Daily Insight

U.S. stocks spent most of Thursday’s session in negative territory, but climbed to the plus side late in the afternoon and accelerated to the close. For most of the session energy shares were the only group offering the broad market support, but by the time the closing bell sounded all but two of the 10 major sectors closed higher. Technology and financial shares were the laggards.

Energy shares rallied, by far outperforming the market, as the weekly energy report showed gasoline stockpiles plunged 5.23 million barrels, more than four times the decline expected.

The price of crude for November delivery jumped to $77/barrel and wholesale gasoline extended its four-session increase to close at $1.94/gallon – up 20% over the past three weeks as the wild range of $1.60-$2.08 during the past four months lives on. Refiners have slashed production over the past few weeks and this will eventually lead to an increase in crude purchases in order to rebuild refining product. What refiners receive for refined product relative to the price of their input (crude) is lower than it needs to be to drive production. The crack spread, or the refiners’ margin, is currently 35% below the 10-year average. An increase in gasoline and heating oil prices, or a decline in crude prices, will resolve the lack of refining production issue.

Advancing shares barely edged out the number that declined on the NYSE Composite. Volume was a bit improved as 1.3 billion shares traded, in line with the six-month average.

Market Activity for October 15, 2009
Jobless Claims

The Labor Department reported that initial jobless claims fell for a second week in a row, down 10,000 to 514,000 – lowest level since January. The previous week’s reading of 524,000 was revised higher, initially reported to be at 521,000. This is a helpful move, but anything above 500K is an elevated level from a historical perspective and thus the decline in claims was not a market mover.

The four-week average of claims fell 9,000 to 531,500.

Continuing claims fell 75,000 to 5.992 million. The continued move lower in this data is failing to make anyone hopeful that even a slight return to job creation has occurred as many of these people are simply moving to the extended benefit rolls – between extended benefits and the emergency unemployment compensation (EUC) program, this extends benefit by an additional 33 weeks.

The good news is that the rise in extended benefits was less than the decline in traditional benefits (traditional continuing claims fell 75K and extended and emergency benefit rolls, combined, rose just 16K) so maybe some of these people that came off of benefits were able to find a job.

Emergency unemployment benefits hit a new record (up10K to 3.331 million), and extended benefits to a new high too (up 6K to 471K).

Consumer Price Index (CPI)

The Labor Department reported that headline CPI rose 0.2% in September (in line with expectations), following a 0.4% increase for August. The core rate, which excludes food and energy prices, also rose 0.2% (0.1% was expected) after a 0.1% increase in August. Core CPI is trending 1.5%-1.8%, so this presents no issues right now – I’ll add though that this is not a deflationary environment as many people are still stating. (It would take another leg down in credit activity to make deflation a concern).

Outside of the transportation-related components CPI is not presenting a problem for the Fed. Although, the headline reading is up 3.9% at an annual rate over the past four months – but the Fed can talk this away.

On a year-over year basis headline CPI is down 1.3%. It’s true that CPI rarely posts declines (go back to 1945 and there are only two other periods of this occurrence, 1949 and 1955) but the fact that the reading is being compared to the high mark on the CPI index (not the percentage change figure, but the index itself) due to last summer’s commodity-price spike, down just 1.3% shows there may be embedded inflation out there.


CPI will not begin to pose any problems until November/December when year-over-year comparisons become very easy.

I will note that the Owners Equivalent Rent component in CPI (which makes up 24% of the index) fell 0.1% -- only the second decline in 17 years. This number is calculated in what seems to be a counterintuitive fashion (not getting into that now), but it does seem to be working for the current environment. Take a drive around and notice all the “for rent” signs. Rental rates have to be getting hammered by the 10% unemployment world we find ourselves in.

Empire and Philly

The manufacturing surveys out of both New York and Philadelphia were out yesterday, showing the two remain in expansion mode. Empire soared, hitting 34.57 (twice the forecast) for October, after September’s reading of 18.88. Philly remained in expansion, but the rate of growth decline a bit to 11.5 (slightly less than forecasted) from 14.1 in September.

