Stocks got off to a poor start, but rallied after the latest regional manufacturing survey showed factory activity in the Southwest U.S .meaningfully improved. The reading from the Dallas Federal Reserve Bank (which covers the Southwest) had April factory activity contracting at a milder pace than expected and respondents to the survey were relatively optimistic about business prospects six months out.
Financial and basic material shares were the hardest hit. Consumer discretionary shares were held down by consumer services stocks such as hotel and restaurants on the swine flu news. Transportation stocks took a pretty good beating also on fears of a contagion. But again, after a 46% jump in the trannies from the March low, traders were also waiting for a reason to take profits. Not surprisingly, health-care shares outperformed.
Market Activity for April 27, 2009
The Latest on Washington Motors
In the latest plan to offer GM assistance the U.S. Treasury would extend another $11.6 billion to the company (bringing gov’t injections to $27 billion), which the government would forgive half off in exchange for equity in a restructured GM. The U.S. government would be a majority shareholder (50.1% share) and thus have the full-blown authority to demand the type of car GM produces. Private bond holders, which also hold $27 billion of debt, would get a 10% equity ownership in the restructured company, as devised by this latest plan. So the private sector bondholders receive a 10% stake and the government receives a majority position – that’s nice.
This will not end well for the company. A traditional form of bankruptcy would be much more conducive to the company’s viability after the restructuring and keep us from traveling further down the treacherous path of intense government involvement. The deal, in its current form, won’t get done anyway as it is highly unlikely bondholders agree to these terms. Something tells me, however, the government is going to get their majority stake.
Dallas Fed Survey
This is another one of those regional factory activity surveys, but not one of the major readings such as Chicago PMI and Philly Fed – these two offer the best indication of where the manufacturing sector is headed, but we may want to pay closer attention to regions other than Chicago as it will be especially hard hit by the idling of auto plants over the subsequent two months. The less watched indexes, such as New York, Richmond and Dallas may therefore offer better clues over the next couple of months as they are not heavily weighted to the auto industry.
The Dallas Federal Reserve Bank stated their manufacturing activity index continues to improve nicely from the depths hit at the end of last year, even as it remains well in contraction mode. Still, we shouldn’t disregard that the 17-point improvement in April is substantial and probably offered some support to the market when released (as stated above stocks moved into positive territory shortly after the figure was announced).
The sub-indices of the report edged upward but because the readings remain well-below zero it shows the improvement reflects fewer companies seeing declines in these measures (new orders, capacity utilization, shipments etc.), rather than more firms reporting recoveries.
The best news within the report came via the six-month outlook. (This is the segment of the survey that measures respondents’ expectations of business activity six months out.) This reading rose to 5.0, the first positive print in 10 months.
Source: Federal Reserve Bank of Dallas
This Week’s Data
Things pick up on the data front beginning this morning with the S&P Case/Shiller Home Price Index and Richmond Fed Manufacturing Index. Case/Shiller is expected to show major price declines continued in February, estimates are for an 18.7% decline in home prices from the year-ago period for this measure of the largest 20 metro areas.
However, since this index measures the largest cities, it is weighted toward the West and thus many of the areas that have witnessed the highest foreclosure rates. As we’ve seen in other housing indices of late, bargain hunters have moved in to buy up distressed properties and this activity may ease the decline in prices and allow Case/Shiller to post a better-than-expected reading.
We’ll also get the Richmond Fed – another regional factory survey. It is likely to show manufacturing activity remained depressed this month for the region covered by the Federal Reserve Bank of Richmond, but it has shown nice improvement from the depths hit a couple of months back – pretty much as the other regionals have illustrated. If the reading can post a -10 or better, the market should respond to the move.
On Wednesday we get the first look at Q1 GDP, which is expected to show the economy contracted substantially again in the first quarter. The market expects a reading of -4.7% (that’s in real terms at an annual rate), which follows the large 6.3% contraction in the fourth quarter.
These readings are the worst GDP numbers we’ve seen since the 1981-82 recession. Indeed, everything changed in September. Prior to the Lehman collapse the economy remained resilient in the face of a nasty housing correction (that was almost two years in the making by September 2008) and an energy price spike that had the price of oil holding above $110 per barrel. When Lehman went down on September 15 the credit chaos that resulted caused business activity to either seize up as a direct result of the credit contraction or caused business managers to become terribly cautious in terms of those not directly affected. The consumer was then put down for the count as their two largest savings vehicles (homes and stocks) took a beating – the peak to trough 57% plunge in stock prices (and the stunning 42% nosedive September-November) crushed confidence.
We think the GDP figure will come in a bit worse than expectations, maybe not on this initial reading, but by time of the first revision – consumer activity won’t live up to estimates and the quarter endured substantial inventory liquidation. However, the inventory dynamic (the production necessary to rebuild very low inventory levels) will help to bring a positive GDP reading by the third quarter if we had to guess based on what is currently known.
On Thursday we get initial jobless claims, personal income and spending, and Chicago-area manufacturing.
Jobless claims are likely to remain very elevated, but beyond the next couple of weeks we’ll be watching for this figure to trend to the 500K handle – when this occurs it will mark a very clear sign that monthly jobs losses have eased.
Personal income for March should continue to show the only segment of the report that continues to grow is government transfer payments. This is a consumer-led recession (the first one of its kind since the 1980 recession) and as a result it will be tough for GDP growth to hit the levels we generally see as the economy bounces back before private sector income growth makes a comeback.
Personal spending will remain soft and will likely post a negative reading for March after showing increases in January and February following six-straight months of decline.
Chicago manufacturing, if the other regional factory surveys offer a good clue, will remain in deep contraction mode. The index is expected to rise to 35.0 from the nearly 29-year low of 31.4, but until this figure moves back to the 40s, it’s tough to find a silver lining. I was expecting these manufacturing numbers to begin to show signs of recovery by June, but now that GM is idling a number of plants a true recovery in factory activity will probably be pushed back.
Futures
Stock-index futures are lower this morning on news the stress tests run on Citigroup and Bank of America didn’t go well and both will need more capital. I thought we weren’t supposed to hear results until Monday March 4? So much for schedules.
Have a great day!
Brent Vondera, Senior Analyst
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