Also hurting stocks is the fact that the broad market has moved to the highest valuations in seven months; the press was all over this story over the past couple of days and it no doubt increased concerns things have gone too far too fast.
We’ll add, the valuation on the NYSE has gone from what seemed to be a very opportunistic 10 times earnings back in March (and a dividend yield of 5.50%) to a very rich (especially for this market) 21 times trailing 12-month profits, at the present -- the yield does remains attractive at 3.99%. Stocks should, and no doubt will, pull back very soon as we’ve returned to levels that have removed worst-case economic and profit scenarios. Further, the Dow Transportation Average appears exhausted here, after a 60% jump from the low. This is an important index to watch as the overall market is unlikely to trade much higher if the trannies don’t.
Friday’s leadership were Monday’s laggards as financials, energy and industrial shares led the market lower. Telecom and information technology shares were the only two major S&P 500 industry groups to close higher, also a reversal from Friday.
Market Activity for May 11, 2009
Interest Rates and Fed Purchases
The yield on the 10-year Treasury note has blown through 3.00% (this support level broke down after the Fed decided to leave its planned purchased of Treasury and mortgage-backed bonds unchanged at $300 billion and $125 trillion, respectively). Many of you may recall our discussion explaining how the Fed’s planned purchases had placed a ceiling on rates as investors flooded back into the Treasury market each time that note hit a yield of 3.00%(and since the price of a bond and its yield are inversely related this level offered price support); based on those planned purchases, traders saw a quick and easy way to make some profits as prices would rally off of those levels.
Well, since rates have been heading higher over the past three weeks, don’t be surprised to hear the Fed announce it’s stepping up its purchase plans. We’ll watch the 30-year fixed mortgage rate for an indication that they’ll be moving in this direction. If that yield moves in on the 5.00% level and threatens to blow through it, they’ll very likely do so in order to move the rate back below 5%.
This will make it difficult for those who have made big bets that rates are going higher, at least over the next 12 months. But the Fed won’t be able to play this game for very long as they will eventually be over-whelmed by the market.
This action will also increase the odds that they, the FOMC, will not be able to manage policy around inflation trends. If inflation does become a problem (and I certainly believe the environment is set up for this scenario) they will hold off from attacking it – what does one expect them to do (especially since they are hardly independent of Capitol Hill right now), start taking away the quantitative easing by selling Treasury and mortgage-backed bonds? If they do rates will jump and it will not only shut down what may be a nascent housing rebound but also a rebounding economy by that time – quite unlikely that they’ll do so. Although, such action would be appropriate as we’ll at some point need to take our medicine, it’s only a matter of time. The economic recovery on the other side of this very likely double-dip will then have a shot at sustainability, but the not without additional trouble first.
For those confused by these remarks, what I’m saying is the economy will rebound, but will run into a wall of reality shortly thereafter – based on what we now know about policy (both monetary and fiscal). At which point, we should be prepared to deal with another downturn before the business cycle is allowed to expand with both vigor and endurance.
The Week’s Data
We were without a data release yesterday but we’ll get back to it this morning and round out the week with important figures.
Today: Trade Balance and Budget Statement.
We know things were weak as the first quarter came to a close, but it’s still worth viewing export and import trends within that trade balance figure – although next month’s release of the April figures will be much more important as it will set the stage for the current quarter’s trade picture.
We’ll also receive the monthly budget report for April, which is expected to show a pretty mild deficit. Good things too as we’re on pace to hit a $1.8 trillion shortfall for fiscal year 2009. If so, it will mark a deficit-to-GDP of 13%, more than double the prior post-WWII record of 5.6%.
Wednesday: Mortgage Applications, Import Prices and Retail Sales.
We’ll need to see another increase in mortgage apps and hopefully another increase in purchases – we don’t want it all coming from refis. If purchases pick up in this latest week, it will mark the first back-to-back increases since late March when the fixed rate made its move below 5.00%.
Import prices will be a non-event. It’s likely we’ll see another meaningful monthly increase (expected to come in at 0.5% after the same reading last month) but no one is paying attention until the main inflation gauges like CPI and PCE begin to head higher.
Retail sales will be a hugely watched number. We’ll need to see a positive reading after the March report and latest chain-store sales data pretty much crushed the thought that consumer activity was back.
Thursday: Initial Jobless Claims and PPI
PPI (producer price index) won’t get much attention, as touched on above, but the normal Thursday ritual that is jobless claims is one of the most important indicators right now. We need to see this reading move into the 500K handle – came close last week as the figure hit 610,000.
Friday: CPI, Empire Manufacturing and Industrial Production
CPI will get some attention as this is one of the main inflation gauges. We expect this reading to begin to slowly tick higher and accelerate by year end, driven by the energy component.
Empire manufacturing, while showing New York area factory activity contracted again in April, the pace of decline slowed substantially. We’ll need to see these manufacturing figures continue to progress to expansion mode, this will give the market some hope business equipment spending is on the rebound. The problem is the auto-sector woes will put pressure on the readings, thus we’ll need to pay more attention to what respondents are saying that the overall readings, which will be affected by the idling of auto-production and parts plants.
Industrial production had declined in 14 of the past 15 months, and the degree of decline over the past seven months has been one of the most severe moves in the post-WWII era – industrial capacity in use (utilization) fell to the lowest level since 1967. This number must show a rebound to positive territory or the equity markets will respond adversely.
Have a great day!
Brent Vondera, Senior Analyst
No comments:
Post a Comment