Daily Insight

U.S. stocks tumbled yesterday after the weekly report on jobless claims showed the figure is not abating; some had hoped once adjustments to the government’s program to extend benefits began to set in the reading would ease. Now that the figure remains above the 400k level, even as the Bureau of Labor Statistics says the response to that government program has peaked, it’s leading many to believe claims are simply rising because job losses are accelerating, not solely because of the increase in eligibility.

This morning we get the jobs data for August – a decline will mark the eight-straight month of losses, although they have been mild to this point averaging just 66,000 per month. The jobless claims numbers offers pretty good evidence those losses will move to 80,000-100,000 per month.

Up to now the labor market weakness has been more about the lack of new openings rather than layoffs on a large scale. I think the situation will remain that way, but it does look like we’ll get a couple of months here and there that cause people to worry layoffs will rise substantially.

Market Activity for September 4, 2008
All 10 major industry groups got hammered yesterday, with financial and basic material shares performing the worst down 4.69% and 3.83%, respectively. The best performers, of course on a relative basis, were consumer staple and utility shares, which lost 1.13% and 1.21%, respectively – no surprise that those sectors were pressured the least when concerns over global growth arise.

It’s been interesting to watch commodities – as measured by the Commodity Research Bureau – fall 21% since July 15, yet stocks have remained essentially flat. The CRB is down 8% since August 21 and the broad market has down as well, off by 3.2% since that date. Ask someone two months ago how stocks would perform with this level of decline in commodity prices and there’s little doubt most would say a rally would ensue – myself included. But global growth concerns have taken over, which makes it tough for stocks to catch a bid. The S&P 500 remains 2% above the July 15 multi-year low.

And speaking of commodities, crude-oil price fell yesterday even as the weekly energy report showed stockpiles decreased by 1.9 million barrels in the week ended August 29. Again, worries over global growth have now taken over to offset supply concerns, hence the dip in prices even though crude inventories are now six million barrels below the 12-month average.

Expectations were for a 450,000 barrel increase in supplies. I’m not sure what logic drove that estimate, but one wonders where these analysts have been over the past week – maybe they believed Mr.Gustav would be kind enough to deliver supplies to the ports and terminals.

In international news, both the ECB (European Central Bank) and the Bank of England decided to keep their benchmark interest rates unchanged (4.25% for ECB and 5.00% for BOE) even as EU growth has flat-lined and many call for them to cut. Yet, inflation remains elevated in the Eurozone – close to a 16-year high – so they are holding steady for now.

The relevance of this weak EU growth with regard to the dollar is that caused traders to question why exactly they had pushed the euro to such a lofty level – some of those funds have flowed into the dollar as a result. Still, the interest rate differential remains in the EU’s favor, but many assume it is just a matter of time until the ECB does in fact cut their benchmark rate and thus narrow that differential.

Still, as we’ve talked about for a couple of weeks now we need to see the Dollar Index hit 80 before getting to excite. For now, we’ve got a great trend going.


On the economic front, the Labor Department reported that Q2 productivity surged 4.3% at an annual rate, revised up from the previous estimate of 2.2%. A large upward revision in output combined with a downward revision to hours worked led to the significant upward revision to productivity. (Productivity measures the increase in output per hour worked.)

Just to put this reading into perspective, a number above 2.5% is considered large. Non-financial sector productivity came in at a rip-roaring 5.6% annual rate. That reflected a 3.8% rise in output and a 1.7% fall in hours worked.

These levels of productivity are hugely beneficial, especially now as we deal with energy prices that have climbed roughly 50% across-the-board over the past 12 months. U.S. productivity has increased a powerful 3.38% over the past 12 months.

Unfortunately, within the manufacturing sector, productivity declined 2.2% at an annual rate as output fell 3.7%, while hours worked dropped just 1.5%. This marked the largest quarterly decline in manufacturing productivity since a 2.5% decline in Q2 1989. Unit labor costs in the sector jumped 6.2% -- boosted by a 9.0% rise within the durable goods sector.

In total, compensation per hour has increased 4.0% over the past 12 months, which is helpful but lags the current pace of inflation.

In a separate report, the Labor Department reported that initial jobless claims for the week ended August 30 rose 15,000 to 444,000. For the reading to remain at these levels, it obviously points to more job losses ahead. Some, including myself, were anticipating this figure to fall as the government’s program to increase unemployment assistance wore off, or at least that the response from this program had peaked. The fact that the reading has not come lower illustrates there’s a good possibility we’ll see monthly job losses increase to 80-100k over the next several months. (In the seven months in which the job market has shed positions, we’ve averaged 66,000 monthly losses.)

