U.S. stocks fell for only the fourth time in the past 16 sessions, and even as the indices lost some ground the degree of decline was pretty much a moral victory as the benchmark’s appeared destined for a 5% header with about an hour left. But stocks rallied in the final half-hour to pare earlier losses.
The NASDAQ took the brunt of the damage, falling 2.10%, erasing Friday’s nice move in which the tech-laden index outperformed the broad market.
There was a sense on Friday that technology firms will participate in next year’s stimulus program, which is true, but weak manufacturing and industrial production reports reminded traders of the downbeat business spending environment. New York-area manufacturing showed business spending on tech-equipment contracted significantly over the past month and the industrial production survey drew the same conclusion.
Market Activity for December 15, 2008
Among sectors, financials led the decline, falling 3.99%, after a Merrill Lynch analyst stated credit costs in the U.S. will get worse – not sure this of great surprise. Relative winners were consumer staples, energy and basic material shares – down 0.20%, 0.28% and 0.38%, respectively.
The Economy
The New York Federal Reserve Bank reported manufacturing activity in the region remained very depressed, hitting a record low. (We’ll note the index only goes back to 2001, so when we say record low it’s not saying a lot; still we know other factory surveys that have been around for decades are hitting their lowest levels in nearly 30 years.)
The index known as Empire Manufacturing registered -25.8, the lowest in the survey’s history. Factory activity in the New York-region has been extremely weak for three months now (the global economic situation changed on September 15) – certainly this area of the country is one of the hardest hit as it is home to the financial industry.
Forward looking indicators, like the new orders index of the survey, remain near record lows as illustrated below.
The outlook among respondents did improve a bit, rising to 19.5 – a number around 40 would be seen in more normal circumstances.
The capital spending index held near the November low, coming in at -10.6 for December. The technology spending index hit a new low of -12.8, so no help in this regard.
In a separate report, the Commerce Department reported industrial production slipped 0.6% in November. Manufacturing output, or lack thereof, put the most pressure on the reading, falling 1.4% last month.
(On the chart below we explain the September decline just to clarify why such outsized weakness occurred.)
Utilities and mining production rose 1.6% and 2.5%, respectively. Business equipment was also up, rising 3.2% for the month – this was helped by a jump in aerospace orders.
Consumer goods production fell 0.7%, motor vehicle production fell 2.8% and construction supply output declined 3.3%.
The decline in manufacturing output was actually worse than it appeared because a 12.8% jump in aircraft production helped the reading. That jump in aircraft output occurred as the Boeing strike came to an end. The auto industry continues to weigh heavily on factory output – the segment is down 21.4% year-over-year. Still, excluding autos, manufacturing is down 6.3% YOY.
We believe industrial production will remain weak for a few months still, but do not think a mild rebound should be ruled out. The decline in business spending is due more to caution that a lack of resources and once the current bout of pessimism wanes, even slightly, we should get a bounce in this segment.
Machinery orders are holding in there, but high-tech equipment has been hurt for three months. Firms will look to add more tech equipment as productivity improvement will remain in focus as average selling prices fall.
I may be reaching at optimism here, but do believe a mild rebound is on the horizon.
Going for Zero
The Fed ends its two-day meeting today, which means we’ll get their rate decision this afternoon. I won’t go against the consensus expectation for a 50 basis point (1/2 percentage point) cut by predicting they’ll do nothing – the implied probability of a 50 bps cut is 100%. However, cut right now is meaningless since what the Fed does is set a target for where fed funds (FF) should trade; the actual rate is already close to zero, 0.125% as of yesterday.
Beyond the cut, people will be focused on the language, which will key in on what is called quantitative easing – which is simply providing liquidity in ways separate from traditional FF rate cutting by setting up lending facilities, as they have been engaging in for exactly a year now. They will also mention what Bernanke calls the “second quiver,” which includes options such as buying longer-term Treasuries to inject even more cash into the system.
But again, I don’t see what this does to improve spreads – that’s what they say they’re targeting by executing these purchases. Treasury yields are already near record lows – the yield on the 10-year sits at 2.48% for goodness sakes. The problem is not a high risk-free rate, but an issue of confidence, which has spreads very wide. Ten-year BB+ rated industrials are trading 1100 basis points over Treasuries, that’s higher than typical junk spreads.
Yes, spreads should be wide because default rates are up and the market is going to demand a lot more return to compensate for this risk. However, some of this widening is due to a crisis of confidence and the most efficient way to counter this situation is to slash tax rates on income and capital. This is not the Federal Reserve’s decision to make, of course. The legislative and executive branches need to get this done – it’s been a big mistake by the Bush Administration to ignore this tool.
Is the implementation of broad-based tax cuts realistic with a central-planner entering the White House in 35 days? Certainly not.. But it’s still the correct remedy. Combine this with the elimination of mark-to-market accounting rules with which capital adequacy ratios are based upon (put in place just 13 months back; the timing could have hardly been worse) and I think most would be stunned how far these simple actions would get us in leaving the worst of this mess behind us.
But go ahead and target fed funds at 0.50%, even though the rate trades closer to zero. Go ahead and buy long-term Treasuries. Go ahead and triple the Federal Reserve’s balance sheet, from 6% of GDP a year ago to 17% today. We hope it works.
