Daily Insight

U.S. stocks sold off on Monday, led by commodity-related shares, as concerns over global economic growth increased after New York-area manufacturing activity contracted in June at a greater rate than the previous month. And it’s not only the worry that a global expansion may take longer to arrive than many had hoped but one should also view a 2.40% pull back (and frankly more days like this should be expected) as a natural occurrence after the 14-week gain that had sent the broad market 40% above the deep depths of March.

Commodity prices in general, as measured by the CRB, have sold off about 4% in the past two days and the basic materials index, which largely tracks the direction of commodity prices, has given back five percentage points of the 56% gain from the March lows. As we touched on last Monday, such things are to be expected after a run of this magnitude. Additional short-term weakness is likely but it’s doubtful this group will remain down as a declining dollar, large global infrastructure projects, an eventual bounce in economic activity and the probability that China will continue to stockpile commodities (as a dollar hedge) foments the resumption of the uptrend.

Financial shares were also one of the main losers yesterday. I think it’s likely the group will weigh on the market again today as traders will avoid the sector until President Obama unveils his regulatory oversight plan on Wednesday – in fact, unless today’s economic data surprises to the upside traders may sit on the sidelines altogether. We’ve got a decent outline of what they want to do (and the model will give the Fed enormous authority and oversight – let’s hope the Federal Reserve regains its independence, which is not currently the case) but the devil is in the details so there will likely be a wait and see approach.

Market Activity for June 15, 2009


Empire Manufacturing

The New York Federal Reserve Bank stated factory activity in the region contracted at a faster pace this month, falling to -9.4 after posting -4.6 for May. (Readings below zero on Empire Manufacturing mark contraction, whereas 50 is the line of demarcation for the nation-wide ISM and Chicago surveys, just to clarify for new readers)

The road to recovery within the factory sector will take additional time, particularly as auto-sector woes continue to put pressure on the figures. What we are watching here is for the inventory and workweek gauges to tick higher. At some point, the inventory dynamic (stockpiles have been liquidated on a massive scale and it will take little in the way of a demand boost to drive inventories to dangerous levels, which means increased production when it occurs) will occur to catalyze growth; the market is betting on this to take place soon, hence these will be the two most important aspect of the factory reports for a while.

To this point, these indicators have yet to show signs of a bounce. The inventory index remains very weak, firms are unwilling to boost stockpiles as a sales rebound has yet to occur.

The workweek reading is another key indicator as one cannot expect the employment picture to improve. Businesses are never quick to boost hiring when an economy turns as they wit to make sure the recovery is for real. As a result, they demand more output from existing workers, and this will show up via marginal improvement in the workweek index. Nothing so far illustrates such activity has taken place – only stabilization from very low levels.

If a bounce within these segments of the manufacturing sector fails to occur in the next two months, you’ll see third-quarter GDP expectations (which currently call for GDP to post its first positive print in a year) reduced and that could weigh heavily on stocks. We continue to believe that growth will show a mild advance in the third quarter, followed by a more robust reading by the fourth, but the economy faces major headwinds (debt liquidation within the consumer arena and the affect higher tax rates and regulations will have on the business community) so it is especially difficult to judge..

The market has received a boost as these manufacturing readings ascended from the deep levels of contraction the economy endured late-2008/early-2009. From here, continued improvement will be needed to go much higher; the market is watching these regional reports very closely for signs of progress.

Empire Manufacturing also offered a series of supplemental questions, chief among them was an inquiry into capital spending plans for 2009 relative to their actual 2008 spending. To no one’s surprise capital outlays will be lower, significantly lower in fact. Across all respondents, firms averaged $1.9 million in capital spending plans, down 24% from 2008 spending.

Net Foreign Investment Flows

Net foreign investment flows into U.S. financial assets (equities, government and corporate notes, bonds and agency bonds) grew but at a slower pace in April, up $11.2 billion compared to $55.4 billion in March – analysts expected an increase of $60 billion and I haven’t seen the forecast missed by this degree in a long time. However, foreign holdings of Treasury securities, alone, rose $41.9 billion compared with $55.3 in March – despite the big miss from an expectations standpoint on the headline figure, this last number is pretty good and the latest Treasury auctions showed foreign demand remains healthy.

The concern here is based on a longer-term perspective. China, Brazil, Russia, et al. have expressed a desire for a new global currency reserve as the dollar’s value hasn’t exactly been stable for several years (a direct result of monetary policy up until now; from here massive budget deficits may also put pressure on the greenback). But a new currency reserve will not occur overnight, which means we have time to get monetary and fiscal policy right again. What these numbers can illustrate in the meantime is the direction of interest rates over time. If we get a multi-month period in which foreign purchases of Treasurys slows, watch out.

It will be important to keep the watch segmented (specifically to the Treasury aspect of the report) as the hunt for yield resulted in a flood into corporate debt, which will drive the overall readings in coming months. Rates will move prior to the release of these figures due to the lag, but the readings can still give the market a picture of where rates will go from there based on this inflows trend and the extent to which foreign government become fed up with their dollar holdings, if only at the margin.

There are really only two ways to create a relatively strong and stable currency: one is sound monetary policy and the other is low tax rates on capital. When both of these policies move in the other direction, unsound monetary policy combined with higher tax rates on capital, you can be sure the greenback will lose purchasing power over time. Our deep and liquid markets can offset some of this pressure for a while, but eventually the world will find something better if the dollar is not it.


Have a great day!


Brent Vondera