On Empire: new orders, unfilled orders and employment (first positive in the number of employees gauge since June 2008). The average workweek jumped to 20.78, the highest level since October 2007. Inventories remained negative though, but 7 points better than the previous month. This is a very good report overall – with the exception of inventories, which we’ll touch on below – but we need to see it confirmed by the broad ISM reading as Empire is particularly volatile.

On Philly: the numbers were so-so. The headline number posted a reading in expansion mode, but prices paid vastly outpaced that of prices received (not good for margins); the number of employees improved but remains in contraction mode; delivery times sped up (you want to see this slow); and inventories were horrible, falling 13.7 points to -31.8 (barely better than the average during the height of the crisis).

The inventory data increases doubt that a full-blown rebuilding of stockpiles will occur even in the fourth quarter. This manufacturing data (for October) gets Q4 started off on a bad note in this regard.

FOMC Minutes

This text from the latest FOMC meeting was released on Wednesday, but I ran out of time to touch on the comments in yesterday’s letter – so here we go.

Overall, the minutes didn’t reveal anything terribly new. The consensus was to hold the Fed’s benchmark interest rate at rock-bottom (full-blown emergency) levels for an extended period. (It doesn’t appear the Fed is as quite as sanguine as that of the stock market – understatement!). The only new comments were that some FOMC members expressed a desire to increase their mortgage-backed security purchase program for fear of a housing market relapse.

In terms of their comments on the overall state of things:

• Industrial production (IP) has increased from very low levels thanks largely to auto assemblies
• Business spending has stabilized (transportation equipment rising, investment in equipment and software stabilizing after falling sharply)
• Vacancy rates in commercial real estate continue to rise and property prices fell further (this is for August-September)
• Firms reducing inventories at a slower rate
• Business contacts expressed relief that the most severe economic outcomes have been avoided, but remain cautious about recovery
  

After the release of these minutes, and comments from Fed Vice Chair Kohn earlier this week that there is no need to even mildly shift rates higher, it is no surprise that the dollar continues to decline against a basket of other currencies. We’re in danger-zone territory here and I peg 70 on the Dollar Index (DXY) as the alarm bell that eliminates the current luxury of keeping fed funds floored. The safety trade rescued the dollar in 2008 when it approached 70 on DXY, but of course the events that caused investors to run for safety smashed everything else. Seems like a precarious situation, but this is obviously a minority view at the present.

Futures

Futures are lower this morning after the latest earnings reports fail to show final demand is coming around – a necessary condition for higher revenue growth.

IBM’s earnings release after the bell showed operating earnings jumped 17% from year-ago results, gross profit margin rose 180 basis points to 45.1% (up 20 of last 21 quarters) and services backlog up 4%. The company raised its full-year 2009 earning forecast. All good right? Problem is revenues fell 7% from the year-ago period. That’s not bad, but does show final demand has yet to arrive. Geographically, the Americas third-quarter revenue fell 5%; Europe/Middle East/Africa fell 12%; and Asia-Pacific revenues were flat. The other issue within the report was a 7% drop in signed services contracts – this is an indicator of future business.

Google also reported last night after the bell and showed the ad market is beginning to recover. Third-quarter profit was up 27%. Revenue rose about 10% from the year-ago period, boosted by a surge in mobile searches (smart phones). This is going to be a nice driver for Google’s results over the next couple of quarters, but Google’s revenue results are an isolated case.

Bank of America’s results are out too, but I haven’t had a chance to look over the report. Consumer defaults continue to rise, and this surely is what led to their earnings miss. I see old Ken Lewis got smacked by the government’s Pay Master. I’m sure Mr. Lewis isn’t going to find much sympathy, he’s not going away a poor man, but the government’s dismantling of contracts (and this is not the first case, remember the way senior bond holders of GM and Chrysler were treated) is not the American way. Oh, I’m sorry; it’s the new American way.

So futures are lower on the revenue concerns via the IBM report, and just released results from GE (also showing bottom line is still being boosted by aggressive cost cutting and no help from revenue, which was down 20%). But the direction of futures has shown little bearing on final results as the market has the easy-money/zero-interest rate trade going for it.


Have a great weekend!


Brent Vondera, Senior Analyst