The four-week average of jobless claims did tick down, but just barely, and remains elevated. I will point out, however, that when you view the chart below keep in mind that the labor market is 12 million stronger than it was 10 years ago and 32 million stronger than it was 20 years back. Point is, jobless claims of 445,000 is not what it used to be at lower job-market levels. Nevertheless, this is well-higher than we want it to be.


Lastly, the Institute for Supply Management issued its latest look at the service-sector as its nonmanufacturing composite index (which equal weights the survey’s business activity, employment, new orders and supplier delivery indexes) showed activity accelerated a bit. The reading rose to 50.6 in August from 49.5 in July. Over the past six months the index has averaged 50.3 – 50 is the cut line between expansion and contraction.


The business activity index rose nicely to 51.6 from 49.6 in the previous month.


The employment index fell to 45.1 from 47.1, which is another sign today’s jobs report may come in weaker than expected.


The prices paid index fell to 72.9 from the extreme level of 80.8 yet remains higher than the average of the past two quarters. A year ago the prices paid index was running in a range of 60-65.


All eyes will be on the August jobs report, released at 7:30 CT. We’ll also get the mortgage delinquency figure for the second quarter at 9:00.

Have a great weekend!

Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks ended mixed as the S&P 500 and NASDAQ Composite fell for a third-straight session, while the Dow Industrials managed to close higher helped by shares of Home Depot, United Technologies, Proctor & Gamble and Chevron.

Information technology shares put pressure on the tech-laden NASDAQ and basic material, energy and those tech shares kept the S&P 500 down.

We’ve been trapped in a trading range between 1215 and 1450 on the S&P 500 since the beginning of the year and over the past month stuck between 1250 and 1300. The market doesn’t know what to do. Multiples are not high enough to send us much lower – based on what is currently known – and there are simply too many uncertainties lurking to propel the index out of this range.

The nearest term event will likely be the election. At least then we’ll have a good sense of where tax rates are going as after-tax return expectations on capital, dividends and labor income (small business consists two-thirds of the top federal income tax bracket) are necessary to assess the correct market multiple. Disposable, or after-tax, income growth is also hugely important right now, and the tax-rate uncertainty raises an issue here as well. Until then, we’ll just have to lean on patience.

Market Activity for September 3, 2008

That said, there are many individual stocks that trade at attractive P/E levels, but uncertainty is a terrible thing for stocks and these opportunities often get ignored in such an atmosphere. There are also entire sectors that look cheap in my view, as the S&P 500 index that tracks tech shares trades at 19 times earnings and industrials trade at 15 times. Energy stocks are back down to 10 times trailing earnings and 9 times this year’s profit expectations as many focus on oil’s recent decline and forget that these firms will make a lot of money at $110/barrel oil. The good news is the major indices seem to have found a bottom – knock on wood.

Yesterday we mentioned how all will be focused on the direction oil trades as the weekly energy report will surely show a big drop in inventories due to Gulf-rig shutdowns and closure of the LOOP. In addition, 13 refineries in the area were shut down completely and 10 others ran at reduced rates due to Gustav. The problem is I forgot that due to the holiday the weekly energy report, which is usually released on Wednesday, will be pushed back by a day. So, we’ll have to wait a couple of hours still for that report.

In any event, it does seem that production will resume quickly as the hurricane did very little damage to production infrastructure -- we should see stockpiles rebuilt in short order.

On the economic front, the Commerce Department reported factory orders rose 1.3% in July, beating the 1.0% estimate. This followed a large 2.1% increase in June that was revised up from the initial estimate of 1.7%. That’s a meaningful revision and may push the second-quarter GDP reading a bit higher when we get the final revision at the end of this month.

For this quarter, the July reading puts the period off to a good start and reinforces our view that business spending (capital expenditures) will provide an offset to what will likely be weak consumer activity (in real terms) during the third quarter. For instance, the non-defense capital goods, ex-aircraft, component of this report – which is the business capital spending number – jumped 2.5% in July.

It will be very interesting to watch the trend in capital spending as this is on top of three months of pretty strong growth for this component. I’ll note: the rebound in capital spending corresponds directly to the increase in current-year business write-off allowance and bonus depreciation the president signed into law back in May. Unfortunately, the way I understand the legislation, this will expire in 2009 as he had to drag Congress kicking and screaming to add it to the tax-rebate bill and could only manage a very short-term incentive boost as a result.

