Daily Insight

U.S. stocks caught a bid yesterday as the key domestic manufacturing report hit it highest level since August offset a weaker-than-expected preliminary report on the job market for June. Stocks did give back much of their early-session gains as traders likely questioned getting to aggressive in front of this morning’s official monthly jobs figure.

The late-session release of U.S. car sales also caused some hesitation as wishful expectations for consumer activity hit the wall of reality, again. Many expected sales volumes to hit what the auto industry calls the break-even point of 10 million units (at an annual rate). Actual sales volume for June failed to hit that number, in fact coming in even weaker than the May results.
Eight of the 10 major industry groups closed the session higher, financial and health-care shares being the only losers, as utility and consumer staples led the broad market higher. One wouldn’t think the traditional areas of safety to lead the way on a day that the factory data hit its highest reading since the economy went into a tailspin in September – that’s a significant development. But that jobs data is weighing on people and causing a lack of conviction. So long as monthly jobs losses of at least 400K is seen as a distinct possibility (this is a level that, if even touched during a recession, is a one month deal, not the eight-month reality we’ve been hit with) investor certitude is going to be slight.

A great indication of this lack of conviction is trading volume, which has been weak for about three weeks now. Yesterday was one of the lightest days we’ve seen as just 905 million shares traded on the NYSE Composite, that’s 35% below the three-month average. This is summer, but levels this low are generally not seen until August when most traders are off to the beach; we should be hovering around the three-month average of 1.4 billion shares per day at this stage.

Market Activity for July 1, 2009
Mortgage Applications

The Mortgage Bankers Association reported its index of mortgage activity fell 18.9% in the week ended June 26 as refinancings declined 30% and home purchases dropped 4.5%. Refinancing activity, as a percentage of total applications, has plunged to 45% from 75% back in April. This shows the degree to which refi activity has cooled and is a direct result of the rise in mortgage rates.

Purchases haven’t looked too bad on a relative basis even as they fell last week; they are coming off of a nice 7.3% rise in the prior reading. It’s tough though to see this segment go on a multi-week run if the 30-year fixed rate remains above 5.00% -- it settled in at 5.34% last week – as the labor market weighs heavily on the housing market and it may very well take (we’re getting technical here) super-duper low rates to partially offset this factor.


125%? How Special!

And while we’re on the subject of the mortgage market, we see Fannie and Freddie will begin refinancing mortgages with loan-to-value (LTV) ratios of as much as 125% as the visible hand of the Obama administration (all of you Adam Smith fans should appreciate that snide remark) seeks to slow the foreclosure rate via their Refinancing Program. This LTV requirement (gosh it feels bizarre to even term this as a “requirement”) is up from the previously adjusted 105% and the historic level (the sane level) of 80%.

You see, the prior program was not getting much participation, even in this interest-rate environment. Why not? Because too many borrowers had a LTV of greater than 105%, apparently. Well, let’s see if 125% does the trick. But wait, even if it does allow more to refi, does it mean that all is well? Will the horribly underwater borrowers have the fortitude to tough it out and make that payment no matter the sacrifice?

Oh dear taxpayer, I fear this is not going to end well. And this will only delay the foreclosure reality that is currently making its way through the system, which means it may very well delay the recovery.

The Preliminary Jobs Reports

The Challenger Job Cuts survey (a measure of layoff announcements via the outplacement firm Challenger, Gray & Christmas) showed another month of substantial improvement in June. The survey measured that layoff announcements actually fell for the first time since February 2008 – down 9.0% from the year-ago period.
Planned firings fell to 74,393 from 81,755 in June 2008. It appears that employers have accomplished the payroll levels they feel is needed to get through this period, which is something we’ve talked about for a couple of months now.

