We’re headed for the worst annual performance on the S&P 500 since 1931 (although I’ll add that the 47% decline that year followed a 28.5% decline in ’30 and a 12% loss in ’29, so the current move is more in line with the 1973-1974 period – down 47% combined – than the years of the last depression. This year’s performance will end a five-year winning streak).
In any event, we may find a rally here in the final four days of the year as tax-harvesting may have run its course. Still, mutual fund managers will want to show high cash balances for quarterly statements, so any gains should be subdued.
Reports on personal spending and durable goods orders, while weak, came in above expectations. The durable goods report showed business spending actually rose 4.7% last month and that helped sentiment.
Market Activity for December 24, 2008
The equity markets have meandered for three weeks now, but at least the moves have been relatively subdued. We have given back a quarter of the 20% rally off of the November 20 multi-year low but that leaves us 15% above that mark. The market appears to be in a feeling out process; no one knows which way things will go but based on similar bear markets – for instance the 1974 bear – there’s a good chance we’ll rally from here.
We may test those lows again, but the de-leveraging event has pushed us below where we should be from a fundamental perspective. For sure there’s a lot of bad news out there, but with the NYSE trading at 13 times trailing earnings with a 4.54% yield (remember the 10-year Treasury carries a 2.16% right now) and the S&P 500 trading at 14 times the consensus estimate for trough earnings (generally the trough earnings multiple is significantly higher than this) stocks have the bad news, and then some, priced in.
Stocks will have to face additional tough forces over the next year – higher regulations, the prospect of higher tax rates, what I believe will be an energy policy that is not conducive to growth, a likely inflation event that will force the Fed to substantially raise rates and will drive long-dated Treasury yields much higher and a new president that may be tested by Islamic radicals, just as the prior two were just months into office – hopefully changes over the past seven years have helped us thwart attacks.
However, we’re trading at very low levels right now and a nice rally is warranted. Further, if any of the stated concerns do not come to pass, stocks will respond positively as a result. Still, without a tax-rate response to the current issues, it is unlikely the next couple of years will be an easy ride. An economy has never spent its way out of a problem and we’re guessing without a reward for success and measured risk-taking (by driving tax rates lower on capital and income) we’re not going to prove history wrong this time.
The government crammed in a bunch of economic releases on Wednesday, some of which would have normally been due out yesterday, so we’ll touch just briefly on each one to keep from getting too long.
Mortgage Applications
The Mortgage Bankers Association’s index of applications to buy a home or refinance a loan rose to the highest level since 2003, jumping 48% in the week ended December 20. The groups’ refinancing gauge rose 63% and purchases gained 11%.
The average rate on the 30-year fixed-rate mortgage dropped to the second-lowest level on record. Let’s hope these rates are low enough to at least partially offset what has become an additional drag on the housing market – a weak labor market.
Durable Goods (November)
The Commerce Department reported that durable goods orders fell 1.0% last month; however, the reading was much better than expected as a decline of 3.0% was anticipated. We’ll note the revision to the October data was revised downward big time, coming in at -8.4%. Significantly lower than an already large 6.2% decline previously estimated.
The ex-transportation reading on durables actually increased in November, rising 1.2%. This is a big surprise and, even if it’s off of a horrible 6.8% drop in October, should be viewed as a good sign.
Non-defense capital goods ex-aircraft, a proxy for business spending within the report, rebounded in November, up 4.7%. However, for the quarter this segment is down 21.6% at an annual rate. A huge reversal from what we saw in the second quarter and first-half of the third as the figure was up 15.25% at an annual pace. This shows how quickly things changed in mid-September.
Overall, for the first two months of the fourth quarter total durable goods are down 41.6% at an annual rate, which puts orders on track for one of the largest quarterly declines ever. The intensification of the credit crunch, the Boeing strike and Hurricane Ike (which made landfall last quarter but affected the first month of this quarter) have combined for the perfect storm to hammer durable goods orders and manufacturing and industrial production in general.
Personal Income and Spending
The Commerce Department also reported that personal incomes fell 0.2% in November, marking only the second monthly decline in the past three years.
So, we’re beginning to see some meaningful deterioration in incomes as the year-over-year reading has dropped below 3.0% -- it came in at 2.5% from the year-ago period for November. Compensation was up just 1.7% in November. The wage and salary segment was up 1.5%. Proprietor’s income fell 1.7%. These are year-over-year readings.
On the positive side, dividend income, while down from high single-digit growth six months back, has held up pretty well, up 3.6%. (The decline in financial-sector payout rates has put pressure on the figure). Rental incomes continue to soar, more than doubling on a year-over-year basis as the housing market correction has fueled rental occupancy rates.
Personal spending fell 0.6% in November, marking the fifth-month of decline -- although, the drop last month was less than estimated. That’s on a nominal basis. Adjusting for inflation, real spending rose 0.6% in November, marking the first increase since May.
We’re looking for the December reading to break this nominal spending trend. Bad weather across the nation over the past two weeks may have held things back a bit, but the 65% decline in gasoline prices has left significant cash in consumers’ pockets and this should show up in the December figure. The plunge in energy prices has brought overall levels of inflation down to almost nothing, so real incomes remain positive, which is meaningful.
Consumer will continue to boost cash savings, as their main savings vehicles – the home and stock market – have endured major damage. Still, the decline in gasoline prices is very powerful and even if the December spending figure fails to show a bounce, it will occur over the next couple of months.
Inflation Trend
Inflation has been led lower by a plunge in energy prices and this should not be confused with what’s known as monetary deflation. While consumer activity must be affected by a deteriorating labor market, the current decline in energy prices is great news for the U.S. consumer and should help to drive spending in other areas over the next couple of months.
The inflation gauge tied to the personal spending data (the PCE Deflator) showed overall price activity came in flat during November (no change from the October reading) and has dropped to 1.4% on a year-over-year basis from as high as 4.5% in July. So this massive deceleration in the rate of inflation should help to augment consumer activity. That said, we do not believe inflation will remain tame; this is a transitory event.
The massive liquidity injections by the Fed will combine with an infrastructure-based stimulus program -- that will likely reach $1 trillion when it’s all said and done -- to kick up commodity prices again and thus overall inflation. But that’s another story and likely several months out.
Jobless Claims
The Labor Department reported that initial jobless claims jumped 30,000 in the week ended December 20 to hit 586,000, remaining at a 26-year high.
While this is a very elevated level, as we continue to point out, claims of nearly 600,000 are not what they were back in 1982 when civilian employment stood at just 99 million, today it stands at 144 million. Adjusting for the increase in employment, we’d need to see claims hit nearly one million to match the 1982 level. We think this perspective is important.
(That 144 million figure comes from the Household Employment Survey, which includes the self-employed. The Establishment Survey, which measure just payrolls and excludes the self-employed, stood at 88 million in 1982 and stands at 136 million today. This does not change the prior point, I just want to clarify that there are two different surveys to view.)
The four-week average of initial jobless claims continues to rise, increasing 13,750 to 558,000 – the eighth week of increase.
We’re without an economic release for the next two business days, so things will be quiet as they normally are in the final week of the year.
On Tuesday, we’ll get some home-price data and manufacturing activity out of the Chicago region. On Wednesday, mortgage apps and jobless claims – again a day ahead of the normal schedule as Thursday is another holiday.
Have a great weekend!
Brent Vondera, Senior Analyst
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