Ten stocks fell for every seven that rose on the NYSE. Some 1.4 billion shares traded on the Big Board, roughly in line with the three-month daily average.
Energy and financial shares led the declines – financials ahead of the stress test announcement and energy stocks were held back by a decline in the price of oil after a five-session jaunt that pushed crude for June delivery up 12%.
Health-care and industrial shares outperformed, as measured by the S&P 500 indices that track these components. There seemed to be some sector rotation going on, out of financials and energy and into pharmaceutical stocks.
Market Activity for May 5, 2009
Bernanke Testimony
Federal Reserve Chairman Bernanke, in comments to the Joint Economic Committee of Congress, stated the recession appears to be losing steam, with growth likely to resume later this year on the back of higher household spending, a bottoming in the housing market and an end to inventory liquidation. He warned though that the recovery may be slower than usual and the unemployment rate may remain high for an extended period as businesses remain cautious about hiring and business investment remains weak.
This possible lack of activity with regard to the business side is the correct concern. Specifically, business spending on capital equipment must reverse course; we’ve seen this figure rebound over the past two months off of very depressed levels, but that bounce has been slight. Before touching on the business side though, I’m not sure his relative optimism on the consumer is justified. We’ll see intermittent pops in consumer activity but one should not expect a sustained improvement – the consumer still has to deal with large amounts of debt that are tough to manage now with the labor market in the shape it’s in and incomes flat – not to mention the declines in stocks and houses that have the consumer appropriately shy of engaging in much consumption. These debt levels were quite manageable when the unemployment rate hovered around 5% and incomes were growing at a nice clip (and rising investments boosted confidence) but that has all changed.
As a result of this scenario, we will rely on business spending to augment growth. However, as government has inserted itself as the economic driver this may actually have an adverse effect on business activity over time. We will most likely see a two-three quarter jolt in GDP as firms increase production in order to rebuild stockpiles after massive liquidation (the inventory dynamic we often refer to) and the government’s additional billions in spending kicks in. But the government cannot create aggregate demand, no matter how many Keynesian economists say it is so – if this were true, central-planning economies would be the beacons of economic virtue instead of the slow-to-no growth baskets cases they are in reality. Therefore, it will be difficult for sustained growth in GDP if the government effectively crowds out the private sector.
Substantially higher levels of spending and debt mean that taxes will rise and the debt issuance to provide immediate funds for that spending must be purchased – both remove funds from the private sector spending pool. In addition, this activity also has the potential to cause firms to hold back as higher tax rates reduce confidence in future economic activity, and thus firm’s sales growth forecasts. If the policy were focused on reducing tax rates (on capital, labor income and corporate profits) we’d have a much better shot of businesses boosting plant, equipment and inventory spending in an aggressive manner – they have the means. But this is not the case.
Bernanke is right to have focused his caveat on the business side – we will depend on this segment of the economy greatly over the next couple of years. Let’s hope the government’s actions do not scare business into prolonged caution.
Earnings
First-quarter earnings season, while posting big declines, has come in better-than-expected. Even as S&P 500 profits are down 32% (that’s from the year-ago period with 80% of firms reporting thus far), 68% of companies have beat expectations with 26% missing and 6% reporting results that are in line. The longer-term average for the positive/negative reading (positive being those that beat, negative for those that miss) is 59%/24%, with 17% meeting estimates.
The fact that some economic readings suggest the worst in certain areas of the economy have been seen, along with historic levels of cash in this zero interest rate environment, have been main contributors to the rally of the past couple of months; certainly the scenario that roughly 70% of S&P 500 companies have surpassed even very weak estimates has played a major role as well. We shouldn’t get too carried away, estimates were pathetically soft and this is true for second and third-quarters profits, expected to decline -38% and -30%, respectively. Nevertheless, the market has found reason to celebrate the worst-case scenario that was being priced in back in February and early March has not come to fruition.
We have many issues to deal with still, those touched on above along with rising consumer default rates, the commercial side of the mortgage market is only in its early stages of deterioration and (as discussed yesterday) every action that the government engages in has to be viewed as having a consequence that the market will have to deal with in the not-too-distant future. One of the main consequences may be levels of inflation. A harmful inflationary event will have to be met, at some point, by tighter monetary policy. This means we’ll have higher interest rates and higher tax rates combining at the same time – not exactly a mix that augments economic growth, just the opposite in fact.
But for now we should celebrate the market rally and the fact that first-quarter earnings have come in at better-than-expected rates on the whole.
ISM Service-Sector
The Institute for Supply Management reported its service-sector survey rose to 43.7 in April (42.2 was expected) after posting 40.8 for March – this indicates the non-manufacturing sector contracted at a slower pace than the month prior. I was thinking this reading had a shot of hitting 45.0, which would have been very positive for stocks, but we’ll take these smaller steps toward the 50 level. (50 is the dividing line between expansion and contraction)
I don’t think we should expect an uninterrupted march to expansion mode, the trend to that reading may prove choppy (much like the pullbacks in Feb. and Mar. after the Dec.and Jan. readings looked to suggest we were going to move up consecutively from the November low). Still, we should be able to move closer to the 50 mark over the next four months – assuming nothing changes for the worse during this time. A move above 45 when the May figure is released will be convincing.
The new orders (both domestic and exports) sub-indices of the survey offered encouraging signs regarding the next couple of months.
The new orders index hit its highest level since September.
The new export orders gauge jumped too; still in contraction mode, but barely.
Unfortunately, the employment gauge remains deep in contraction mode, but this will be the last of the sub indices to improve.
This morning we get preliminary reports on the April jobs situation. Two surveys, one from outplacement (finding people new jobs) services firms Challenger, Gray and Christmas and the other from payroll services firm ADP, will offer a decent glance of how Friday’s official jobs report will turn out. So the market will be focused on those readings.
Too, we’re getting reports that Bank of America will need $34 billion in new capital, as determined by the government’s stress tests and this may very well put pressure on market as the, in my view, stupid and unnecessarily damaging decision to switch the measure by which capital adequacy is determined may wreak havoc. That is, regulators are now using what’s known as tangible common equity as the way to count capital, moving away from the historically used measure of Tier 1 capital – the former excludes preferred shares, the latter includes it. This will have investors worried about conversion from preferred shares to common shares and the dilution and increased government power within the banking industry that will result.
That Challenger Job Cuts survey is just out and it showed that year-over-year job cuts rose 47%. This may sound bad, and it is, but it is a huge improvement from the 180% increase the figure posted in last month’s reading.
Have a great day!
Brent Vondera, Senior Analyst
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