The market likes to see firms put money into the market, so gets juiced on the merger and acquisition (M&A) activity from the tech and pharmaceutical industries (the Xerox and Abbott Labs deals). If only this were true for business-equipment spending; there are few things more powerful for job creation than a plant and equipment spending binge. Of course, such activity takes confidence and it appears the business community is just fine with lying low right now.
Many people believe a surge in M&A activity will present itself as firms go hunting for profits as final demand remains weak, cost cutting gets you only so far and firms have slashed to the bone. But today’s degree of cost cutting means tomorrows lack of demand -- if the jobless rate remains at 26-year highs it’s kind of tough to see demand dynamics improving much. I’m not sure firms will go on buying sprees with demand where it is.
Friday’s biggest losers, financial and basic material shares, led Monday’s advance. The traditional safe-havens – health-care, utilities and consumer staples – were the laggards on the session, although they did move higher as well.
Volume was dirt, the lowest level since the holiday weekend of September 4, nearly 30% below six-month daily average.
Market Activity for September 28, 2009
Fed Bank Economic Conditions GaugesWe received two rarely watched business surveys yesterday, readings we generally do not report on but since these were the only two releases yesterday…well, it’s time to talk about them.
The first was the Federal Reserve Banks of Chicago’s national index, which draws on such indicators as industrial production, capacity utilization, the jobless rate, consumer spending and housing starts, to name a few – 85 economic indicators in all. The survey came in at -0.90 for August, only mildly in contraction mode, but the reading was worse than July’s -0.56.
The Chicago Fed stated that they believe a three-month average of greater than 0.20 needs to be achieved following a period of economic contraction to provide a significant likelihood that the recessions has ended. We have yet to see this occur as the three-month average is -1.09. Still, I think it is safe to say that the recession has ended.
The second was a reading out of the Dallas Federal Reserve Bank, which also stated activity continued in contraction mode, but this reading was for September. The trend is looking good though as the chart below illustrates. (This reading is specific to the manufacturing sector)
All sub-indices within the report remained in contraction with the exception of new orders and volume shipments. New orders rose to 8.0 from -1.7 in August. Volume shipments posted 0.3 after a -11.2 in August.The finished goods reading remained deeply weak though, coming in at -21.3 from -23.2. This indicates the region fails to show improvement in final demand, a topic of concern we’ve had for some time. If final demand doesn’t rebound here these improvements seen in the factory surveys over the past four months are unlikely to continue.
Further, as the other factory gauges have shown, this survey’s prices paid index posted another month in expansion mode – came in at 9.8 after hitting 9.9 in the prior month – while the prices received index recorded another negative reading, -17.9 vs. -21.4 in August. This does not bode well for profit margins.
Failing to Learn from History’s Guide is Unwise
Last week we focused on a new protectionist precedent taking hold in Washington with the Obama Administration’s decision to levy a 35% tariff on Chinese manufactured tires. This action went beyond WTO anti-dumping rules, citing simply that these imports were harming the U.S. tire industry. (I’ll remind everyone that the recent inflow of imported tires was fostered by the CFC program. The auto industry saw annual car sales fall to nine million from 16 million in a matter of one year. As a result, tire plants were idled and when the CFC-driven sales meant vehicle assemblies had to speed up…well, you had to get the tires from somewhere.)
Now, the paper and steel industries have gotten into the mix, yeah they’re being “harmed” by competition too, by lobbying the administration to place tariffs on these imports. You can bet there will be more industries that will do the same.
Further, in a recession, and a labor market that is likely to remain weak for an extended period, it is very easy for the populace to see the “harm” that certain industries endure via intense globalization and trade, while ignoring the benefits society in general enjoys from free trade. This makes a trend of protectionism even more likely; there may be no stopping it until time enough passes to make clear the perils of trade barriers.
The sparks of protectionism can quickly turn into a raging forest fire, this is what history teaches. When one side sets up trade barriers the other side is very quick to counter, this leads global economic activity to deteriorate and obviously does damage to living standards.
Thankfully, there is a higher degree of interdependence within the global economy today (due to freer trade over the past 25 years) and this may keep trade wars at bay longer than has occurred in the past. But that fire will eventually rage if smarter heads do not prevail.
The Market and the Fed
On this day last year the Dow plunged 778 points, or 7%, as Congress failed to pass the TARP. Still, the Dow closed 576 points higher than its current quote. The S&P 500 got nailed by 107 points, or 8.8% -- 43 points higher than yesterday’s close.
I bring this up not because of why the market plunged, but only as a reminder of how volatile things can get. We shouldn’t forget these wild swings because there’s a high likelihood we’ll see more of it over the next several months, likely driven by central bank actions.
As Mohamed El-Erian recently wrote, central bank synchronization is coming to an end. We’ll begin to see some parts of the globe begin to tighten just a bit and this may very well result in another wave of high volatility as global markets begin to reassess things; the equity markets are currently very cozy with the massive easing and liquidity pumping measures of central banks, specifically policy from our own Federal Reserve. (There’s little doubt a main element of the Bernanke strategy is to repair household balance sheets by pumping up the stock market – all of this liquidity must go somewhere as the Fed holds to its zero interest-rate policy, thereby removing the bond and money markets as an alternative to stocks.)
Indeed, we see this occurring already, if only via words for now – in time not to distant this will become action if the current path of fiscal and economic policy doesn’t cause an additional period of significant weakness.
European Central Bank President Trichet was out yesterday harping on the importance of a “strong” dollar. Trichet is worried that the strength of the euro vs the dollar will hurt EU export markets, so that is one reason for his statements on dollar weakness. But when the head of a foreign central bank becomes outspoken about the dollar’s value -- at a time in which our own Fed, the only party that has a monopoly on dollar creation, refuses to even mention the greenback in their meeting statements – you know monetary policy synchronization will soon come to an end.
Trichet, and other central banks, may remain moored to Bernanke’s easy money ways for a while as they fear hiking interest rates will only further strengthen their domestic currencies against the dollar. But it won’t be long before they realize that capital inflows, promoted by sound money policy, will offset the hit to export markets and at that point, if the Fed remains easy for a prolonged period, they’ll separate from the Fed’s hitch. That will send a strong signal that the stock-market pumping activity from the Fed will begin to unwind. The easy-money trade will end in anticipation of this shift; it won’t wait for implementation of the unwind.
(This whole process will result in a major conundrum – to use a Greenspan term – for the Fed. If other central banks begin to raise rates, while our Fed remains near zero, you’re looking at significant dollar weakness even from these levels. But, if the Fed begins to raise rates, then the $500 billion in IO resets coming in 2010-2011, the commercial real estate default rates and overall bank-industry woes become an even larger problem for the economy to handle. This will be very interesting/troubling to watch play out. The Fed has backed itself into a corner and there is no easy way of returning to the center of the ring.)
Have a great day!
Brent Vondera, Senior Analyst
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