This move has done additional psychological damage and it may just take some time for the market to form a base as a result.
We’ll open today with the S&P 500 at it lowest level since October 1996, which puts the index at an extremely low P/E of 9.8 based on trailing earnings. This would normally be a level stocks should not move down to, especially with interest rates and inflation this low (even if the levels on both will not remain this low for too very long), but government policy has investors throwing in the towel as it becomes extremely difficult to evaluate shares when we’re all so intensely at the whim of Washington.
Compounding the whole thing is a complete lack of clarity with regard to the plan that would remove toxic assets from bank balance sheets. Dang, get to it! Eliminate mark-to-market, supply low-cost funding to purchase, corral these troubled assets (until the real estate market rebounds and they can then be sold at a level much closer to intrinsic value) and for Heaven’s sake do not punish the very people you’ll need to facilitate these trades. The administration is in the process of raising tax rates on private equity firms, this is just dumb. We need to incentivize these people to come in and buy these assets, lowering their after-tax return expectations will only keep them on the sidelines.
Every major industry group got wacked yesterday, the relative winners were technology and consumer staples, down 3.22% and 2.62% respectively.
The price of crude got clocked as well, down 10.52% to $40.05 per barrel on concerns global demand will remain depressed. As we’ve touched on a couple of times now, domestic demand is not all that bad as we’ve seem it stabilize, according to the latest Energy Department report, but things are trading on perceptions as well as actual economic deterioration. When stocks slide like this, and we’re now 7% below the former multi-year low hit on November 20, few people care about any positives that are out there, they sell out of fear.
The really sad thing is we do have positives like high levels of productivity, enormous levels of cash on the sidelines, businesses that are streamlined and poised to dominate on the global stage and a plunge in energy prices that has caused inflation to flat-line thereby boosting real income growth. If we could just get a couple of policies out of Washington that are somewhat kind to the private sector we could be onto something. But that’s the problem; investors are saying all they see is destructive policy.
Market Activity for March 2, 2009
The Economy
The Commerce Department reported on it personal income and spending figures for January, both of which came in at better-than-expected rates.
Personal income rose 0.4% in the first month of the year, posting the first gain in four months. Although, the increase came solely from the government as transfer payment jumped 3.5% for the month.
Most private-sector segments were flat to down – excluding government payments personal income fell 0.2%. Compensation came in flat, unchanged from December; wage and salaries fell 0.2% -- the third month of decline; proprietors’ income was down 0.7%; rental income (one of the bright spots of the last three months) fell 0.4% and interest income dropped 0.7%. Dividend income was the only private-sector segment that rose, up 0.1%.
Again though, the flat inflationary environment has allowed real incomes to jump, and that’s a good thing.
Personal spending gained 0.6% in January, posting the first gain in six months. The level of real spending stands 0.8% above the fourth-quarter average at an annual rate. We’ll need to see spending rise again in February to offer a more concrete view that the consumer side of things will contribute to GDP this quarter. I suspect we’re a little early here, that boost from the consumer will likely have to wait until the second quarter. We shall see.
The personal savings rate (cash savings) hit 5% a couple of months faster than we thought would occur (something we’ve been watching for as a signal consumers feel better about spending given the decline in asset prices). Although again, the boost to income last month was due to government transfer payments, not private-sector dynamics, so I’m not sure the higher cash savings rate will flow into confidence and thus boost spending in a sustained manner just yet.
The inflation gauge tied to personal spending, the PCE Deflator, continues to pretty much flat line. Core PCE, which excludes food and energy, rose 0.1% in January – the year-over-year core rate slowed to 1.6% from 1.7% in December.
However, I would not expect the inflation figures to remain low for long. Soon enough inflation rates will spike as the Fed has pumped massive amounts of money into the system and huge levels of government spending will combine to send enormous amounts of money into the economy. The Fed’s action has not shown up totally as the velocity of money (the number of times it turns over) has been held back as banks have eased lending. But when lending returns to more normal levels, we will have the classic scenario of too much money chasing too few goods.
Remember, as if you need reminding, production has been weak. What’s needed to absorb all of this money is an upshot in production and the best way to do this is by slashing tax rates, thereby incentivizing producers. Without this action, which we are not getting, troublesome levels of inflation are inescapable, in my view, due to monetary and fiscal policy actions.
Manufacturing Sector
In a separate report, the Institute for Supply Management showed its manufacturing index improved ever so slightly from the month prior, posting a reading of 35.8 last month from 35.6 in January. February’s reading is basically unchanged from last quarter’s average of 36.0. ISM figures are one of the best economic indicators, so what we saw in the fourth quarter is shaping up for this one, according to this measure.
The various sub-indices were not much changed either, although the important employment index fell further, hitting 26.1 from 29.9 in January – for newer readers I should mention that 50 is the dividing line between expansion and contraction.
On a brighter note, this is the second month in which ISM has improved, the problem is the index remains well in contraction mode and the improvements have been very slight. Look for the index to move into the 40s and initial jobless claims to fall back to 500,000 and this should signal we’ve seen the bottom. Until then, those calling a bottom are probably just going on hope. The theme we keep touching on is inventory liquidation, and it is this dynamic that will require higher levels of production that will catalyze economic growth, maybe by next quarter.
Construction Spending
In yet another release, Commerce announced construction spending fell 3.3% in January, marking the fourth month of decline. The public sector will begin to take over during the next…well, I don’t know how long frankly. The public sector numbers have declined for a couple of months now as state and local tax revenues have dried up, but this segment will kick back up when the infrastructure programs begin to take affect.
So, over the next year one should expect the pubic sector side of things to push overall construction spending higher, or at least largely offset declines from the private side. But as we get into 2010 we’ll see private residential construction begin to rise again, if the response we’re seeing from the government doesn’t distort economic decision making and cause the private sector to hold off. The commercial side (or non-residential as it’s technically termed) should remain depressed for some time as this is the last thing firms engage in after the economy rebounds.
Today’s Data and News
This morning we get pending home sales for January, which is a closely watched reading these days for obvious reasons. We’ll also get some testimony from Treasury Secretary Geithner; it will be very important for him to perform better than the last time we heard from him.
Have a great day!
Brent Vondera, Senior Analyst
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