Daily Insight

U.S. stocks lost ground on Tuesday, reversing pre-market enthusiasm that followed the morning’s earnings releases, as worse-than-expected news out of the home construction industry and a particular comment from Caterpillar gave traders some pause. It’s also likely that traders held back from getting in front of a number of bank-industry earnings scheduled for release today before the bell.

The market did pare its losses, recovering about half of the morning-session decline as the day wore on, something we’ve seen a lot of lately on days in which stocks come under pressure.

The housing starts figure was a bit of a shock to the market as the latest revisions showed starts actually fell in the previous month and thus won’t provide quite the boost to GDP that was expected. The reading on housing permits, a gauge of future activity, declined and single-family building permits in particular fell by the most since March – which happens to be the month before housing starts hit the cycle low.

More than the housing number though, comments from Caterpillar may have had the primary effect on market activity. The company seems to be counting on global central banks to keep monetary policy floored (which isn’t exactly a stretch) or they fear the global economy will relapse into recession – a recession, according to CAT, that would result in “an even worse recession than the one just ended.” Needless to say, the company doens’t think much of the expansion is self-sustaining argument.

Nine of the 10 major sectors declined on the session, the S&P 500 index that tracks technology shares ended the session unchanged. Utility, basic material and consumer discretionary shares were the worst performers.

Volume was fairly weak again, as 1.17 billion shares traded on the NYSE Composite – that’s roughly 10% lower than the six-month average, but a bit higher than that of the past 10 sessions.

Market Activity for October 20, 2009
Producer Prices

The headline producer price index reading continues to bounce all over the map, falling 0.6% (expected to come in unchanged) for September after the 1.7% jump in August. It all depends on the monthly direction of the gasoline component right now, which jumped 23% in August, leading to that large 1.7% rise in headline PPI. For September, gasoline fell 5.4%, and headline PPI was down, as just stated. For October, gasoline (as measured by the wholesale price) is up 13% thus far, so we’ve got a good idea that PPI will print a pretty strong increase when released next month.

For the year-over-year comparison, PPI is down 4.8% from the year-ago period – although this is being compared to a level that is just slightly off of the all-time high (Summer 2008’s commodity price spike that has oil at $140/barrel and copper at $4/lb., etc. The y/o/y figure will have a positive sign in front of it by November when the comparison becomes much easier.

The core PPI reading (and for new readers “core” just means that energy and food components are excluded) fell 0.1% last month and is up just 1.8% from the year-ago level.

Overall, headline producer prices present little problem for the Fed right now, as is true with all inflation gauges.

The two components of this data to watch, which seems to be largely ignored but is a great indication of future trends, is the crude and core intermediate goods readings. The crude goods reading (not to be confused with crude oil, this is just the goods at the earliest level of production) jumped 3.6% in September and has soared 60% at an annual rate over the last three months. Now, productivity eases the vast majority of costs at the initial level of production, but I mention it only to offer some color as to the degree of increase. The core intermediate goods reading (the next stage of production) rose 0.9% in September and is up 7.2% three-month annualized. These components show the rise in commodity prices may begin to present an issue for the headline inflation gauges a few months out.

Housing Starts

Housing starts rose 3,000 to 590,000 at an annual rate in September, which gets the figure back to the June level. The readings of the previous two months had shown improvement from the June level, but the latest revisions to those readings now show and overall decline occurred in housing starts since June.

The September reading was 20,000 less than expected as economists estimated starts to rise to 610,000. A 15.2% decline in multi-family construction was the drag on the overall reading. Single-family construction rose 3.9% in September after a 4.7% decline in August.

Below are long-term charts of housing starts and permits, going back to 1960.

Permits, a gauge of future construction, fell 7,000 to 573,000 at an annual rate.

The market will be waiting for that extension to the homebuyers’ tax credit; I would be extremely surprised to see Congress punt this one. Since many are now expecting an extension (and possibly offering the credit to all homebuyers and boosting the actual credit amount) this may lead to a harsher deterioration in both starts and sales as homebuilders and potential homebuyers wait for the new support.

Dollar Down

We’ve talked a lot about the dollar for a while now, a discussion I’d like to think that began well before it became all the rage in the media. The greenback rose ever-so-slightly yesterday but is down 10 of the past 14 sessions. Old green really has nothing going for it right now. The direction of tax rates, massive budget deficits and the flooding of dollars into the system all weigh on the buck.

The only thing that looks able to rescue the U.S. dollar here is the same thing that rescued it from the all-time lows hit in 2008 – that is the safety trade. (When I refer to the all-time low on the U.S. dollar it is via the Dollar Index, which goes back to 1967. This measures the U.S dollar against a basket of other currencies.) This is not what you want to see, needless to say. You don’t want the only thing our currency has going for it to be economic and stock-market weakness.

(For those curious about that spike and precipitous decline in the mid-1980s, I’ll explain what occurred below)*

Banks appear to be on a quiet road of asset erosion and this has me increasingly concerned. In order to protect capital ratios due to eroding assets, banks simply borrow from the Fed at roughly 0% and lend that money back to the Treasury – T-bill/note holdings are counted as capital. This is not a growth story. A growth story would be to lend that money to small and medium-sized businesses, which would help drive activity, jobs and incomes. But banks can’t do that right now as they remain in a precarious situation.

And this is where the safety trade comes back in. If the banking system endures another leg of significant asset erosion, the safety trade will flow again because people will understand exactly what it means for the economy in the very near future. This is the kind of stuff that causes the greenback to rally lately, such as the massive safety trade that occurred when we went through hell late/2008- early/2009. When this is all the greenback has going for it, it doesn’t have anything going for it.

Only sound policy will cause a shift in the reasons to own dollars and when sound policy returns, the U.S. dollar will rally again on good news, which is the way it should be.

* The spike and precipitous decline in the Dollar Index in the mid-1980s occurred when the Plaza Accord was agreed upon in 1985. The dollar soared in the early 1980s due to the powerful economic expansion that began in 1982 and was rip-roaring by 1983 -- actually termed the miracle of 1983 by a number of foreign governments as coming out of the 1970s everyone thought the U.S. was in decline; sound familiar? Decline is a choice not an inevitability and we chose to remain the global leader. Anyway, a turn to sound monetary policy and smart economic policy in the early 1980s allowed for the U.S. economy get on its horse, which lasted for the next 20 years nearly unabated. But as the world was amassing dollar-denominated assets in the mid-1980s, the U.S. worried that such a strong dollar would continue to hurt exports and other governments worried that their currencies were too weak relative to the almighty dollar. So, the G5 -- now an even goofier organization of basket cases as it is currenlty the G20, no wonder they can’t get anything done with all of these competing self interests -- decided to sell dollars and that brought the greenback back down 90 or so on the Dollar Index.

Have a great day!


Brent Vondera, Senior Analyst