Daily Insight

U.S stocks moved higher on Friday after Thursday’ respite from the up, up and away trend of the past two months. This latest leg of what has been an amazing seven-month rally off of the damnable March lows has seen the broad market surge 22% in just 10 weeks. Analysts’ upgrades of consumer discretionary, energy and tech shares sparked Friday’s advance – funny how these upgrades come out of the woodwork after massive upswings; their absence when the market tanked and valuations were much more attractive is telling.

Market activity was mild even as the third Friday of September (and true for March, June and December as well) brings quadruple witching, the expiration of stock-index and single-stock futures and options. This usually makes for pretty large swings at different parts of the session, but not so on Friday, not by today’s measures anyway.

Volume, as a result of these expirations, was the strongest since late June as 2.22 billion shares traded on the NYSE Composite, 66% more than the six-month daily average.

For the week, the S&P 500 gained 2.45%; the Dow Average added 2.24%; and the NASDAQ Composite rose 2.50%. Mid cap stocks, as measured by the S&P 400, rallied 3.26% on the week and the Russell 2000 (small cap stocks) jumped 4.09% -- smalls by this measure have soared 80% since early March.

Market Activity for September 18, 2009
More “Fixes” to Come

Regulators are working on rules that would require bank-company policies that set pay for employees to receive Federal Reserve approval in an attempt to reign in risk taking. This means for the first time in U.S. history the Fed could reject any compensation decisions that heretofore were up to the boards and executives. The topic of compensation decisions having to abide by government approval isn’t new, we’ve all heard of the “pay czar” for some time. But having to get Fed approval is a new one, as the degree and scope – previously regulators were focused on just the largest 25 banks and the top executives – has increased to include all banks and most employees.

You see the irony here. The focus is to set compensation in a way that does not incentivize excessive risk taking, but it is exactly Fed policy that encouraged excessive risk taking, as it will do again with the Fed’s current zero-rate stance. Yet policy makers want to put this same Fed in charge of even more oversight.

And digressing for a moment, what sort of compensation is it that can exactly keep top trading/investment banking talent from engaging in shorter-term actions while also allowing firms to hold onto that talent? Will traders have to now wait five years to find out if their strategies continue to hold up in order to get paid? Will their best employees stick around even as their strategies funnel into big profits for the firm, yet are not promptly compensated for this contribution? I doubt it. Then you have places like Hong Kong where such regulations on salaries and bonuses will be shunned. The areas of the globe that refrain from this policy will magnetize the best talent. This used to be what the U.S. was all about.

But back to the focus on the Fed, they continue to escape criticism while the industry absorbs all of the blame. What exactly are firms supposed to do when the Fed pushes real short-term rates below zero (fed funds below the rate of inflation) for three full years? This encourages leverage, and you can be sure to see more of it, just as we had. If the Fed would concentrate on getting policy right instead of taking on more jobs (many of which they have zero experience in implementing) I don’t think we’d be talking about any of this in the first place; the over-leveraged state of financial institutions and the market meltdown would not have occurred. Alas, we’re headed in a very different direction.

In addition, the regulators are looking at increasing capital requirements within the banking industry. Probably not a bad idea, but if policymakers want credit to start flowing a bit (currently it is declining), well they better watch their timing of these stricter standards. Again though, so long as the Fed gets its policy largely right you don’t have much of a problem. If very easy money policy remains in play for an extended period this go around (which seems likely), regulations have no chance at efficacy as banks simply move more leveraged positions off of the balance sheet to escape oversight – exactly what happened during the previous few years.

Indeed this is occurring again. I see that Barclays is about to engage in some window-dressing by deciding to move some of their riskier assets to a hedge fund – oh, and they’ll provide a loan for the hedge fund to “purchase” and manage these assets. (Here we go again.) There are two primary reasons for this move:

1. Barclays knows more trouble is coming and they want to get these assets off of the balance sheet so they don’t have to mark them and take a hit to their capital ratios.


2. They see the stricter capital standards coming that would force them to raise funds because of the nature of these riskier assets.
   

Neither one is a particularly good sign.

The Week’s Data

We were without an economic release on Friday but get back to it today with the LEI (Leading Economic Indicators) index for August – although this has been a deceiving indicator of late as the government’s prop job of the bond, housing and stock markets (the aggressively sloped yield curve, rebound in housing starts and surging stock prices have been the main contributors) is juicing this data set.

Later in the week we get more important things like the FOMC meeting (there will be no surprise by way of policy decisions as they will keep monetary pedal floored, but we’ll be waiting for their comments), the weekly jobless claims reading, both existing and new home sales and consumer confidence readings.

To touch on a couple of these releases:

Initial Jobless Claims
Market participants will be watching to see if initial claims can hold below the 550K level (came in at 545K in the latest week). The last time we were below 550K was in the week ended July 10, which was another period in which a holiday distorted the data (Labor Day holiday may have affected the latest reading). If we can hold below this mark, and then make progress toward sub-500K, it will offer a strong sign we can get to monthly job losses in a the range of 80K-100K in pretty quick order – while still job losses, these are statistically insignificant levels.

Durable Goods Orders (August)
It will be important to build upon the strong 5.1% increase seen in July, and we should get it as once again the data may be driven by auto assemblies. We’ll need to see this data get some boost from business spending (capital equipment and software expenditures), which heretofore has been AWOL.

Home Sales (both existing and new homes for August)
The data for August will very likely continue to build on the nice trend we’ve seen over the past couple of months as very low interest rates and the first-time homebuyers’ tax credit has helped to offset the damage done by a weak labor market. For obvious reasons, the market has been acutely focused on these number, but the readings near the end of the year will be the more important figures to watch as there’s an outsized chance home sales will roll over again as the tax credit expires. (Even if Congress extends the credit for another six months to a year, which is probably inevitable, there will be some break in the continuum. Also, we shouldn’t forget that the past three months are historically the strongest for home sales so there will be some easing simply from a seasonal perspective.)


Have a great day!


Brent Vondera, Senior Analyst