Nevertheless, it will take additional time for this decline in layoff announcements to flow into the monthly payroll declines. Firms have slashed and burned expenses, and payrolls are the largest expense, ever since the shock of the Lehman collapse/credit market chaos that ensued. The monthly job readings will continue to record big losses, as the ADP report illustrates (touched on below), but one would think we’ll move back to a more normal labor-market recession of 150,000-200,000 in monthly job losses as we enter the fourth quarter. While this level of decline will illustrate that the labor market remains fragile, it’s a massive improvement from the currently outsized payroll losses.

In a separate report, the ADP Employment report, a survey that is more appropriate to gauging the official monthly jobs data, measured that 473,000 payroll positions were cut in June. This gauge has done a really good job of tracking the official jobs data, as compiled by the Bureau of Labor Statistics (and a reading we’ll get this morning) – although ADP’s May reading did overstate the degree of decline (ADP said -485K and Labor Department recorded -365K) unless today’s release shows a downward revision to that May data.
This level of decline out of ADP pretty much matches what the jobless claims data is suggesting – monthly payrolls declines of at least 400K will remain the rule for June and possibly July.

From a stock market perspective, it’s a bit concerning that the consensus estimate has payrolls falling just 365,000 – if the ADP number is gauging things accurately for June, the market is going to be quite disappointed. This is very short-term activity we’re talking about here, but I feel it’s worth mentioning.

According to ADP, service-producing industries shed 223,000 positions in June and goods-producing cut 250,000 jobs – both of which are right at the average level of decline we’ve seen in the official data over the previous three months. Large firms cut 91,000 positions in June; medium-sized firms (50-499 employees) cut 205,000 positions: and small firms reduced payrolls by 177,000.

Within a couple to three months we should see monthly job losses ease to a level that resembles the normal recession, as expressed above I’m thinking we’ll move to a range of 150,000-200,000. However, we’re not there yet and the data for the next couple of readings may show we’re stuck in this 400K-450K range.

ISM Manufacturing

The Institute for Supply Management (ISM) reported that its nationwide factory gauge showed another month of improvement. The index rose to 44.8 for June from 42.8 registered in May. While the measure remained in contraction mode for the 17th straight month (a figure below 50 means activity continues to decline), it is doing so at a reduced rate. This is the highest level since the economy spun out of control in September.

Further, the fact that the gauge darned-near made it to 45 very likely shows the weak readings we’re getting out of Chicago PMI (the most important regional factory survey) is vastly due to auto-sector troubles and not necessarily from heavy weakness in other areas.
ISM economists like to say that a reading of 42 over a period of time on their survey is commensurate with mild real GDP growth. The figure averaged 42.5 for the entire second quarter, but if we continue to see mild improvements, this reading will help support our view that the first positive GDP print in five quarters will occur in the third quarter.

Seven of the 18 industries tracked by the index reported business growth in June, that’s up from five in May and one in April – now this is meaningful progress, let’s hope policy decisions don’t ruin it..

Results remained mixed with regard to the sub-indices within the report.

The most encouraging was the production measure, which moved to 52.5 from 46.0 (and has jumped 12 points in two months). The supplier deliveries index also moved to expansion mode, hitting 50.6 from 49.8 in May. But these were the only sub-indices to make it above 50, which does raise some doubts about continued progress over the next two months.

The new orders index, the best leading gauge within the report, fell to 49.2 from 51.1; the backlog of orders index fell slightly to 47.5; the inventories index fell to 30.8 from 32.9 (lowest level since 1982) – this raises doubts firms are on the cusp of boosting inventories after two quarters of slashing stockpiles at a record pace.

The employment index did jump to 40.7 from 34.3, nice move but it will be a while before factories begin to boost workers. We generally have to see two meaningful quarters of GDP growth before the factory sector begins to add jobs again.

This morning we get jobs data overload as both jobless claims for the week ended June 27 and the employment report for June are out. This data will set the stage for trading as we come back from a holiday weekend. I guess what has become North Korea’s own fireworks display could have an affect on trading as well. We shall see.


Have a great weekend and a great July 4!


Brent Vondera