In terms of overall factory orders, they have risen for five-straight months now and in dollar terms stand at the highest level since the series began on an NAICS (simply put, a new classification system) basis in 1992.

Importantly, the unfilled orders figures is up 29 of the past 30 months and also stands at the highest level since the series began reporting on an NAICS basis. One would expect, outside of normal fluctuations, orders will remain on an upward trajectory for at least the next few months based on this heightened unfilled orders figure.

The weakness within the report came from high-tech equipment, specifically computer orders -- down 11% in July and 4.8% from July 2007.

In a separate release we received Challenger’s Job Cut Announcement survey (this is comprised by the executive outplacement firm Challenger, Gray and Christmas), which stated that the rate of layoffs slowed in August as they reported 88,730 job cuts were announced -- 103,312 were announced in July. However, while that number was lower than their July figure, job cut announcements were nearly 12% higher relative to August 2007. This is not seasonally adjusted data.

According to this report, one-third of the 88,736 in August came from the automotive and government sectors.

In other news the Fed released its regional economic survey known as the Beige Book. This report is released every six weeks and to be honest is a bit outdated, but is worth a read nonetheless. It found:

• Consumer spending was slow in most districts and many districts showed a pattern toward discount stores and lower-priced brands. (I think we should expect consumer activity to exhibit a two quarter respite after pretty good numbers over the past few months and inflation has cut into real income growth)
  
• Manufacturing was weak and declining in most districts, but improved in KC and Minneapolis (this doesn’t totally match with the ISM reports, which show things are a bit more optimistic within the sector)
  
• Residential real estate remained soft in most districts, save KC (no surprise there)
  
• All districts reported continued upward price pressures, with Boston, New York, Philadelphia, Atlanta and Dallas indicating businesses have stepped up the pass-through of higher costs. (This matches with what both small and large business price surveys along with the ISM and NAPM (factory surveys) reports have shown. Further, the Cleveland Fed’s Trimmed-Mean CPI, which takes out the most volatile components, and non-energy CPI are both at 17-year highs)
  

One obviously hopes the large and rapid decline in energy prices will ease price pressures, but the more data one studies the more it paints the picture that the 48.5% rise in crude, the 41.5% in gasoline and the 45% in diesel prices over the past year have become at least partially embedded.

This morning we get a number of data releases, with the final revision to Q2 productivity, weekly jobless claims and the ISM service index for August receiving the most attention.

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks reversed course as a substantial early-session rally fizzled, succumbing to losses within the energy and basic material sectors; driving the broad-market into negative territory by mid-day was deterioration within the tech-sector. With all three of those sectors losing between 1.4% and 4.6%, and no real help from anywhere else save financials and consumer discretionary shares, the market could only go lower.

Energy stocks got drilled, pun intended, as oil prices shed $5.75, or 4.98%, to close the session at 109.71. Crude had been down as much as 8.8% yesterday, but a roughly 5% decline ended up being plenty to clock the sector. Oil is down to $108.32 this morning, the lowest level since early April.

Energy, basic material and information technology shares combine to make up 33.2% of the S&P 500.

Market Activity for September 2, 2008
As the chart below depicts, stocks started the day much higher after Hurricane Gustav’s impact proved to be much less than initially feared, sparing drilling platforms in the Gulf of Mexico and the New Orleans’ levees mostly held. However, things nonetheless fell apart as information technology, industrial and health-care shares erased early gains providing zero offset to the basic material and energy stock woes.

The S&P 500 began the session up 1.6% at the get go, but ended up losing 2.0% from that intraday high. The broad market declined 0.41% relative to the opening price. (The yellow line represents that opening mark.)


This morning, as the day progresses, it will be interesting to see how the oil market prices things in as we get the weekly energy report. Supplies will surely drop as the LOOP (Louisiana Offshore Oil Port) remains closed and Gulf production was shut down. Too, we have Hurricane Ike that looks to be making its way to the area.

On the economic front, the Institute for Supply Management (ISM) reported that manufacturing activity (on a national level) remains right at that dividing line between expansion and contraction. The reading came in at 49.9 for August and has hovered there for six months as the average for this period is 49.5.

The fact that the survey failed to show a pick up is decent proof the large acceleration in the Chicago-manufacturing reading (which we touched on yesterday) was mostly due to an increase in auto production – U.S. auto production is a large component within that regional survey. Normally, this would be fine, but since vehicle sales remain subdued, one shouldn’t expect auto production to have much staying power. That said, it is remarkable the manufacturing sector – from a national perspective -- remains solidly at the 50 level even as housing weighs heavily on the sector. (Again, above 50 marks expansion and below that mark, contraction – a reading very close to 50 on either side is a push.)

