Financial shares got sandblasted after Moody’s stated it may cut JP Morgan’s credit rating – of course the market needs to pay attention to what the ratings agencies are saying, but one wonders why as their performance has been pathetic over the past few years.
Energy, industrial and basic material shares also took a beating on that news, or lack thereof, out of China. My take is China will eventually boost their stimulus plans, they’ll have to to tamp citizen uprisings.
As traders geared up for what may be the worst monthly jobs report yet, consumer discretionary shares also took it on the chin.
Market Activity for March 5, 2009
Please Stop (but they’re only just beginning)
We’ve talked at length about how the degree to which the government is involved is causing major issues and making it very difficult, if not impossible, to read the market. Beyond the fact that we’re at the whim of Washington, thereby affecting decision-making capabilities, we have this issue of the $1 trillion stimulus (actually $878 billion for now but it will get to a trillion) and annual deficits that run 10%-12% of GDP (for perspective, the long-run average is 2.4%).
One area that is specifically tough to gauge right now is the bond market. Normally, when the long-end of the Treasury curve rises (yields) during economic duress it signals the business cycle is bottoming, but maybe not this time. Are long-end Treasury yields 75 basis points higher (nearly 100 basis points prior to the past 24 hours) over the past two months because the market believes the business cycle has troughed, or is it solely because of the huge levels of new debt issuance as a result of massive spending? I suppose it is the latter, but the point is the level of opacity has increased due to government involvement.
The same is true for the equity market. You can look at nearly the entire market and witness valuations that are extremely attractive. Even acknowledging that earnings will get worse from here, we are simply trading at ridiculous multiples relative to interest rates, inflation (at least the current rate) and long-run profit averages. But the government is not allowing the market to efficiently allocate resources – or they are signaling a path toward blocking the market’s free choice and stocks trade on expectations.
Take cap and trade proposals for instance. The market will always gravitate toward the most efficient source of energy (or any resource for that matter), yet if the government is going to raise fossil fuel costs by artificially increasing the price due to higher tax rates on these activities it creates distortions. This leads to a less efficient marketplace and thus harms growth potential.
(What I find hilarious, in a sad way, is that the administration understands levying higher tax rates on fossil fuels will result in less use of that source. However, they seem to believe tax rates can be raised on capital and incomes without a reduction in work and investment. Maybe they know this but simply do not care, as they are more interested in ramming through their agenda. Ok, their choice. They have been granted a huge majority by the country and they are absolutely justified (although hugely wrong) in doing so. But the market will continue to beat them – and the rest of us in the meantime – for this obtuse behavior.)
Jobless Claims
The Labor Department reported initial jobless claims fell 31,000 to 639,000 in the week ended February 28. The four-week average of claims rose 2,000 to 641,750.
Continuing claims declined 14,000 to 5.106 million in the week ended February 21 – continuing claims lag initial by a week – and the insured unemployment rate held steady at 3.8%.
The employment survey week (the week in which the initial estimate for the February jobs report, which is out this morning) was February 14. The four-week average of claims rose meaningfully in that week, hitting 620,000 from 543,000 two weeks prior. So, as other employment indicators have shown, we should see another 600,000-plus in jobs losses for the month.
In this latest data, the four-week average is another 22,000 higher from that February 14 level (now at 642,000). There is no sign of a slowing rate of employment contraction just yet and as we’ll explain below the productivity number out yesterday as well helps to confirm this.
Productivity
The Labor Department reported nonfarm productivity fell 0.4% in the fourth quarter, revised down big time from the +3.2% (these are at annual rates) that was initially estimated. This changes things rather dramatically for me at least with regard to the labor market. After that previous 3.2% estimate on productivity I had assumed the degree to which businesses had cuts jobs over the past few months was overdone – largely as they were spooked by the credit market chaos and the plunge in equity values that would clearly affect consumer psyches. Such a strong productivity reading, meant that job cuts had outpaced the degree at which production has dropped, but this latest news of a 0.4% decline in productivity (measured as output/hours worked) shows this is not the case. I am completely confused now as to the direction of the labor market, maybe the February jobs report will not prove to be the worst we’ll see.
Factory Orders and Chain Store Sales
Finally, a couple more reports but we’ll just touch on them briefly.
Factory orders were reported as falling 1.9% in January. This isn’t the big news as we’ve already seen durable goods orders for that month. What’s important to note is the 5.7% decline in non-defense capital goods ex-aircraft – this is the proxy for business equipment. This figure stands 35% below the fourth-quarter average (at an annual rate). Inventories (excluding petroleum inventories, in order to adjust for the decline in price) fell $51 billion at an annual rate compared to $5 billion last quarter, according to RDQ Economics.
These two aspects of the factory orders report show that the first-quarter GDP reading is going to be just as bad as the last. It appears, the consumer side of things will not be as bad as last quarter but the inventory liquidation is going to be a huge drag on GDP. The business spending numbers show how necessary it is to deliver incentives back to the market. This can only be done by slashing tax rates on corporate profits, capital and incomes in general. Further, we must make permanent bonus depreciation and write-down allowances. The fact that policy is pointed in the opposite direction is very damaging.
The good news is the inventory dynamic (falling at these levels) will catalyze growth when we do rebound. (Firms will have to increase production to boost stockpiles even on a slight boost in sales).
In that chain-store sales report (based on the year-ago levels) the data showed consumer activity remains depressed in a number of areas – apparel store sales were down 7.9%; department stores down 9.8%; luxury continues to get hammered, down 19.2%. However, discount stores and wholesale clubs (ex-fuel sales) showed another month of life, up 3.1% and 5.0%, respectively.
While it is not good to see the components outside of discounters so depressed, the figures for the discount group have improved. This may be a sign consumer activity has troughed. It’s a stretch for now, but we shouldn’t ignore glimmers of optimism.
Have a great weekend!
Brent Vondera, Senior Analyst
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