Egad! TARP the insurance companies? Following other actions, such as forcing TARP funds on some banks, a proposal to make Treasury Secretary Geithner the official arbiter of “appropriate” compensation, and now appearing to use the government’s bank stress tests to force the selling of “troubled” assets this gives the impression that one big power grab is the agenda. If you’re an insurance company that is in trouble – its receivership for you. This process works just fine; besides, we need to get a grip, polices aren’t paid out all at the same time and most never need payout at all. Let’s not go overboard here, especially since many insurance profits are only back to 2005 levels – we don’t need to bailout insurance companies’ investment portfolios.
Back to yesterday’s trading, the economic data drove the market higher, reversing what looked to be a down session as futures were meaningfully lower in pre-market. The fact that the purchases segment of the mortgage apps data showed a nice increase and wholesaler sales rose for the first time since the economy hit the dirt late last summer, which is why the inventory/sales ratio improved, was big news.
The gains were broad-based, as nine of the 10 major industry groups gained ground – led by consumer discretionary and tech shares. Telecom was the only group to remain below the flat line.
Market Activity for April 8, 2009
Crude
The price of oil for May delivery rose for the first session in four after the Energy Department’s weekly inventory report showed stockpiles rose less than expected. Crude supplies rose 1.65 million barrels to 361.1 million last week. Even though this is the highest level since July 1993 stockpiles were forecast to jump 6.94 million barrels. Crude had declined the past few days on the assumption of a much higher inventory build and even though stockpiles are at a 15-plus year high, and demand is down, the much lower than expected build ruled the day.
Mortgage Applications
The Mortgage Bankers Association reported their mortgage applications index rose for the fifth-straight week – this time though the rise in purchases surpassed the increase in refinancings. Purchases jumped 11.1% in the week ended April 3 and refis rose 3.2%. The 30-year fixed mortgage rate fell below 5.00% during the week of March 6 and the index has gained ground ever since.
Refinancing activity remains the driver of the index as this segment makes up 78% of mortgage-loan activity, but the double-digit rise in purchases is a very welcome sign – it will be interesting to watch if the very low mortgage rates will be enough to offset the drag a bad labor market has on sales.
Wholesale Inventories
The Commerce Department reported that wholesale inventories fell at double the rate expected, declining 1.5% in February. The sales data recorded the first increase in eight months, a very good sign that may provide evidence the production needed to rebuild stockpiles is not far down the road – this will work as a nice catalyst to GDP growth by the third quarter if the sales pick up becomes a trend.
Durable goods inventories plunged 2.4% for February, the largest decline on record (the record isn’t that long though, just back to1992) led by a large 7.9% drop in automotive stockpiles.
While the very large inventory declines (down $62.6 billion over the past three months at an annual rate, which means the larger business inventories figure will show a $250 billion decline when we get that reading on April 14) will weigh heavily on the first-quarter GDP reading, this is very good progress for subsequent quarters. Again, we need to see the sales data trend higher.
Inventory Dynamic (but is a sustained economic rebound likely?)
And speaking of inventories, the WSJ ran a good piece yesterday morning touching on how inventories have been liquidated to the point that they’ll need to be boosted fairly soon – that means more GDP-enhancing production as stated above.. This is a topic long-time readers of this letter are familiar with as we have talked many times of inventory trends over the past several years and specifically of the inventory dynamic over the past couple of months.
It’s important to realize that we went into this downturn with a much lower inventory-to-sales ratio than is typically the case. The amount of inventory bloat generally determines the duration of an economic contraction as excess stockpiles must be sold off prior to production ramping up again. The fact that we began at low inventory levels at this point in the business cycle (not to say the inventory-to-sales ratio hasn’t sky-rocketed over the past several months as sales plunged due to the credit event that began in September, because it has as the above chart shows) will help to make this downturn less severe than it otherwise would be,
That said, the problem with this recession is that it is led by a credit event and a very serious contraction in consumer activity as very low interest rates encouraged too much debt – a situation that will take time to work off. And the policy decisions of late do not address this issue -- in fact what we’re doing will only compound issues over time. Simply because overall stockpiles have come down in a large way, it is not a sufficient condition for sales to bounce back in a way that normally occurs to drive the inventory-to-sale ratio much lower. (The most abrupt decline in stock prices since the 1974 bear market may also keep consumer activity somewhat subdued – call it the reverse side of the wealth effect. This move in equity prices has even more meaning today; most consumers did not have their savings in the stock market back then; same is true for the 1987 market crash.)
We’ve spent so much time harping on the need for broad-based reductions in tax rates because this is the surest way to fire up investors’ animal spirits – especially via tax rates on capital. And as goes the direction of the stock market, so goes consumer and business optimism. What’s more, lower taxes on income will drive disposable income higher as we wait for business spending to come back around – and we need businesses to be confident about the future because the business spending segment of GDP will be relied upon to drive things as consumer activity will not be as robust as it had been over the past several years.
We can’t stress this enough – confidence is key. I’ll remind you that during the previous expansion firms managed their businesses in a pretty cautious manner (likely because of heightened geopolitical risks and high energy prices). This will be the case this time as well, but intensified, as firms are surely watching what the government is doing and therefore may lack the confidence that is needed for a serious production ramp up. This caution from business is not all bad as firms will remain extremely streamlined and at some point things will flow again. However, the point in the shorter term is that this is just another reason (along with the time consumers will need to get things right again) the expansion that will eventually come may prove to have a much shorter life than the previous three business-cycle upswings; caution among businesses will have a negative effect on job growth and production.
Have a great day!
Brent Vondera, Senior Analyst
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