In terms of the sub-indices, which are hugely important to watch as they give evidence of future ISM readings, most remain subdued but a couple did improve from the July readings. For instance, the new orders index rose to 48.3 in August from 45.0 in July. Backlogs of orders increased slightly to 43.5 from 43.0.

The production index did slip from the July reading but remained in expansion mode, coming in at 52.1 in August after 52.9 in July. Inventories remained below 50 for the second-straight month, but did rise, coming in at 49.3 after July’s 45.0 – one watches this reading to gauge the effect inventories have on GDP. However, the customer inventory reading hit 54.5 – a 7.5-point jump from July. A reading over 50 for this index shows that respondents believe their customers’ inventory levels are too high. (This illustrates the cautious nature of business more than anything else as we know that inventory levels in a broad-based sense are at historic lows)

New export orders jumped to 57.0 from 54.0 in July.


The prices paid index has decelerated nicely, yet remains elevated.


Bottom line: the report was a decent one as the headline ISM reading remained very near the 50 level, yet it doesn’t give us a sense the manufacturing sector is ready to engage in rip-roaring activity anytime soon. That big increase in new export orders is a great sign though as many have worried economic weakness in Europe will cause export activity to ease. This reading shows other regions of the globe are filling the void.

It is good to see the prices paid reading come lower, but we’ll need to see continued deceleration to ease broad-based inflation concerns.

In a separate report, the Commerce Department reported that construction spending fell 0.6% in July after two months of gains. A 2.3% decline in private residential construction in the month led the overall figure lower. Non-residential private-sector construction (commercial) was also lower, falling 0.7%, marking the first decline for this figure in more than a year. (Private-sector residential construction is down 27.5% year-over-year. Commercial construction is up 16.0% since July 2007, just to mention the contrast)

July marked the first month since January 2007 in which private-sector commercial construction has not helped to offset residential weakness.



The public-sector did help to prop up the overall reading as public-sector residential construction rose 3.4% in July and non-residential (boosted by transportation and schools) rose 1.4%.

I’ll note, however, even though residential construction remains mired as inventory levels are hugely elevated, we have seen some encouraging signs as the degree of decline has waned over the past three months. For instance, single-family new homes sales fell at an 18.5% annual pace over the past three months – about half the 35.3% decline of the past 12 months. Pending home sales – those existing home sale contracts that have been signed, but not yet closed -- have jumped 32.2% at an annual rate since April, compared to the 12.1% decline over the past 12 months.

The pig in the python is foreclosures, as it will take some time still for this figure to peak. U.S. loans past due have increased to 6.35% of the total mortgage market vs. 4.84% a year ago. (These will not all turn into to foreclosures as this reading accounts for all mortgage loans just 30 days past due, but the number is nonetheless higher) Prime loans past due hit 3.71% as of the latest data. Subprime loans past due hit 18.79% for that universe. That is up from 2.58% and 13.77%, respectively.

This morning we get the latest factory orders report, which should show business spending continued to trend higher. This is the big bright spot from a domestic GDP standpoint (outside of trade) as we’ve seen signs that the business side will offset any consumer weakness in the current quarter.

Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

• U.S. stocks ended a three-day winning streak on Friday as the Commerce Department showed personal spending was weak during July and incomes declined for the first time in three years. More than anything though, Friday’s down market was more a function of traders’ unwillingness to take on additional long positions considering the increased uncertainty that Hurricane Gustav wrought.
  
  That personal income figure was really more a function of the government’s rebate check program coming to an end as this caused government transfer payments to fall substantially. The fundamental components of the data continue to look pretty good, as we’ll touch on below. (Real income growth remains a chief concern, but the income data looked much better in July than the headline number would lead one to believe.) Further, it’s tough to blame economic data for Friday’s stock-market decline considering the most important regional manufacturing survey showed activity was just shy of robust last month.
  
  Market Activity for August 29, 2008
  

All 10 major industry groups ended the week on a down note, with information technology, utility and industrial shares leading the declines. Financials were the best-performing sector on a relative basis, falling just 0.59%.

Crude-oil prices have plunged this morning, falling 6.30%, or $7.27 per barrel, as Hurricane Gustav failed to strengthen to the level many had feared and thus oil and gasoline production should resume in pretty quick order. We won’t know the extent of the damage until tomorrow – firms will get out and assess rigs today – but there’s a strong possibility we escaped major damage. That said, the Louisiana Offshore Oil Port (LOOP) has been closed for a few days and likely won’t be able to begin taking shipments again until Thursday, so this will have a meaningful effect on stockpiles in the very short term.

