Commodities rallied on that news out of China, helped even more by a dollar that continues to get crushed, as basic material shares led the broad market higher. Energy shares also helped lead the rally as crude marched back to $71 per barrel.
The S&P 500 has now jumped 48% from the wicked March 9 low of 666. This is great news, it is certainly very nice for the American psyche, but I also find it difficult to get excited about the latest leg of this move – I’m talking about the 12% move in the last three weeks. (And just for the record, for those who may not remember, in the March 10 letter we stated it does feel like something powerful is about to occur as we were 515 days into the bear market and the S&P 500 was down 57% -- following the 1929 crash the broad market was down 42% 515 days in and this is no Great Depression. Others know that my view of fair value is 900 on the S&P 500, so I don’t want anyone to believe that my comments of concern means that the vast part of this rally is not justified; the vast majority of this rally is justified – particularly since health-care legislation and Cap&Trade have run into trouble).
But one understands, or should, that when things go up this fast, even if it is off of an unjustified low, the pullback is not far off. The degree of the pullback will depend upon the extent to which values run up beyond what is rational. The concern here is that when the inevitable move down of 15-20% does occur, investors will fear a replay of last March and exacerbate the retrenchment. I don’t think it is beyond reason to guard against this possibility. Don’t’ increase your equity exposure and chase this thing higher.
The Institute for Supply Management’s manufacturing index rose to 48.9 for July, easily surpassing the 46.5 that was expected, up from 44.8 for June. While this latest reading shows factory activity contracted for an 18th straight month, a reading over 42 suggests the overall economy is growing (although as the ISM report states, “it would be difficult to convince many manufactures that we are on the brink of recovery”).
Most of the sub-indices of the report looked really good, with production hitting a pretty robust level of 57.9 (second month of expansion), new orders hitting 55.3 (second month in three above 50) and the backlog of orders posting 50.0 (first 50 print since the September debacle).
Export orders also moved into expansion mode, posting 50.5 and this is going to be a number that drives ISM, and helps the economy in general over the next few quarters.
Still, the inventory gauge remains deep in contraction mode, moving up to 33.5 from 30.8 but nevertheless really depressed as the chart below illustrates. I happen to look at this as not such a bad sign as it means the production needed to rebuild stockpiles is soon to come, but most economists view this low level as a possible sign that businesses are still very cautious and may not rebuild stockpiles to a meaningful degree.
This is a concern, and one I share but over a longer-term perspective. Whether it occurs in the third or fourth quarter (the boost to GDP from inventory rebuilding), it doesn’t really matter, it’s going to happen. But businesses know that tax rates are going higher and this adversely affects their expectations for growth. As a result, they’ll hold back over the next year more than would otherwise be the case. This is why I believe the government’s spending, while helping GDP in the short term, will come back to haunt thereafter as the capital sapped from the private sector will do damage.
Six of the 18 industries within the survey reported growth in July, matching the June report. Here is what ISM reported respondents as saying:
“There is concern about overall health of strategic suppliers – continue to see new suppliers filing Chapter 7 or 11, posting significant risks to supply chain.” (Machinery industry)
“We believe our inventories are now at the bottom of this cycle, driving stronger demand for raw materials.” (Paper Products)
My comment: This speaks well for the commodity trade.
“While our aftermarket business has improved slightly, we are still awaiting an increase in OEM demand.” (Transportation Equipment)
My comment: This will turn as auto plants kick start production, which should be soon as “cash for clunkers” will drive auto sales for a couple of months. Problem is it will be short-lived.
“Looking at another round of shutdowns to align supply with projected demand.” (Nonmetallic Mineral Products)
“No stimulus for manufacturing.” (Fabricated Metal Products)
My comment: this is one of the problems. These last two responses illustrate that economic activity remains very soft and outside of the areas that either the Fed or fiscal government stimulus specifically goose, things don’t look much like a recovery.
Construction Spending (June)
The Commerce Department reported that June construction spending rose for only the third month of the past 12 as residential building activity offset weakness on the private-sector commercial side of things.
Spending rose 0.3% in June to $965.7 billion at an annual rate, after a 0.8% decline in May, as both private and public sector residential activity increased. The big boost came from government outlays for both residential and commercial projects (up a large 4.6% for residential and 0.9% for commercial). Private-sector residential construction rose 0.5% and was down 0.5% on the commercial side.
As we’ve talked about for six months, the government construction spending will drive this overall reading higher and will be able to offset weakness within the private-sector commercial component, which I suspect will get pretty ugly over the next year (20% of hotel loans are expected to default through 2010 and warehouses, distribution centers and industrial buildings are having a rough go due to very weak activity).
While private-sector residential construction spending rose at a nice pace for June, I don’t think it will stage a sustained uptrend as sales will have too many issues weighing on home purchases. The tax credits for new home buyers will run out after this year and unless interest rates remain very low, the fragile job market will keep sales from rebounding outside of one-two month pops.
U.S. Vehicle Sales
The CARS (Car Allowance Rebate System) program – also known as “cash for clunkers” – helped to spark vehicle sales in July, pushing the figure above what the industry believes to be the breakeven point of 10 million units for the first time since December.
Total U.S. sales (both domestic and foreign) rose to 11.3 million units SAAR (seasonally-adjusted at an annual rate), up from 9.7 million in June. I don’t think there is any doubt the CARS program will be extended as the plan’s originally allotted $1 billion in funding has run out. The House passed legislation to add another $2 billion and we may find another couple of billion dollars added on top of that before it is all said and done.
This is one of the most economically stupid plans the government has ever come up with, and that’s saying something. Yes, there will be those that state it’s a huge success, and no doubt when people are going to be given money they’ll take advantage of it. But even if this plan were smart economics, all we’re doing is borrowing sales from the future and encouraging consumers to take on more debt as the unemployment rate has double-digits in its sights and incomes are stagnant-to-lower for most workers.
What’s more, as stated above, these sales should boost manufacturing activity as auto plants will ramp up production again, but this too will just front load things. What happens when the unemployment rate remains high, incomes flat and the consumer is saddled with a higher debt burden? It doesn’t take a genius to answer that one.
From an economic point of view, it makes zero sense to destroy vehicles that have a useful life. The familiar “cash for clunkers” nomenclature gives the impression that the trade-ins are all 1980 Chevy C-10s, but many of these vehicles are very likely 12-year old SUVs that have plenty of life in them – the dealership is required to destroy the motor before collecting their $3500-$4500.
Beyond that, one wonders if those at the lower rungs of the economic ladder are not hurt the most by this program. You can bet there will be less 10-15 year old cars on the market and that means higher prices for those who cannot get a loan to buy a newer car and have only enough cash to buy vehicles such as those now being destroyed. Like so many things that come from those who prop themselves up as the champion of the “little guy,” their incredibly stupid ideas hit those at the bottom the hardest.
Have a great day!
Brent Vondera
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