A couple of better-than-expected economic reports helped investor optimism, especially the ISM number that is showing early signs of making progress. The Institute for Supply Management’s economists believe a sustained move above 41.2 is consistent with economic expansion and since yesterday’s reading came in above that level it worked as a big catalyst to yesterday’s rally. The key word here is sustained, and that is where the questions arise.
S&P 500 1000, the last time we saw this mark was on Election day (November 4), is just a pitch shot away now. We have those who bailed at much lower levels scrambling to get a piece of this market; surely fund managers who have to compete with broad-market returns are in full-blown panic mode and are rushing in as well.
Nevertheless, the S&P 500 has jumped 40% from the March 9 low and it is tough to see a lot more upside as uncertainties abound. Then again, I’ve been saying this since 900, which is where I see the upper limit of fair value when factoring in both economically endogenous (higher tax rates, massive deficits, the capital sapping reality of much higher government spending, and a monetary policy that will have to be unwound at some point) and exogenous issues (geopolitical risks). Things may run beyond what makes sense here as is typically the case, just as we had witnessed to the downside, but over the next several months the market will reflect the aforementioned risks – remember the credit markets also still need to show they can stand on their own when the Fed does remove its several funding facilities.
Market Activity for June 1, 2009
Personal Income and Spending
The Commerce Department reported that personal income rose 0.5% in April and disposable personal income (DPI) – this is after-tax income – jumped 1.1% for the month. (The DPI reading was boosted by reduced personal current taxes and increased government social benefit payments associated with the American Recovery & Reinvestment Act of 2009)
Private wages and salaries fell for the seventh-straight month; however, government wages and salaries increased, which kept the overall wage and salary component of the PI data flat – it came in at 0.0%.
Proprietor’s income rose 0.4% for the month thanks to a 16.2% jump in farm income. Nonfarm proprietor’s income rose 0.1% after a 0.7% decline in March.
Rental income was also positive after three months of large declines (down 3.6%, 2.8% and 3.6%), up 3.1% in April.
So for the first time in a number of months we’ve seen some private sector components of the data add to incomes. Still, the private wage and salary data remains depressed and this number will have to come around in order for incomes to gain in a sustained manner.
In terms of the government side, social benefits rose 2.3% in April, up 14.3% year-over-year. Unemployment insurance jumped 8.6% for the month, up 115% over the past 12 months. The government components account for 20% of total personal income and at the current trajectory that percentage will be rising.
Personal spending fell for a second-straight month, and for the eighth month in 10, as rising unemployment and wealth destruction prompt households to boost cash savings. Spending on durables (autos, appliance, furniture, etc.) fell 0.6% and is down 10% year-on-year. Outlays for non-durables fell 0.7%, down 7.3% over the past 12 months. Spending on services rose 0.2% in April and is up 3% year-on-year.
The personal savings rate jumped to 5.7% in April.
The price gauge tied to this data (known as the personal consumption expenditures index, or PCE) rose 0.4% on a year-over-year basis – it is only reported on an annual basis. The core PCE, which excludes food and energy, accelerated to 0.3% in April, up from the 0.2% increase in March. This core reading is now up 2.7% at an annual rate over the past four months, which is above the Fed’s stated comfort zone for this measure is 1.5%-2.0%. However, they aren’t much bothered by this at the time as the overall inflation gauges are showing prices to be flat in an overall sense – certainly some components such as food and energy are on the rise.
ISM
The Institute for Supply Management’s measure of nationwide manufacturing activity continued to march from deep lows, posting the most salient move year as the May reading hit 42.8 – up from 40.1 in April. This shows contraction in the manufacturing sector is easing (a reading above 50 needs to be achieved to mark activity is expanding).
As we’ve talked about over the past month, ISM manufacturing needs to move to 45, if it does that’ll be a signal we’re really on to something – while this level means the sector remains in contraction mode it is commensurate with mildly positive GDP, something around 1.3% at a real annual rate. ISM manufacturing has been in contraction mode for 16-straight months.
The reading didn’t only beat the expectation, but was viewed in a significantly more positive light after that ugly reading we received from Chicago PMI (factory activity for the region) on Friday. The test here will be how the factory sector reacts to auto-plant shutdowns and whether the index will be able to sustain a moved above that 41.2 mark mentioned above.
The new orders index, probably the most important sub-index of the survey right now as it’s the main leading indicator, jumped to 51.1. That’s the first move into expansion for this figure since November 2007 and surely helped to juice the equity market.
On the other hand, the employment and inventory readings remain deep in contraction mode and we’ll need to see some improvement here before getting too carried away. Employment will take a while to approach the 50 level, but the 40 handle will have to be hit. Same is true for the inventory gauge. That figure moved down to 32.9 from 33.6 and a bounce back into the 40s will need to be seen in order to foretell the current level of business caution is waning.
It is difficult to see this sector moving to expansion mode, a multi-month move above 50 and sticking there, anytime in 2009 as businesses remain very cautious and are unlikely to boost capital spending much over the next several months. The survey has a section that touches on what respondents are saying and this aspect of the report will be key to watch.
Factories that make machinery equipment stated they “don’t see any major customers looking to place business until mid-2010 at the earliest.”
Further, respondents within the computer and electronics arena stated: “some amount of havoc is about to erupt, with companies pushing for increased capacity when suppliers have taken capacity offline.” No doubt one can see the positive side of this comment, but is that bounce-back effect realistic over the next few months if the capacity is not there? What’s more, this could have an affect on prices, thus increasing the chances of a quick and substantial run up within the inflation gauges. We’ll keep our eye on these comments over the next two months in particular.
Construction Spending
Finally, the Commerce Department also reported construction spending for April beat the market’s expectation, rising 0.8% -- destroying the expected1.5% decline. The surprise, and the driver of the overall number, came from private sector commercial construction, which rose a strong 1.8% and followed a robust 2.6% in March. Frankly, we don’t know what’s going on here, except that this is the backlog of jobs coming through the pipe – there certainly aren’t many new projects occurring.
On the private residential side, activity also increased, up 0.6%, but this followed a series of large monthly declines that ranged -3.6% to -10.4%. The public side continued to contract as state governments, most of which are being run by people with zero regard to managing finances properly, are in a world of hurt now that tax revenues are in the tank.
But this will soon change as the federal government’s fiscal stimulus begins to kick in a few months from now. I guess all of those “shovel ready” projects we heard so much of back in January and February involved a slight bit of hyperbole, as we discussed back then. Eventually these projects will make it through the state appropriations process and get rolling, but it is likely to come at a time in which the economy has already begun to move into expansion mode.
Have a great day!
Brent Vondera, Senior Analyst
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