co.
In a separate note, the Federal Reserve released it minutes (notes essentially) from the October 29 meeting when they decided to cut their target on fed funds back to the “scene of the crime” of 1.00%. Touching on all of their comments regarding the economy would be a waste of time as we talk about the data each day, but their near-term outlook is worth mentioning.
FOMC participants were divided on 2009 growth, particularly in the back-half. Some expected the economy to recover by mid-2009, and some judged the period of weakness to persist through next year.
Our take is the economy is seeing its worst levels in the current quarter and weakness (while slightly improved) will extend into the first quarter of 2009. However, there’s a huge amount of monetary easing that has been pumped into the system, and so long as tax rates and trade pacts do not move in the wrong direction the impetus should be there for the business cycle to expand again. The current level of tax rates are very acceptable – certainly not onerous, although pushing rates on capital and income lower would provide a nice jolt to optimism – and if we get a few trade pacts that are currently held up, passed (sending the market a signal that protectionism is not on the horizon) we should be back on a nice trajectory.
No one really knows how this will play out or how long a contraction will last. But what we do know is U.S. businesses are streamlined like never before, corporations are sitting on mounds of cash, we’ve already endured 2 ½ years of serious housing construction contraction and inventory levels remains low. Once we begin to get our legs back, the resources are there and much of the housing froth of the 2003-2005 period has been removed. Also, no one talks about these low inventory levels. Once the current fears wane, the sales bounce will drive stockpile levels to a point where production must ramp up.
Further, the 60% plunge in the retail price of gasoline has substantially raised disposable income adjusted for fuel costs. Crude calculations place this income boost at $330 per month for the typical family – spread that out across the entire economy and that’s a massive increase.
Have a great day!
Brent Vondera, Senior Analyst
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