Financials led the rally, with energy and basic material shares also among the best performing groups – another dollar rout, hammered back down to a 13-month low, sent commodity prices like gold (back to $1015 per oz.) and crude (back above $70 to $71.55 per barrel).The traditional safe-havens – consumer staples, utilities and health-care -- along with telecoms were the downers on the session.
Advancing stocks beat decliners by more than a two-to-one margin, but it occurred on yet another day of unimpressive volume as 1.2 billion shares traded on the Big Board, roughly 16% below the five-year average.
Market Activity for September 22, 2009
Richmond FedManufacturing activity in the Central Atlantic region remained in expansion mode during September, according to the Federal Reserve Bank of Richmond’s factory index. The index reading came in at 14 for the third-straight month and has been in expansion mode for five straight. This is now the third regional factory gauge we’ve received for the month, all showing activity continues to expand.
But just like the other readings for September (the others being the New York and Philly regions) the sub-indices suggest some deceleration in the pace of activity. For instance, new orders volume slipped to 13 from 18 – still a good number though. The order backlog figure fell to contraction mode, coming in at -5 for September vs. 4 in August – needless to say that’s not a good sign. Also, as component of these regional surveys we have talked about lately, the vendor lead times (or supplier delivery times) fell to contraction mode as well, hitting -3 from the 2 posted for August – this means supplier deliveries sped up, you want to see them slow as it shows orders are coming in faster than they can easily handle.
On the bright side, the average workweek remained elevated, coming in at 15 – basically unchanged from August’s reading of 16. The wages component accelerated to 9 from 6, which will be a helpful event if it is sustained and proves true for the entire factory sector. And, while hiring plans among respondents were mixed, the overall employment gauge rose to 5 from 0 in August – the first positive reading since December 2007, which is the month the NBER says was the “official” start of the recession.Home Price Index
The Federal Housing Finance Agency’s (FHFA) home price index rose 0.3% for July -- an increase of 0.5% was expected. The June reading was revised substantially lower to show a 0.1% rise vs. the initial reading of 0.5%. This puts home prices down by 4.2% year-over-year and just 10.5% from the April 2007 peak, according to this measure. By contrast, the existing home sales data has the median price of a home down 15% y/o/y and 22.5% from its peak hit in July 2006. The FHFA reading is geographically diverse, but does not include properties with jumbo mortgages.
This reading breaks prices down into eight different regions. Here are the results:
FOMC and Overall Policy Direction
The Federal Open Market Committee (FOMC) began their two-day meeting yesterday. Today, while there is no doubt the FOMC’s current interest-rate policy stance will remain unchanged, market participants will be focused on the statements from the members as that meeting comes to a close. What will they say on quantitative easing, the duration of their current policy stance and any shift in key phrases with respect to the economy?
The truly concerning aspect of current policy, and this involves fiscal and trade policy too (tax rates and protectionist trends – and if you think I’m sounding a false alarm here there are studies stating protectionist policies have jumped 31% since this time last year), is that it is intensely focused on the consumer while ignoring business and fails to understand the damage that results from higher tax rates and tariffs.
To concentrate solely on the Fed for a moment, while it is true consumer activity is the largest segment of the economy, currently making up 70% of GDP, policymakers must allow this percentage to revert to the long-run average of 65%, even if it means additional economic hardship in the short term -- this adjustment will work as a large drag on growth, but by attempting to impede this adjustment all you do is delay the inevitable and set up other challenges for the economy.
There must be a focus on policies that allow, or incentivize, other parts of the economy to take over as the consumer engages in a, let’s call it two year, period of repair.
For the record, I must admit a failure to see what was occurring a couple of years back – solid income growth, a very low unemployment rate that averaged 5.1% in the five years that preceded the crisis, and a massive wealth effect as both home and stock prices were elevated caused me to believe debt levels were quite manageable. Indeed, they were, until these events changed to a situation of falling-to-stagnant income growth, a 9.7% jobless rate and a crushing blow to home and stock prices.
It’s quite clear that part of the Fed’s strategy is to juice the stock and housing markets. Very low interest rates and a flood of liquidity will naturally result in money flowing into stocks as investors see little by way of FI yields. The Fed’s purchases of Treasury and mortgage-backed securities (part of this quantitative easing campaign we keep referring to) keeps mortgage rates down, which clearly is also helping the housing side of things.
Simply put, Bernanke and Co. are targeting household wealth as a way to combat consumer debt levels in the hope they will begin to borrow again and spend. This is a primary reason I believe the economic expansion will be relatively shallow and short in duration – this approach will cause other problems for the economy over the next 12-18 months, the reduction of household credit must take place. Those who expect the normal business-cycle expansion, which have lasted between six and 10 years over the previous quarter century, are fairly removed from reality in my opinion. In addition, current policy works as an assault on the dollar and no society has devalued their way to prosperity. We won’t be the first.
It would be much better for the Fed to keep some of their programs in place, programs that ease the adverse effects of declining loan activity, but get rates to a more appropriate level – uh, something above zero at least as this only causes investors to improperly assess risk in their hunt for yield. We saw this result from their 2002-2005 policy mistakes and it is happening again. And the QE aspect of the easing campaign must come to an end, they should have never gone down this road. Now to take it away will cause even more harm as the market has come to expect it, adjusting price levels to the Fed’s bond purchases.
Where the problem of a lackluster economy should be aggressively addressed is through tax policy. (And no, the current tax-rate policy did not fail. How does allowing people to keep more of their income, leaving more capital within the resource-allocating private sector and incentivizing business to engage in productivity-enhancing capital expenditures hurt the economy? It was a careless Fed that provided the oxygen for an over-leveraged system. That over-levered state of things is what got us here to begin with. The Fed is one of the primary origins of the crisis, yet they escape much of the criticism.) The correct response, going back to the Bush Administration in 2008, should have been to slash income, capital, dividend, and corporate tax rates. This would have likely placed a higher floor on equity prices and corporate profits, and just as importantly put disposable income on a more beneficial path.
In addition, they should have made permanent the very successful program of higher current-year write-down allowance and bonus depreciation schedules. This is the most powerful way to get businesses to spend, and it is also a huge job creator as the plant and equipment orders spur employment.
But we failed to take this path, instead deciding to go down a road that is reminiscent of the policy decisions that caused havoc for economic well-being in the past – a combination of decisions, some that mirror steps taken in the 1930s and some that are similar to policies of the 1970s. As a result, expectations must be pared and a heightened level of caution is appropriate.
This is the world we are currently in and it is best to recognize it even as the stock market goes on a tear.
Have a great day!
Brent Vondera, Senior Analyst
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