Daily Insight

U.S. stocks began the session higher, led by industrial shares, on news the Chinese government would inject nearly $600 billion into their economy through 2010. But the benchmark indices quickly reversed course as focus turned to the reality that the current quarter’s earnings figures will be less than auspicious, to put it mildly.

As you can see, industrial shares led the early session rally, up 3% from the get go, but also gave it back even though much of this group will benefit from China’s spending.

It is also impossible to currently gauge the duration and depth of the economic contraction that surely began in September, and this is also making it tough to hold rallies. However, we are down 42% from the peak, so it appears the market has priced this event in, even if we get something that compares to the significant 1982 downturn.

I don’t believe there as been such a rapid decline in confidence and economic data since at least 1973-1974, so we could be headed for a similar contraction – certainly the stock market activity of the past few months compares well to that period. That 1973-1974 economic downturn lasted roughly 18 months.

While the current earnings season (last quarter’s results) is shaping up quite well, sans the financial and consumer discretionary sectors, there is little doubt the current quarter will post some real weakness – earnings will be significantly affected by the shutdown in spending among consumers and an extreme level of caution among businesses that the stock-market decline and credit-market chaos wrought.

Senate Numbers

Another drag on confidence is the uncertainty regarding the filibuster power of the Senate. There are still three Senate seats that have yet to be decided – Minnesota and Alaska are in a recount and Georgia, which is still counting, appears headed for a runoff. (GA is like LA in that if there are three candidates in the race one fails to receive over 50%, then the top two head into a runoff election, which is roughly 20 days out)

This is a huge event. A Senate with filibuster ability – meaning Democrats hold less than 60 seats, currently it’s at 57 – is the only check and balance on an Obama/Pelosi/Reid legislative and executive branch agenda. We know the voting records of this three-some along with their statements of the past several months and the agenda is not exactly market friendly. So the fact that the Senate race remains undetermined seems to be a big market issue right now. (President-elect Obama will be out president and must be embraced. But one finds it hard to get past his voting record and associations. We should all hope those concerned over the direction he desires to take the country – myself included -- are dead wrong.)

China’s Stimulus

The Chinese government pledged to inject $586 billion into their economy, largely for infrastructure projects. The funds will be delivered by 2010, but the first tranche -- $100 billion – is scheduled for this quarter and to be spent on low-rent housing, roads, railways and airports. The government will also allow tax deductions for purchases of fixed assets like machinery, plants and electrical equipment – which is big news for U.S. firms that provide the Chinese economy with a good degree of these equipment and construction orders.

The degree of this stimulus is huge, amounting to nearly 20% of their GDP. For perspective, this would be equivalent to the U.S. spending $2.8 trillion – our own government is in the process of spending a lot, but we haven’t yet approached this percentage, thankfully.

Economic Data

We will be without a data release for a couple of days, but get back to it by the second-half of the week.

Thursday, we get the weekly jobless claims data and look for claims to remain elevated. The market will be watching to see if we hold below the 500k level. Most readers are familiar with the jobless claims chart, but I’ll post it again to illustrate.

We also get the trade balance for September, which will show meaningful declines for both export and import activity. Imports will decline to a larger extent than exports and thus the trade gap should narrow. On an inflation-adjusted basis, the trade gap will have narrowed to the lowest level since 2002.

Those who have yearned for a narrower trade gap are getting their wish, but it comes on the heels of slow growth, or economic contraction, which we have mentioned for several years now.

On Friday, we’ll get import prices (October) and business inventories (September).

On import prices, the market expects the figure to continue to ease from extreme readings of the first half of the year. The US dollar rallied 18% from July through October and this will naturally bring import prices lower. Further, the plunge in energy prices will also move the index lower.

That said, we expect the easing we’ve seen within the inflation gauges to reverse and turn up again as we look out over the next year -- the combination of fiscal stimulus (of which we haven’t yet seen the extent) and the massive liquidity the Fed has pumped into the system will cause the inflation gauges to shoot higher again. Currently, the financial press is focused on deflation, and most economists I’ll add. This is quite unlikely though with what the Fed has done. We’d watch for inflation to kick up after a multi-month respite. As you can see on the chart below, import price inflation has come off of extreme highs, but even excluding energy they remain dangerously high.

On the business inventories data, we expect the figure to fall as the manufacturing and wholesale figures have already offered evidence of this. Business sales have remained very upbeat over the past several months, but everything changed in late September and into October. There is no way sales will have advanced based on what’s occurred. The hope is that this decline will prove to be a two-month event. We shall see.

Veteran’s Day

Today is Veteran’s Day and the 90th anniversary of the symbolic end of WWI, signed on the 11th hour of the 11th day of the 11th month of the year 1918. The bond market will be closed, but stocks and currencies are open for business. Thank you veterans; thank you for all you endured and accomplished for the rest of us.

Corrections:

Yesterday I stated that $3.8 billion sits in money market funds as of the Fed’s latest report. It is actually $3.8 trillion. I’ve cited this figure before, so most of you likely assumed what I meant to type. A reader pointed the error out to me yesterday morning. Thank you.

Also, in terms of the mini nuclear reactor story, I noted that the $25 million initial cost for each reactor (able to power 10,000 homes) would come to only $250 per house – that number would actually be $2500. .

Starting today, we will not be including the tables or charts in the blog version of Daily Insights. If you would like the complete version, please send us your email information at info@acrinv.com.

Have a great day!
Brent Vondera, Senior Analyst