The tax credit thing appeared to be what caused the market’s sudden reversal. Stocks rallied 1.2% right out of the gate, but erased those gains and them some after a Washington research group noted the Reid/Baucus amendment will include a phase out of the credit – it was previously understood that the idea would fully extend the credit through 2010.It’s not official, but talk is that the phase out will extend the $8,000 credit to March 31 and then be reduced by $2,000 each successive quarter until expiring at year-end 2010.
(The amendment also involves yet another extension to unemployment benefits and the loss “carryback” for business, which allows certain firms that record losses in 2008 and 2009 to get refunds for taxes paid in the previous five years. I love this stuff, as if businesses are going to run out and spend this refund even though they remain cautious. Firms are very concerned about higher tax rates and what that does for economic growth and thus demand for their products. It is the policy direction that Washington is signaling that’s keeping firms hesitant to spend even on inventories. I’m not hopeful this loss “carryback” plan will have a positive effect in the economy.)
On top of that, the news that the government wants Bank of America to increase its capital ratio before it repays TARP money also weighed on the market. Reports that regulators want the bank to raise $45 billion via a new capital offering (which would substantially dilute current shareholders) before repaying the government renewed concerns other big banks may have to do; this put pressure on the entire sector. A downgrade of Fifth-Third, SunTrust and U.S. Bancorp by Dick Bove also pressured shares. If that’s not enough we’ve got financial regulations entering center stage and the chairman of the House Financial Services Committee is expected to unveil his “to big to fail” proposal today.
We’ve talked about issues for the banking industry for some time. It’s not just that credit-quality is a mess, but the government can come along and make a decision at anytime that puts more screws to the sector. At least in terms of credit quality, it seems that more people are beginning to consider that maybe the financial sector is not exactly in up and away mode. You think about the commercial defaults coming down the pike and it only adds on to what we’re seeing in residential and consumer credit losses.
It seems quite remarkable that the equity market continues to hold up so well considering these headwinds. But then, the market is juiced on the easy-money trade. It’s not just that traditional banks can borrow from the Fed at basically zero and buy stocks. Don’t forget that firms like Goldman Sachs were made commercial banks at the height of the crisis in the name of “too big to fail.” I guess it shouldn’t be all that surprising stocks continue to push aside troubles as the cost of money is zilch.
This zero-interest rate policy also provides vast amounts of liquidity and it causes people to become irrational as it takes the fixed income side of things out of the game – you have people saying they hate bond yields and decide to take more risk than they otherwise would within the stock market as a result.
Market Activity for October 26, 2009
Bond MarketThis week we’ll get $123 billion in government bond issuance (adding to the $1.1 trillion in net sales this year), so the relatively heightened anxiety with regard to auctions will certainly continue. (The anxiety is just relative at this point, normally there is zero anxiety over Treasury bond auctions, but I’m expecting it will continue to increase over the next 12-18 months.)
There has been a lot of talk about how the Fed will begin to remove liquidity. This is the Fed’s way of getting expectations moving regarding this liquidity drain, certainly they must engage in this first step before actually doing so. But as the central bank completes their purchases of Treasury securities (assuming they don’t shift and actually end up increase purchases in the near future due to a deteriorating economic environment, which is a pretty big caveat right now) this will put added pressure on auctions and may be the trigger that increases anxiety – an anxiety level that would flow into stocks.
For now, demand for U.S. government debt remains strong. If the erosion in credit-quality continues, and banks therefore must continue to hold capital dear, the economy will have a rough time expanding and thus a run for safety will keep demand for Treasury securities elevated. But at some point, and I’m not talking years here, one has to assume that the market will demand a higher return to absorb evermore debt issuance. When the Fed can no longer risk damage to the dollar and thus will no longer be there for backstop support, these auctions are likely to run into some trouble.
On the dollar, it rallied hard yesterday. Just as stocks reversed to erase gains, the dollar reversed course and rallied to erase its early-session losses. Bad news is the only thing the greenback has going for it and that’s not going to change so long as the Fed keeps monetary policy aggressively easy.
Dallas Manufacturing
The Dallas Federal Reserve Bank’s survey on manufacturing activity came in worse-than-expected, posting it 24th month in contraction. The reading for October posted -3.3, a reading of -0.5 was expected.
