It was a slow news day yesterday with regard to economic data, all we received was a gauge of sentiment among homebuilders. The report is not one of the widely watched releases, and it unexpectedly fell to boot, so it’s not like anyone can point to this data as yesterday’s market driver.
In terms of analysts’ recommendations, as we’ve touched on a number of times now, Wall Street’s bandwagon mentality is in full swing. RBC Capital Markets suggested buying shares of Caterpillar. As a firm that owns Caterpillar, we thank them for the boost the recommendation gave to the stock yesterday. But let’s get serious, the stock already has a lot of good news prices into it. I can see recommending the shares when they were at $25 back in March, but now that the shares trade at $57 (and 29 times next year’s earnings estimate)…well, that’s where the bandwagon part comes in.
Diversified manufacturer Eaton Corporation did report better-than expected profit results before the bell, that certainly put futures on the right track and the positive sentiment flowed into the official trading session. But the revenue side saw declines in all divisions – down 26% all told from the year-ago period. The bottom line was helped by a slashing of employees and the shutting of plants (oh, and the one-and-done event that was clunker cash, which boosted the automotive unit). There was no sign of a pick up in aggregate demand, which is what I thought third-quarter earnings were supposed to show.
We need to be aware of these realities. Getting carried away will only get one in trouble in this market, many have forgotten this after the surge from the March lows but it will remind us all again – obviously I have no idea when; I can only say what valuations makes sense based on the reasonable prospects of economic growth and historical precedent, which is why I’m skeptical of the current leg of this rally.
All 10 major sectors participated in Monday’s rally. Volume was fairly punk as just 1.035 billion shares traded on the NYSE Composite.
Market Activity for October 19, 2009
CrudeThe price of oil for November delivery approached $80/barrel as crude is up $10 in eight days – closed at $79.40 yesterday. This is completely the down-dollar trade as demand fundamentals justify a price closer to half this level. But, commodities (hard assets and oil in particular) look to be melding into the new currency the world wants as they seek to hedge against a dollar that continues to decline in value. And speaking of the dollar…
Dollar Policy and Then Some
I caught last week’s CNBC interview with Treasury Secretary Geithner in which he was asked about his thoughts on the direction of the dollar. He pretty much side-stepped the question that pertained to the current direction of the greenback, but commented that the government needs to get its fiscal house in order to boost the value of the buck over time. What does this statement say?
First, the Obama Administration, just as the Bush Administration wrongly exhibited, is just fine with a weak dollar right now. They need exports to make the GDP numbers look marginally better. But this is a dangerous game as the lack of confidence in dollar stability will come back to haunt. The point of this comment is to make clear that despite what Treasury says about wanting a “strong dollar,” it’s just talk – nothing new there for those who watch these things, but we’re hearing an exceptional level of “strong dollar” comments as the greenback gets slammed.
But to the question above, when Geithner says we need to get our fiscal house in order, what he is signaling is the administration’s focus on raising tax rates. Surely, no one believes we’ll see a decline in spending considering the huge government programs Washington is currently attempting to erect (fiscal year budget deficit totaled $1.42 trillion, or 10% of GDP and double the previous postwar record – expect worse for 2010).
Nor are we going to get pro-growth policies that attack the economic side of things as a way to drive incomes, job creation and entrepreneurial desires in order to increase the tax base – the correct way of driving government tax revenues, in my opinion. No, we will see higher tax rates, and these higher rates will not only arrive via the expiration of the Bush tax rate reductions (end of 2010) but from new U.S. experiments, such as value-added taxes and raising the social security tax income cap.
This isn’t just about the Treasury and the Obama Administration in general though, one would be quite wrong to let the Fed off the hook, there is more than just a fiscal element to the dollar’s value. The Fed has the monopoly on dollar creation and so long as they keep policy floored (emergency level rates for an “extended period”) the dollar will get trounced. So, between tax rates, massive budget deficits and the flooding of dollars into the system nothing is going in the dollar’s favor from a fundamental aspect right now.
This is just the political cycle we are in and it’s vitally important to be aware of it.
Beyond just the dollar situation, there was something else I found disturbing from the interview. It was the overt statement from Geithner that “the world will depend less on the U.S. as the engine of growth.” This is exactly the defeatist attitude that marginalizes countries over time. I also find the statement highly offensive for anyone who believes in American interests.
To the contrary, we must do everything we can to make sure the U.S. remains the leader in every regard, but especially in the area of economic status – everything else either flourishes or falls apart from there, depending upon whether we take the reigns and say we’re going to make the 21 century another American century, or we take this defeatists attitude and slowly relinquish our lead.
NAHB Housing Market Index
The National Association of Home Builders (NAHB) reported that the index tracking confidence among homebuilders slipped in October after three months of mild increase. Economists had expected the index to rise again.
The coming expiration of the first-time homebuyer’s tax credit has homebuilders very worried, concerned enough that both the NAHB and NAR (National Association of Realtors) sent a letter to the White House yesterday asking for a one-year extension – and to expand it to include all homebuyers, increase the amount of the credit and to make the credit available at closing. Well, now that’s going for the gusto!
The housing market has benefited from many crutches: the Fed’s quantitative easing campaign (Treasury and mortgage-backed securities purchases in order to drive interest rates lower); government agencies such as Fannie, Freddie and the FHA, which make up the vast majority of mortgage originations; and the first-time homebuyers tax credit. You take away just one of these, the tax credit, and the housing market relapses. I’m not saying it would make a new low, the level of home purchases in January (the cycle low) is not likely to be tested. But this is a microcosm of the economy in general. Take the crutches away (and the support cannot remain in place for long, soon enough the economy will have to be tested to find if the expansion is self-sustaining) and we‘d be lucky to post 0.5%-1.0% GDP over the next year. The market seems to be pricing in 3%-4% GDP growth, if only for a short period of time. It seems to me the rubber will have to meet the road when it comes to equity-market valuations.Fed Speeches
We’ll have something like nine speeches from Fed officials this week. It was be interesting to see how the market reacts to these comments. If recent history is any guide, the speeches will be quite conflicting in nature as some central bankers seem to have no problem keeping monetary policy floored, while others commiserate over the perils of such action.
Indeed, if the Fed were to gently raise rates right now it may very well have a positive effect on stock prices and the dollar would surely rally. (I believe a mild increase in fed funds, going to 50 bps next meeting and another 50 in December would be helpful – bringing fed funds to 1.00% would still be massively accommodative, it would only take away the abyss-type emergency easing that Bernanke continues to extend; we are out of abyss-type circumstances right? That’s what stocks are saying.) Certainly, banks would feel a little more pressure as the zero-interest rate policy is all they’ve got right now.
However, the longer we keep policy at emergency levels, the harsher the unwind is going to be – the effect on the economy will be pronounced. But hey, when the punch is spiked, very few want to call an end to the party.
Last call? You’re not throwing this crowd out yet. Besides, Bernanke is the liquor patrol agent right now and he’s telling the bartender to keep serving.
Earnings and Futures
Apple reported fabulous results last night after the bell, awesome top and bottom line growth. So what we have here is good results from Intel and IBM, and great results from Apple. The rest of the universe has yet to show revenue growth, which is what we heard last quarter that everyone would be looking for. As a result, futures are mixed as the NASDAQ is up big, while the S&P 500 is down, but not by much.
Correction:
Yesterday, in explaining the deterioration of credit quality within the banking system I stated: Bank of America’s non-performing loans fell 9.1% from the previous quarter. I obviously meant to state that non-performing loans rose 9.1% from the previous quarter. Sorry for the confusion.
Have a great day!
Brent Vondera, Senior Analyst
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