The big earnings news of the day seemed to be Caterpillar’s results. The heavy-equipment maker whipped analysts’ estimates, even as earnings per share fell 58% from the year-ago period and sales plunged 41%. The firm raised its full-year earnings forecast (I’m not sure you can actually call their very wide range of $1.15 - $2.25 per share much guidance) as even the low end of this range is above the previous forecast of $1.12. Cat stated global stimulus plans (namely out of China) will help results. The news boosted basic material shares, and this is why you want to own the sector, or names related to it.
Health-care shares led the advance with utilities, energy and the aforementioned materials recording a nice session too. There is a possibility that Congress will wait until after the August recess to vote on health-care legislation. If they do, it decreases the chances of passing as the longer this thing sits out the worse it looks. It’s probably not a coincidence that health-care shares led the broad market higher.
Advancer just about matched the number of shares that declined on the Big Board. Some 1.1 billion shares traded on the NYSE Composite – the three-month average is 1.3 billion per day.
Market Activity for July 21, 2009
Bernanke TestimonyThe Fed Chief was on Capitol Hill yesterday testifying before Congress on the state of the economy and shedding some light on the FOMC’s exit strategy -- the process of unwinding the unprecedented monetary easing they’ve been in engaged in for 18 months now.
Rather than getting into the specifics of the tools by which they’ll be able to tighten, and they are many, let’s just say it may prove politically difficult for the central bank to remove much of this liquidity as the unemployment rate is likely to remain elevated for a prolonged period – and that political battle will be fought both within and outside of the Fed system. He’ll have to battle those on the policymaking committee who depend on the unemployment rate to drive their decision-making process and those in Congress who will also put pressure on the Fed to keep monetary policy loose if the jobless rate remains heightened ahead of elections in both 2010 and 2012 – that is if Bernanke is even around by that time, he’s up for re-appointment in January 2010.
At least the Chairman does acknowledge inflation expectations to be a risk in the not-too-distant future, which is more than one can say for a number of FOMC members who believe price levels cannot rise when economic slack is this large. By slack we mean high unemployment and low plant use. The Chairman did downplay inflation concerns in the near term.
On current policy, Bernanke said that the economy remains too weak to start tightening policy and that despite improvements the fed funds rate will remain near zero for an extended period. He seemed to concentrate on the potential for commercial real estate default rates to cause another blow to the system, which is a topic we’ve mentioned several times over the past few months. The Fed Head also mentioned that household spending remains a key risk because of continued job losses and falling home values. And speaking of the consumer...
Consumer Activity – Don’t Count it to Lead the Economy
Monday night I listened to an economist (one of reasonable prominence) who was saying consumer activity was coming back just like nearly every other business-cycle turn from contraction to expansion. The person interviewing him stated that private sector incomes are stagnant to falling, isn’t that going to keep activity depressed? The economist stated that this is always the case at the end of recession, and this doesn’t stop the consumer from releasing pent up tendencies to purchase, they’ll do the same this time.
Yes, it is true that incomes go stagnant – even short-term negative – at the end of recession and into the next expansion. Incomes do not rebound quickly, just as job creation lags. Nevertheless, I just don’t see how one can count on consumer activity rebounding in a sustained manner.
Why is it different this time? The reasons are copious. Consumers generally have access to fairly easy credit (very easy credit coming out of the previous downturn), but this is hardly the case this time. Further, it is extremely unusual for stocks to fall to this magnitiude (currently the S&P 500 is 40% off the peak and down 57% at the March 9 nadir) and also for falling home prices to beat the consumer into submission.
Before continuing on, let me explain to relatively newer readers that I was the guy ripping on the inaccurate “consumer is tapped out” phrase back in 2004, and then again in 2005 and 2007 when the term made a comeback. Nothing could have been farther from the truth. Expectations that tax rates would remain low were high, credit was easy, the unemployment rate stood at 5% and real income growth was solid. Also, home prices were flying and stocks were back to record highs (the wealth effect was rolling!).
But today we have not one of these factors helping out. I’m not going to say the consumer is “tapped out” but it will take some time to get things right again, dealing with the debt levels that a low interest rate environment encourages is difficult to manage around with incomes, stock/home prices and unemployment all tugging in the wrong direction. Oh, and I wouldn’t rule out a large increase in the social security cap, which would result in easily the largest tax hike in history. And this is a job killer too, don’t forget that a higher cap on FICA taxes raises the cost of employment. This makes resurgence in consumer activity all the more unlikely.
As a result, we are going to see personal consumption as a percentage of GDP move back to 65% (the historic average) from the current 71% -- this will be a huge drag on economic growth. This will not be a consumer led recovery; it will be a statistical recovery by which some inventory rebuilding takes place after record-setting liquidations and exports add to growth as they easily outpace import activity. But the inventory dynamic is more of a short-term pop than something that lasts for years and export-driven GDP advances results in fairly low levels of growth.
By 2010, we will then have the government side of GDP helping out (that’s when the bulk of the stimulus program is released), but this nearly trillion in spending has the chance of crowding out the private sector as funds are sapped from businesses, workers and investors via higher tax rates. Therefore, it may very well work against itself.
The Dollar
One final comment, speaking of export activity helping to drive GDP, White House Chief Economic Advisor Larry Summers made comments over the weekend on how the U.S. needs to drive policy in a direction so to fire up exports. The market reads this as a weak dollar policy – and this is a terrible message to send to trading partners as you can bet that export-driven Asian economies will now have a reason to drive their currencies lower, this is how trade wars get started.
For sure the market is getting the message, as traders drive the greenback down again; the Dollar Index is back below 80. The Bush administration did a terrible job managing the dollar’s value, and certainly easy Fed policy did the most damage. One would hope for a turn in direction here but its going to be a while until sensible dollar policy returns, it seems.
Have a great day!
Brent Vondera
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