Have a great day!
Brent Vondera, Senior Analyst
The NASDAQ took the brunt of the damage, falling 2.10%, erasing Friday’s nice move in which the tech-laden index outperformed the broad market.
There was a sense on Friday that technology firms will participate in next year’s stimulus program, which is true, but weak manufacturing and industrial production reports reminded traders of the downbeat business spending environment. New York-area manufacturing showed business spending on tech-equipment contracted significantly over the past month and the industrial production survey drew the same conclusion.
Market Activity for December 15, 2008
Among sectors, financials led the decline, falling 3.99%, after a Merrill Lynch analyst stated credit costs in the U.S. will get worse – not sure this of great surprise. Relative winners were consumer staples, energy and basic material shares – down 0.20%, 0.28% and 0.38%, respectively.
The Economy
The New York Federal Reserve Bank reported manufacturing activity in the region remained very depressed, hitting a record low. (We’ll note the index only goes back to 2001, so when we say record low it’s not saying a lot; still we know other factory surveys that have been around for decades are hitting their lowest levels in nearly 30 years.)
The index known as Empire Manufacturing registered -25.8, the lowest in the survey’s history. Factory activity in the New York-region has been extremely weak for three months now (the global economic situation changed on September 15) – certainly this area of the country is one of the hardest hit as it is home to the financial industry.
Forward looking indicators, like the new orders index of the survey, remain near record lows as illustrated below.
The outlook among respondents did improve a bit, rising to 19.5 – a number around 40 would be seen in more normal circumstances.
The capital spending index held near the November low, coming in at -10.6 for December. The technology spending index hit a new low of -12.8, so no help in this regard.
In a separate report, the Commerce Department reported industrial production slipped 0.6% in November. Manufacturing output, or lack thereof, put the most pressure on the reading, falling 1.4% last month.
(On the chart below we explain the September decline just to clarify why such outsized weakness occurred.)
Utilities and mining production rose 1.6% and 2.5%, respectively. Business equipment was also up, rising 3.2% for the month – this was helped by a jump in aerospace orders.
Consumer goods production fell 0.7%, motor vehicle production fell 2.8% and construction supply output declined 3.3%.
The decline in manufacturing output was actually worse than it appeared because a 12.8% jump in aircraft production helped the reading. That jump in aircraft output occurred as the Boeing strike came to an end. The auto industry continues to weigh heavily on factory output – the segment is down 21.4% year-over-year. Still, excluding autos, manufacturing is down 6.3% YOY.
We believe industrial production will remain weak for a few months still, but do not think a mild rebound should be ruled out. The decline in business spending is due more to caution that a lack of resources and once the current bout of pessimism wanes, even slightly, we should get a bounce in this segment.
Machinery orders are holding in there, but high-tech equipment has been hurt for three months. Firms will look to add more tech equipment as productivity improvement will remain in focus as average selling prices fall.
I may be reaching at optimism here, but do believe a mild rebound is on the horizon.
Going for Zero
The Fed ends its two-day meeting today, which means we’ll get their rate decision this afternoon. I won’t go against the consensus expectation for a 50 basis point (1/2 percentage point) cut by predicting they’ll do nothing – the implied probability of a 50 bps cut is 100%. However, cut right now is meaningless since what the Fed does is set a target for where fed funds (FF) should trade; the actual rate is already close to zero, 0.125% as of yesterday.
Beyond the cut, people will be focused on the language, which will key in on what is called quantitative easing – which is simply providing liquidity in ways separate from traditional FF rate cutting by setting up lending facilities, as they have been engaging in for exactly a year now. They will also mention what Bernanke calls the “second quiver,” which includes options such as buying longer-term Treasuries to inject even more cash into the system.
But again, I don’t see what this does to improve spreads – that’s what they say they’re targeting by executing these purchases. Treasury yields are already near record lows – the yield on the 10-year sits at 2.48% for goodness sakes. The problem is not a high risk-free rate, but an issue of confidence, which has spreads very wide. Ten-year BB+ rated industrials are trading 1100 basis points over Treasuries, that’s higher than typical junk spreads.
Yes, spreads should be wide because default rates are up and the market is going to demand a lot more return to compensate for this risk. However, some of this widening is due to a crisis of confidence and the most efficient way to counter this situation is to slash tax rates on income and capital. This is not the Federal Reserve’s decision to make, of course. The legislative and executive branches need to get this done – it’s been a big mistake by the Bush Administration to ignore this tool.
Is the implementation of broad-based tax cuts realistic with a central-planner entering the White House in 35 days? Certainly not.. But it’s still the correct remedy. Combine this with the elimination of mark-to-market accounting rules with which capital adequacy ratios are based upon (put in place just 13 months back; the timing could have hardly been worse) and I think most would be stunned how far these simple actions would get us in leaving the worst of this mess behind us.
But go ahead and target fed funds at 0.50%, even though the rate trades closer to zero. Go ahead and buy long-term Treasuries. Go ahead and triple the Federal Reserve’s balance sheet, from 6% of GDP a year ago to 17% today. We hope it works.
Have a great day!
Brent Vondera, Senior Analyst
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