Daily Insight

U.S. stocks rose yesterday after durable goods orders unexpectedly rose in July and concerns over Fannie Mae and Freddie Mac waned for a second day – for now at least, who knows when the next article comes out that causes investors to concentrate more on hypotheticals than current realities and thus swing perceptions back in the other direction.

The durable goods news, which we’ll touch on below, was great to see and may be illustrating – as we’ve mentioned for a couple of months now – that the business side of things will help to offset future weakness that may arise on the consumer side as real (inflation adjusted) income growth has flattened of late and housing prices continue to decline.

All but one of the 10 major industry groups gained ground yesterday – health-care was the laggard. Financial, energy, basic material and information technology shares led the way.

Market Activity for August 27, 2008
The U.S. Federal Deposit Insurance Corporation (FDIC) stated a couple of days back that its “problem list” of banks increased 30% in the second quarter – the figure rose from 90 to 117, marking the highest level since mid-2003. “Problem” institutions are those under closer regulatory scrutiny, meaning their capital cushions are weak.

The media has jumped all over this, but it is hardly an issue at this point – it’s not like we’re talking about the highest level in 20 year, far from it. And think about it, do you even recall hearing about the FDIC “problem list” in 2003? I don’t, which shows this is a relatively low level. In terms of actual failures this year, the figure sits at nine. There will be more to come, but we shouldn’t get carried away.

What this does illustrates is that strong bank earnings may not return anytime soon – it had been expected banking-sector profits would rebound in the fourth quarter; the return of much better results won’t be seen until next year.

But back to actual failures, for now these are being reported over weekends. When bank failures begin to get reported on Tuesdays and Wednesdays, that’s when you’ll know the FDIC pipeline is filling up. It’s been reported that to this point 99% of banks and thrifts remain “well-capitalized.”

On the economic front, the Commerce Department reported durable goods orders unexpectedly rose in July as overall orders increased 1.3%. The ex-transportation figure rose 0.7%. The expectation was for overall orders to come in unchanged from June and ex-trans to decline 0.7%.

These are very healthy increases especially considering orders have trended higher for three months now – total orders are up 11.3% at an annual rate since April and ex-trans up 11% annualized for the same period.

The component that we watch most closely is non-defense capital goods, ex-aircraft (a proxy for business capital spending). The figure jumped 2.6% in July and is up 14.4% at an annualized rate over the last three months – so the nice bounce we’ve seen in business spending continues. This reading is being helped by the increased current-year write-off allowance and bonus depreciation schedule that President Bush demanded to be added to the government’s “stimulus” package back in May – these policy decisions provide meaningful incentives.

Capital spending will help to keep GDP positive this quarter as other components may weigh on growth. The trend in capital goods orders is encouraging -- the segment continues to be driven by industrial machinery orders.

Shipments have outpaced inventories for two months now, pushing the I-S (inventory-to-shipments) ratio lower, which is a good sign for future orders growth. That said we should expect to see durable orders decline when the August number is released simply because of the strength over the past three months – a respite over the next month or two would be quite natural as orders for these big ticket items can fluctuate wildly. The media would use it to spread their proclivity toward hyperbole and typical gloom and doom prose, but we should all be conditioned for this by now.

More economists are coming around to the notion that the credit-market troubles are not having an adverse effect on capital expenditures – this is why we’ve spent several letters over the past few months explaining that corporate cash levels are at or near an all-time high; firms have the resources to engage in projects and large equipment purchases without necessarily borrowing to do it. This is the power of the double-digit profit growth that took Q3 2002 through Q2 2007 – that period of 10%-plus earnings increases marked a post-WWII record and we continue to see feel the benefits today.

This morning we get the first revision to second-quarter GDP, which will be revised higher. Back in July we estimated that GDP would post 2.5%-3.0% real growth at an annual rate, which looked pretty much off the mark when the number came out at 1.9%. This revision should show that estimate was pretty close after all as the figure is expected to be revised up to show 2.7% real growth. A narrower trade gap, stronger-than-initially estimated business spending and better-than-expected inventory data will be the reasons for the upward revision.

The latest durable goods orders figure has also led to higher third-quarter GDP estimates.

Have a great day!

Brent Vondera, Senior Analyst