Daily Insight

U.S. stocks rebounded on Monday after a four-day decline, supported by positive comments from Goldman Sachs and Credit Suisse. The press seemed to focus on the latest ISM service-sector reading as the catalyst, this gauge hit expansion mode of the first time in 13 months, but it wasn’t.

The broad market rallied at the open but pulled back after the service-sector reading. While pretty decent, the reading seemed to be boosted more by promotional activity than outright demand and the employment figure remained sluggish. The market moved to its highs on the session after Goldman Sachs recommended buying large banks (egad! – they are trading at 2006 multiples, yet earnings are less than half what they were back then) and Credit Suisse strategists’ put out a report titled, “No Time to Sell.”

Financials led the rally. Commodity-related energy and basic material shares were the next best performers as another session of dollar weakness causes money to funnel directly to these sectors – metals and oil.

Advancers trounced decliners by an 8-to-1 margin on the Big Board. However, volume was weak again with just 1.07 billion shares traded on the NYSE Composite – roughly 20% below the six-month average.

Market Activity for October 5, 2009
ISM Service

The Institute for Supply Management’s gauge of service-sector activity (the respondents to this report are purchasing and supply executives) rose above 50 (the dividing line between expansion and contraction) for the first time since August 2008. While the measure moved just barely into expansion mode for September, a number of the sub-indices within the report showed really nice improvement -- although, the gains looked to be largely price driven as the prices paid component plunged to 48.8 from 63.1 in August.

The headline index rose to 50.9 for September from 48.4 in the previous reading and 13-straight months of contraction.

For the sub-indices that make up the headline number:

The new orders index rose very nicely to 54.2 from 49.9 in August and follows 11 months of contraction. I’ll note, comments from respondents pointed to “promotional activities” as the driver for new orders – this helps to back up the price-driven comment above.

Business activity rose to 55.1 from 51.3.

The employment index picked up a bit, rising to 44.3 from 43.5; still sluggish but no surprise there. Three industries reported increased employment, 12 reported decreased employment, leaving three reporting unchanged employment compared to August.

As touched on, the prices paid index fell to 48.8 from 61.3. Six industries reported an increase in prices, eight reported prices as decreasing and four unchanged.

Interestingly, even though the overall reading rose, the number of industries that reported growth fell to five out of the eighteen tracked, down from six for August. Respondents’ comments varied and remained quite mixed about business conditions and the overall economy.

The five industries that reported growth in September were: Utilities, Health-Care & Social Assistance, Retail Trade, Construction, and Wholesales Trade.

What respondents said:

• “Sale are very steady and have risen some each month in the past six months. The bottom is now here.” (Construction)
• “Economic recovery turnaround has begun in the financial services sector; however, cautious expense management is still practiced.” (Finance & Insurance)
• “Lack of available capital for new project development.” (Accommodation & Food Service)
• “Continue to see signs of slow recovery, but customers are still putting orders off until the beginning of 2010.” (Professional, Scientific & Technical Services)
  

Government Induced Rise in Energy Prices

The Cap and Trade (C&I) agenda seems dead right now, but never underestimate Congress’ ability to do something really stupid even when the public outcry hit its crescendo. The WSJ reported yesterday on last weeks’ coordinated release of the EPA’s new rules that make carbon dioxide a “dangerous pollutant” (I guess that means we should all stop breathing) and the John Kerry-sponsored energy-tax bill.

As the EPA has now promulgated its decision to label CO2 a pollutant, even if the C&I bill is voted down, the EPA is coming to punish the utility companies (which means the consumer will bear the cost of these regulations). The strategery, to bring back a Bushism, is to get utility companies to back the C&I bill, in which they’ll be better off than the EPA running roughshod over them, as C&I would grant emissions allowances (permits) that they can sell to offset the cost of the EPA’s stricter regulations.

Surely everyone understands that once the EPA designates a chemical compound as a pollutant it has the legal authority to regulate it under the Clean Air Act. If the agenda can’t pass Congress, you’ve always got this to fall back on – isn’t that sweet.

It doesn’t matter that carbon is a result of warming and not a cause – and this is the route proponents take, if we don’t reduce carbon emissions then the earth’s ecosystem will collapse and we’ll all be dead – or so they say. (This too is yet another reason I’m not terribly optimistic about the direction we’re going. The priories are all screwed up as we put an “environmental” agenda ahead of economic growth imperatives.)

Climate change is a function of solar activity, plain and simple; we’re seeing solar activity wane now after a decade-long period of increased activity, and thus the reason for the cooler temperatures. In a period of rising atmospheric temperatures ocean temperatures rise as well, which means carbon is less soluble. Thus more carbon is emitted instead of being absorbed into ocean water – it is a result, not a cause.

(If it were true that humans were the primary cause of higher temperatures, then how exactly were temperatures higher during the medieval warming period that ran roughly 900-1300, an era in which Vikings colonized Greenland -- which means they cultivated crops -- in what is currently a frozen tundra?)

Increasing costs on the economy by regulating, and therefore taxing, carbon in an attempt to reduce this emission is not only futile, it will destroy economic growth in the process. But when Congress is dead set on their command-and-control agenda, it sure as heck won’t let facts get in the way.

I don’t think the market is pricing in the fact that we may not be dealing with a President Clinton here. When Clinton swerved way left following the 1992 election, his political finger always remained in the air. When the public outcry began, he shifted to the center, and even right of center once the Gingrich Congress rolled in in 1995. The Obama administration, conversely, does not appear to be of the same mold to me, they are determined to lay the ground work of their agenda no matter what the public thinks; the coordinated release of the EPA’s carbon decision and the C&I bill last Wednesday illustrates a willingness to get around the normal legislative process.

We cannot burden the economy in these ways. It wouldn’t work well in any situation, but at a time in which the economy remains vulnerable the damage done will be particularly acute.

This Week’s Data

It is a light data week as we have no releases today. We’ll receive mortgage applications tomorrow, which is always something to watch but not a major data set. The big release will be consumer credit for August. This figure collapsed in July and is expected to fall again by a huge amount. Credit in general is declining as credit-card lines are being cut, banks are unwilling to lend to all but the highest credits, and consumer are repairing household balance sheets – thus the demand for credit is down as well.

Then on Thursday, we’ll get the jobless claims figure. We need this reading to fall below the 550K level and make progress toward 500K thereafter. The market is ignoring labor-market conditions right now but won’t be able to do so forever. Jobless claims is one of the few forward-looking indicators within the labor-market data. Average weekly hours worked is the other, and this reading returned to an all-time low in September. Without a substantial rise in average hours worked and a meaningful decline in jobless claims, no one should expect job creation to come back.

On Friday we’ll get same-store sales for September, expected to show its 13th straight month of decline – the declines have eased though from big negatives of 4-5% year-over-year results to -2% in August. September should show additional progress, but consumer activity is likely to remain subdued for some time due to a sky-high jobless rate and much less availability of credit to help us out of this hole.



Have a great day!


Brent Vondera, Senior Analyst