The latest data out of the service sector, which failed to advance toward expansion mode to the degree expected, also put a dent in the prospects for economic growth and thus caused some to question the current market valuation – at least for the day.
Further, comments from Fed Chairman Bernanke to Congress on the unsustainable nature of fiscal policy (and let’s hope he’s thinking the same of monetary policy for which he is tasked to watch over) didn’t exactly give investors a feeling of comfort and nor should it. That said, the broad market did pare earlier losses in the final 30 minutes of trading and one has to expect these pull-backs anyway after the run we’ve been on. (Oh, and on that Bernanke testimony to Congress, Blackrock better watch out. More than once I heard a member of Congress mention the “no bid” phrase regarding the firm’s cooperation with the Fed in facilitating their programs. It appears that the Halliburton syndrome has officially arrived within the financial sector. This is why the PPIP is dead even before it arrives.)
Market Activity for June 3, 2009
Geithner in China
Treasury Secretary Tim Geithner was in China earlier this week and the trip, at least on the surface, showed meaningful cooperation between the U.S. and China may be possible. Geithner has learned to refrain from calling the Chinese a currency manipulator, which was a really amateur thing to do especially since we’ll be issuing $3.25 trillion in government debt this year alone and our own Fed can certainly be accused of the same thing (it happens to be the reality under a fiat money structure), and they seem to be targeting their stimulus in a way that invokes domestic demand, which will be helpful for global GDP as the U.S. consumer gets things in order.
Now, some comments from Geithner were not only laughable, and news is he was laughed at by one audience, but full-blown mendacity on parade. His statements that the Fed is currently independent of political pressures and will focus on currency stability simply does not comport with reality. He also stated the administration is determined to quickly get back to historical averages in terms of the deficit-to-GDP ratio. That would mean reducing the deficit from the post WWII high of 12% for fiscal 2009 (which is double the previous post-WWII record) to 2.5%. Um, there’s just one little problem, much of the stimulus spending is targeted to entitlement programs that will be added to the baseline budget, not to mention the government health-care plan they are determined to burden the economy with – that means vast sums of spending will be added to the budget in a structural way.
Nevertheless, if indeed the U.S. and China are going to be cooperating more closely over the next couple of years this will be a major plus for global growth (and we’ll need all the positives we can get our hands on) and will help stability in other regards as well.
Corporate Profits
We’ve heard a lot of how most, 66% in fact, S&P 500 members beat earnings expectations last quarter – yes, Q1 operating earnings fell 33.5% but they did beat very low estimates. What we haven’t heard much of is that 70% of firms missed top-line (sales) expectations.
What does this mean? Well, it shows that cost-cutting has been extremely aggressive. And we know this as five million payroll positions have been slashed over the past nine months and businesses spending has plunged 26% year-over-year. This means that we should see relatively high-powered corporate profits a couple of quarters out as it will take little boost in demand to boost the bottom line.
However, without policies that incentive producers to produce, engage in capital spending plans and move from a stance of caution to one of optimism that allows for some risk taking, then employment may take a prolonged period of time to expand. The poor sales results illustrate the depressed level of consumer activity and if job growth fails to rebound a year after the economy recovers (one can’t expect job growth any sooner than that even coming out of a mild contraction, which this one is not) then consumer activity will remain weak and the bounce in corporate profits will be short-lived.
The Preliminary Jobs Reports
The Challenger Job Cuts survey (the measure of layoff announcements via the outplacement firm Challenger, Gray & Christmas) showed substantial improvement for May. The survey measured that layoff announcements fell to the lowest level since the economic world changed in September – up 7.4% from the year-ago period, down from 47% in April and 180% in March.
Planned firings rose to 111,182, compared to 103,522 in May 2008. The computer, chemical and auto industries announced the biggest cutbacks, accounting for 53% of layoffs. Challenger did state that they expect the pace of layoffs to accelerate again in the latter half of the third quarter as auto companies restructure.
The other survey, the ADP Employment report, and one that is more appropriate to the official monthly jobs data, measured that 532,000 payrolls positions were cut in May – a bit more than the market was expecting. The April figure was revised up to show a loss of 545,000 jobs from the initially reported loss of 491,000, which could indicate Friday’s official data will show a downward revision for the month.
A decline of roughly 530,000 jobs for May is pretty much in line with what the weekly jobless claims and monthly factory and service sector reports are showing. A decline of this magnitude is certainly an improvement from the 600k-700k losses that occurred in late-2008/early-2009 but this level remains much worse than the monthly jobs cuts we see during most recessions – in fact worse than every recession since the 1949 contraction.
According to ADP, medium-sized firms (50-499 employees) led the cuts by reducing payrolls 223,000 last month. Small firms cuts 209,000 and large firms reduced payrolls by 100,000. It may take a three-four months still but eventually we’ll see the level of job losses ease to a level of 200,00-300,000, which is commensurate with the normal recession. And that appears to be where we are at this point in the economy, back to an environment that looks more like the typical recession in most cases. A main issue is the consumer is going to have stronger headwinds to deal with than is normally the case as we come out of this one and as personal consumption declines to 65% of GDP from 72% it will result in lower rates of growth.
ISM Service-Sector
The Institute for Supply Management reported that their index of service-sector activity contracted for an eight-straight month, although at a slower rate. The measure came in at 44.0 for May, up mildly from the 43.7 recorded for April.
We really needed this reading to move closer to 50 (the line of demarcation between expansion and contraction) and the new orders index within the report did not move in the right direction (fell to 44.4 from 47.0), which doesn’t suggest we’ll see much improvement, if any, in the June reading. In terms of new orders, respondents commented: “Capital purchases has been curtailed.”
Further, while the inventory gauge did improve to 47.0 from 43.0 respondents stated that they are “working down current inventories” and “shorter lead times.” This doesn’t suggest much optimism regarding sales for the next few months. Beyond that though, these comments do indicate when the inventory dynamic does catalyze production it should offer a nice boost to the economy, but we’re not there yet.
The employment index continued to improve from deep contraction mode but the latest reading of 39.0 suggests no help from the service sector on the job front. Comments were a bit conflicting. The more negative: “Layoffs and non-replacement of attrition continue to lower overall employee populations.” The more upbeat comment was: “hired some line workers for small increase in demand.”
Have a great day!
Brent Vondera
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