U.S. stocks ended mixed again yesterday as the S&P 500 and NASDAQ Composite closed to the plus side, while the Dow was held back by Boeing shares for a second-straight session.
The broad market began the day nicely higher after the OECD (Organization for Economic Cooperation and Development) raised its forecast for global growth – the battle among the organizational basket cases is on, recall how it was just two days ago in which the World Bank lowered its forecast. Stocks also got a boost from a much better-than-expected durable goods orders report; however, the broad market pared those gains as traders had time to consider the internals of that report and lost additional momentum after the Federal Open Market Committee’s (FOMC) statement was released. (The FOMC is the monetary policy setting committee of the Federal Reserve System)
Tech, financial and basic material shares led the market higher and in fact all 10 major industry groups closed higher on the day.
Some 1.04 billion shares traded on the NYSE Composite, 25% below the three-month average. Activity has been subdued for about a month now, which illustrates a lack of conviction. Two stocks rose for every one that fell on the Big Board.
Market Activity for June 24, 2009
Durable Goods Orders
The Commerce Department reported that durable orders rose 1.8% in May (easily surpassing the estimate that had orders declining by 0.9%), which matched the 1.8% increase for April – that reading was revised slightly lower, initially reported as a 1.9% increase when the data was released last month. This marks the first back-to-back gain for durable goods in nearly a year.
The ex-transportation number rose 1.1%, following a 0.4% rise in April – this ex-transportation reading is important because very volatile commercial aircraft orders have a propensity to skew the overall reading. Commercial aircraft orders jumped 68% last month, which followed a 1.4% decline in April.
Driving the ex-trans figure was a 7.7% increase in machinery orders and a 2.2% rise in computer/electronics orders. This is very goods news but we need more than a one month move in these key components, a trend must present itself before we get too excited. Machinery orders have gotten thumped over the past year, down 28%; computer/electronic orders are down 12% since May 2008.
Conversely, the drags came from vehicles and parts, down 8.1% (but no surprise there), a 1.1% drop in electrical equipment and a 2.5% decline in fabricated metals.
Shipments of durable goods fell 2.1% in May, and since this is the component of the report that flows into GDP, we won’t see much help from this data for the second-quarter growth reading unless the June figure is up big. However, these back-to-back increases in orders means shipments will rise in the ensuing months, which will help deliver the first positive GDP reading in a year by the time the third-quarter growth number is reported. That has been our estimate, a mild GDP increase in the third, followed by a more substantial level of economic growth by Q4.
The most important component of this data is non-defense capital goods ex-aircraft orders (the proxy for business spending), which jumped 4.8% after a 2.9% decline in April – this figure is down 23.1% from the year-ago period but the three-month annualized decline has improved nicely, down 13.5% vs. -30.5% in last month’s report.
This really remains the big issue, will business spending begin to trend upward. I have my doubts simply based of the way fiscal policy is going. The government is in the process of massive deficit spending (the 2009 fiscal budget will record a shortfall of 12-15% as a percentage of GDP, that’s more than double the previous post-WWII record and four-five times the long-term average of 3%). Firms know what normally follows big deficit spending, and that is higher tax rates. They understand this with ultimate clarity today as the current majority constantly talks about increasing taxes on income, capital and business profits. As a result, firms worry about future growth and may decide to hold off on purchases; the recent earnings report out of Oracle is the latest example of this phenomenon.
Firms need confidence right now and to deliver it, policy makers should be implementing an aggressive tax-rate strategy that drives current-year write-off allowances and bonus depreciation higher. This is one of the fastest ways to deliver a shot to business purchases and economic growth -- jobs will follow. Alas, this is not the direction the current majority will take. Instead, they believe massive government spending will drive aggregate demand --good luck with that -- and in so doing may actually cause the opposite to occur as firms delay purchases for fear higher tax rates will shut down a nascent recovery a couple of quarters out. It will be very important to watch if business spending can muster a sustained rebound, or we’re only to see occasionally monthly bounces off of depressed levels. This is a key watch area, I can’t emphasize that enough.
New Home Sales
The Commerce Department reported that new home sales fell 0.6% in May to 342,000 at an annual rate from 344,000 in April. This figure combines with yesterday’ previously-owned home sales data to show the housing sector remain very weak despite efforts that have driven mortgage rates lower and provided substantial tax credits to first-time buyers.
(There is simply nothing that can be done to revive housing until the labor market – absolutely the largest factor in such a large decision like financing the purchase of a home – regains its health. This is where the consensus has been wrong all along. How many times have you heard a pundit state that the economy is dependent upon a housing rebound. Wrong! We must first put in place the policies that drive private sector growth. The job creation that follows will revive the housing market.)
By region, the Northeast and Midwest saw new home purchases jump 28.6% and 18.6%, respectively. However, sales in the South (the region in which the most new-home sale activity takes place) fell 8.5%. On a non-seasonally adjusted basis, there were only 33,000 new homes sold in the U.S. last month – 3K in the Northeast, 5K in the Midwest, 17k in the South and 8K in the West.
The supply of new homes, relative to sales, barely budged and remains at a very elevated level of 10.2 months worth.
However, the number of homes for sales (not adjusted to the depressed sales rate) has nearly been cut in half over the past 2 ½ years. When sales do bounce the inventory-to-sales ratio (months worth of supply) will fall in quick order, but this rebound in sales will have to wait for the labor market to come around.
FOMC
Well, Monday we touched on how the question regarding the FOMC meeting was whether the members would decide to ratchet up their quantitative easing strategy (by increasing the purchases of Treasury and mortgage-backed securities) as way to keep rates from rising, or go the tamer route of merely attempting to talk down nascent inflation concerns. That question was answered yesterday afternoon as the FOMC chose talk over action. At least for now, I think if rates begin to jump again in the near term they may choose action again.
The Fed stated, “[t]he prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.”
Not surprisingly, they stuck to this Keynesian model in the downplaying of the inflation threat. And for sure, it doesn’t take much to downplay inflation right now as the price gauges are extremely benign. The issues that some have is with commodity prices on the march, higher prices among other early-stage inputs and a declining dollar (which makes imports more expensive and will drive commodity prices higher if the trend continues) all point to trouble down the road.
In addition, if the Fed is not on top of these things, and relies on their typical signals, such as the unemployment rate, they will be slow to meet the inflation issue head on. Unemployment is a massively lagging indicator and if they continue to watch this figure as their main beacon they may find trouble as they have injected unprecedented levels of money into the system – once credit begins to flow, the money multiplier will take off and there will be no stopping a harmful rise in prices. If this occurs, an austere level of monetary tightening will be necessary, thus shutting down the economy – and that is my concern over the next 18-24 months.
All of this said, of course the Fed was not going to raise rates or enter into the so-called exit strategy just yet, but some stronger words would have been a nice balance. The only bone they threw to those concerned about future inflation was to drop the deflation risk comments in the prior meeting’s statement.
The rest of the text was pretty much unchanged:
- The bond purchases program remain the same, and will occur along the same timeline.
- The pace of economic contraction is slowing.
- Household spending shows further signs of stabilization
- Exceptionally low levels of the federal funds rate is warranted for an extended period
Have a great day!
Brent Vondera
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