Daily Insight

U.S. stocks ended the week on a positive note Friday, bolstered by sectors that underperformed the broad market over this five-session rally. Heath-care, consumer staples and utility shares led the S&P 500 higher on Friday, while the areas that propelled the indices over the previous four days ended a bit lower – industrials, tech and energy.

For the week, the S&P 500 gained 10.71% after sliding 26% over the previous nine weeks. That roughly two-month slide put the broad market down 57% from the all-time high hit on October 9, 2007.

It took a year for the S&P 500 to fall 20% from that high, but everything changed in mid-September 2008 when Lehman and AIG went down and the downside accelerated at amazing speed – down 45% from the peak by mid-October 2008, down 52% by late November and finally down by 57% before last week’s rally. This has been the crusher with regard to confidence, lack thereof actually, on both the consumer and business side of things.

Let’s hope we’re onto something here. For sure though we have headwinds ahead of us as the actions taken by the Fed and Congress will very likely engender an inflationary event that will have to be dealt with. If we can extend upon this rally though, it will offer a very needed boost to confidence.

Market Activity for March 13, 2009

Summers’ Call

Fed Chairman Bernanke received most of the attention this weekend (as he made an appearance on 60 minutes – assuming people still watch the news magazine) but it was comments by Larry Summers on Thursday and his speech on Friday that should been given more emphasis by the press.

The head of President Obama’s economic team, and former Treasury Secretary under President Clinton, made a call to G20 members to increase their stimulus spending programs. However, Europe doesn’t seem interested in playing as they have seen for years the ineffectual, and indeed growth damaging aspects of doing so. Western Europe has been in the process of cutting tax rates and spending and while they are engaged in their own stimulus package they do not desire to up the ante.

Of course Western European economies have many obstacles to growth, way too much entitlement spending, productivity-killing work-hour regulations, and a birth-rate problem that makes sustaining their current social safety net impossible. So I’m not trying to say that Europe is in great shape, because they are not, but they made some good policy decisions over the past couple of years.

This is what makes the current U.S. policy so troubling. Instead of encouraging Western Europe to increase stimulus via the old Keynesian ways (more government spending that many times is not directed at areas that produce a productivity return to this spending but rather sap it) we should acknowledge the fact that the rest of the world is doing what we heretofore had been leading by example – cut tax rates at the margin in order to incentivize production and investment. I’ve never thought to be writing such things, but here we are doing exactly what we’ve been telling the world for two decades what not to do.

It is important to clarify and point out that I’ve been a proponent of the idea among some to strike a deal with China – we’ll stop calling them a currency manipulator if they triple their stimulus spending. In this regard China is different. They have a huge savings rate, too large in fact as this makes them overly dependent on export growth. Nonetheless, their savings rate allows them to massively increase spending. The fact that they are an emerging market also means that they need continued infrastructure improvements based on their population and growth rates and in this regard government fiscal spending makes much more sense for them than it does for the U.S. and Europe. For the U.S., we need to acknowledge the fact we’re a capital-intensive economy and thus policy should be directed at inviting capital, which is accomplished on the tax rates side of things.

But Summers has pleaded to the Europeans that they increase their deficit spending, let’s hope they continue to tell him no and that the way to go is to incentive the private sector. You know we have a problem when Chinese Premier Wen is lecturing us about making sure we remain a “credible” nation – as he stated on Thursday night. Obviously, these comments are largely just Chinese rhetoric. But look, foreign holders of our debt are going to have a legitimate worry over this debt issuance. They will eventually become unwilling to buy Treasuries at these interest rate levels and we better get things right or we’ll all deal with the consequences of a declining dollar and onerous interest rates.

On the Economic Front

The Commerce Department reported the trade deficit for January continued to narrow significantly. Surely there are those out there that relish this development, but it also means that things are not good from an economic perspective – it takes significant contraction in the in the U.S. in order for this to occur. (Although, the widening of the trade deficit did get a bit out of control 2005-2007, but this was due to massive monetary easing in the years just prior as this resulted in a credit expansion that was not sustainable.

In addition, Fed policy earlier in the decade meant foreign currency reserves rose to very high levels (via more dollars in the system) and this meant countries like Japan and China needed to buy large amounts of U.S. Treasuries (otherwise their domestic currencies would rise to levels that were not conducive to their export activity) and this also kept interest rates lower than they otherwise might have been, thus making debt more appealing. These are aspects of the credit expansion we all must understand or we’ll make the same mistakes in the future. We have to stop blaming the private sector for everything that has occurred and focus more blame on the Fed for it is their policy mistakes that are the ultimate origin of this situation.

Anyway getting to the data, the trade deficit narrowed to $36.0 billion in January from $39.9 billion in December – a compression that was more than expected. Imports fell 6.7% for the month and exports declined 5.7%.

The narrowing in the nominal trade gap was in some part due to declining oil prices, though most simply due to contraction in U.S. consumer and business activity.

The export data (U.S. exports to other nations) shows the degree to which global economic activity has weakened.

Asia NICs (newly industrialized countries) led the decline showing a 31.8% decline; China posted a 28.6% decline. Canada posted a 27.6% in goods purchased from the U.S. Exports to the European Union fell 17%. OPEC nations recorded the first decline of U.S. export purchases during this downturn, as exports to this region fell 14.1% in January.

The chart below is measures in negative numbers, just in case you can’t see the scale – thus when the figure is rising it illustrates a narrowing in the trade deficit.


In a separate report, the Labor Department reported import prices fell 0.2% in February, a smaller than expected decline. The year-over-year figure showed the decline in import prices accelerated, a plunge in petroleum prices has been the main contributor (imported petroleum prices actually rose last month but are down 52.4% over the past year) – excluding petro import prices are down just 1.9% for the past 12 months.


The month-over-month figure is likely signaling we’ve seen the worst of the import price deflation.


The fall in prices, whether it be import, producer or consumer, has been a function of the collapse in energy prices. If the dollar takes a turn down (a likely scenario when the safety trade comes off and actions by the Fed and fiscal spending put pressure on the greenback as well) import prices won’t take long to shoot up again.

Futures

Stock-index futures are higher this morning, so at least at the open it appears we’ll build upon last week’s rally. In terms of economic data we’ll get New York-area manufacturing activity, by way of the Empire Manufacturing reading for March, and industrial production for February. I think we’ll need to see a better-than-expected reading on that industrial production figure to hold onto gains throughout the day.

Have a great day!


Brent Vondera, Senior Analyst