I’ll note that this is not a major economic release and is not even one of the main regional factory gauges, but it was our only data release yesterday and therefore worth a mention. Six of the eight sub-indices of the report weakened dramatically. Production fell to -8.0 from -0.5; capacity utilization fell to -11.3 from -4.8; new orders declined to -2.8 from +8.0 (which happened to be its first positive reading since 2007); volume shipments dropped to -16.1 from +0.3.
The aspect of the report that I found most important was the inventory gauge, it showed what a couple of other regionals have shown for October: the rebuilding of stockpiles has yet to take place. Dallas’ inventory gauge remained mired in contraction mode, coming in at -24.2 after a -25.6 print in September. (The Philly and New York factory reports also showed inventories remained in contraction mode, the Philly number showed big deterioration and New York reported some improvement, but still contraction.)
The six month outlook for inventory rebuilding (and I’m back on the Dallas number) also worsened, printing -2.3 from -1.1. Again, firms remain very cautious – and will likely continue to exhibit a heightened level of caution until they see policy turn to make more sense regarding a multi-year perspective.
This Week’s Data
The rest of the week will be very busy on the economic data front. Today we get the CaseShiller Home Price Index for August and Consumer Confidence for October.
On CaseShiller, while this data has a huge lag to it, the release is the most watched home-price measure. It is expected to post a fourth-straight month of gains, coming off of the cycle low hit in April. The rush to get in before the homebuyers’ tax credit expires (must close on the contract by November 30 – and it is taking six weeks on average to close these days) will help the reading post another increase.
Also, CaseShiller is heavily weighted to regions that have the highest foreclosure rates, so the areas that got pounded several months back are naturally showing the largest degree of rebound. This number will get interesting as the October figures are released as it may just show the rebound in prices is a short-lived event.
Shifting to consumer Confidence, the reading is expected to show an increase from the September reading of 53.1: however, if the confidence reading from the University of Michigan is any indication, this latest figure will disappoint. (For clarity, there are two confidence readings, one from the U of M and the other, and the most-watched, from the Conference Board). The rebound in consumer confidence from the cycle low has been touted as a big development, but the bounce has been from deep lows, the current reading in the low 50s remains well below the long-term average of 96. The current level matches that of past recessions, so the bounce just gets us back to something that resembles a normal recession. If gasoline prices continue to rise, you can forget about a bounce to more normal levels.
Later in the week, we get durable goods orders, new home sales, jobless claims, the initial reading to third-quarter GDP and personal income and savings.October durable goods orders are expected to rise a bit after a pretty big decline in September. What we’ll watch is the business spending gauge within the report. If this doesn’t begin to show some life, it will spell trouble for those expecting big GDP readings over the next couple of quarters.
Thursday’s initial jobless claims figure remains one of the most watched releases out there. This number has to trend down to 500K (currently stuck in a range of 525K-550K) in order to offer some evidence that the pace of job additions is beginning to outpace that of job losses.
The first look at third-quarter GDP will show the technical end to this deep (and longest in the post-WWII era) recession. Economists expect a reading of 3.2%, which will be driven by a lot of government support, namely the clunker-cash program, which was a one-and-done event. Under normal circumstances, a bounce of 6%-8% GDP growth for a couple of quarters would emerge from such a deep contraction. This will not be the case this time. I think we have a shot at a 4%-5% reading sometime over the next couple of quarters, but this will be a function of inventory rebuilding, but this offers a very short-term pop to GDP. Eventually you need final demand to come back and necessary conditions for this are more jobs and increased business confidence.
Friday’s personal income and spending numbers for September will be key to see what direction the savings rate takes. Overall spending is expected to decline for September after August’s data showed spending hugely outpaced that of the rise in incomes – incomes managed a 0.2% increase, yet clunker-cash and the back-to-school season drove spending higher by 1.3%. The cash savings rates made it back to 5.9% in May, but has been falling again, hitting 3.0% in August. This number needs to go to 6%-8%, that’s just the reality after home and stock prices have been hammered (stocks still 30% off the peak and homes down nearly 25%) and this means lower levels of spending. The longer it takes to get to these percentages the longer it will take for consumer spending to rebound in a sustained manner.
Have a great day!
Brent Vondera, Senior Analyst
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