As the chart below illustrates, we’ve enjoyed a welcome 25% decline in oil prices over the past six weeks, yet remain 43% higher from the this time last year and 24% higher from date the Fed began to aggressively ease with their January 22 inter-meeting cut. (The annualized figures are meaningless for the purposes of this graph, so pay not attention to those readings, if you can even read them.)

It’s been amazing to watch how emotion-driven trading has turned. Just six weeks ago the slightest disturbance would lead to large moves higher as crude hit $145 per barrel in mid July. Now, even when a large production disturbance occurs, so long as it doesn’t reach the worst-case assumption, traders push crude down 4-7%. This is a huge development for the consumer and profit margins.

Helping this trend out is some encouraging signs from Congress regarding the removal of energy production restrictions; let’s hope the recent decline in prices doesn’t cause a reversal. Further, the pro-drill candidate continues to make progress in the polls, which likely has an effect on traders’ mentality as well.

I’ll caution though, OPEC meets next week and you know what that means with crude 25% off its high. Yep, they’re likely to push through a production cut, especially since Russia will put pressure on them to do so. (Russia is not a member of OPEC, but they do have strong, and concerning, ties to Iran and Venezuela – regimes that very much depend on the high price of oil to remain relevant.)

On the economic front, the Commerce Department reported personal income fell 0.7% in July. This decline was due to the rebate-check effect. Recall back in June how we explained the big jump in May income growth was due – largely – to government payments and that there would be some blowback effect as the numbers were adjusted to this one-time situation. Well, here it is.

The large 17.6% decline in the “other” component of government transfer payments moved the overall figure lower. However, the components that really matter – compensation, wage and salary, proprietor’s income, rental income and dividend income all posted decent-to-strong results.

Compensation was up 0.3% in July and 4.0% year-over-year (YOY)

• Compensation was up 0.3% in July and 4.0% year-over-year (YOY)
• Wage and salaries gained 0.3%, up 4.1% over the past 12 months
• Proprietor’s income rose 0.4% -- nonfarm proprietor’s income up 3.2% YOY, accelerating to 8.9% at an annual rate last three months
• Rental income jumped 7.2% in July and has soared 50.6% YOY
• Dividend income was up 0.6% in July and up 8.2% YOY
• Disposable (after-tax) income is up a very healthy 5.8% YOY

So the income components that matter show pretty nice trends, although for the labor-income related segments the growth has not been enough to keep up with elevated inflation rates. Broadly speaking, disposable income does continue to outpace inflation, which is good.

On the spending side, personal consumption rose 0.2% last month and is up 5.1% YOY and just a bit more six-month annualized. One should expect the pace of spending to ease as inflation eats into the growth of income. Lower commodity prices of late will help, but as we’ve touched on in past letters there is a risk that inflation has become embedded. We’ll just have to see how the data turn out over the next two months.

And speaking of inflation, the gauge tied to this personal spending data showed the PCE deflator (one of the big-three inflation gauges) has increased 4.5% over the past 12 months – a large acceleration from the June year-over-year figure of 4.0%.

The core rate also edged up, coming in at 2.4% YOY – well-above Bernanke’s stated comfort zone of 1%-2%. We’ll admit, as this letter has stated before, a comfort zone of below 1.50% is rather ridiculous as some pricing power is important, but I believe it is worth mentioning that the actual readings continue to blow past his comfort level even if the lower end of the range is silly.


Lastly, the Chicago Purchasing Manager’s survey (tracks Chicago-area manufacturing) came in much stronger than expected, jumping to 57.9 in August from 50.8 in July – a reading above 50 marks expansion and a reading approaching 60 borders on robust.


The sub-indices within the survey were extremely encouraging. The production index jumped to 63.4 from 49.2 in July. New orders rose to 60.2 from 53.5 last month. The order backlog reading rocketed to 63.0 from 45.7.

While these are all very good readings, we’ll need the national reading to confirm this strong rebound before getting too excited – and we’ll get that with the ISM report this morning. Stronger auto production of late likely helped to push this figure higher and since auto sales are relatively weak…well, that’s where the caution comes in. Overall, though the manufacturing sector has remained largely upbeat despite housing’s woes -- and the heretofore drag from the auto sector -- and this reading does offer optimism that the sector will remain in expansion mode. That order backlog reading is also very encouraging.

The prices paid index pulled back, falling to 80.6 from 90.7 in July, but remains very elevated.

Have a great day!


Brent Vondera, Senior Analyst