Daily Insight

U.S. stocks spent most of the session below the flat line on a downgrade of chipmakers and investors seemed content to wait for the end of the Fed’s two-day meeting, but the broad market rallied late in the session to close in positive territory. A couple of merger and acquisition deals helped to offset substantial weakness in pre-market trading that flowed into the official trading session. Stanley Works will purchase Black & Decker and then there is the big one, announced early yesterday morning, which was Berkshire Hathaway’s purchase of the 77% of Burlington Northern it didn’t already own.

Industrial shares led the broad market’s advance, propelled by the two deals. The basic material (certainly helped by a big time rally in the price of gold) and energy sectors were close behind. The losers on the session were health-care, utilities, tech, telecoms and consumer staples – all closed lower on the session.

Berkshire’s all-out purchase of railroad giant Burlington Northern is clearly a bet (since Buffett is an economic advisor to the Obama Administration it was probably much safer than a “bet”) on increased infrastructure spending and future taxes on carbon emissions that make truckers less competitive relative to the rails.

Advancers whipped decliners by a two-to-one margin even though the overall market didn’t really have much juice to it. The advancers surely didn’t advance by much, with the exception of the transports on the Burlington deal. The Dow Jones Transportation Average massively outperformed the market (up 5.28% on the trannies vs. the 0.24% pick up for the broad index).

Market Activity for November 3, 2009
Gold

The front-month gold contract rose to a record, spiking $31 to $1085.80 (still well below the 1980 inflation-adjusted price of roughly $2350/oz.) as India’s central bank went on a little buying spree – they purchased 200 tons, or $6.7 billion worth, of gold from the IMF.

Bianco Research

Is this a move to diversify away from currencies (namely the U.S. dollar) as the world loses confidence in governments’ ability to stabilize currency values? It seems that way. The purchase boosted India’s gold holdings by 55%. Hey big Ben, it’s kind of difficult to ignore this transaction!

Earnings Season

We haven’t heard a lot about earnings season after the first couple of weeks of results. It’s interesting how the press makes such a big deal in the early stages of the season when just a few companies have reported, and attention tapers off when it really counts -- and it counts now as 80% of S&P 500 members have released results.

Analysts and financial commentators had talked much of the fact that 82% of S&P 500 members have beat expectations, but those were pretty low-ball estimates – firms have low-balled estimates for several years now, but the percentage of positive surprises shows they were really marking things low this go around; the long-term average of S&P 500 members that beat expectations is 59%.

Profit results overall though are quietly eroding, quietly because no one seems to be talking about it. A couple of weeks into the season results were down roughly 8% from the year-ago period. Last week when we touched on profit results, S&P 500 earnings were down 15%. Currently, with most firms now having reported, overall profits are down 22.3% (down 26.6% ex-financials). That’s not much better than the previous quarter’s results in which overall profits fell 28.9% and ex-financial was down 27.9%. And the current results are being compared against easier year-ago period comps than the comparisons for the previous quarter.

FOMC

We’ve got a lot of important data/announcements for the remainder of this week. We have the preliminary jobs reports via the Challenger Layoffs and ADP Employment surveys as we wait for the official October jobs results on Friday. We also have same-store retail sales results for October coming on Thursday. But we also have the latest FOMC (Fed’s rate-setting and monetary policy committee) two-day meeting and the comments that follow the meetings end, which occurs this afternoon.

So we turn to the Fed and the market awaits the comments. It is clear that one expects they’ll increase the benchmark fed funds rate. So, the market will be intensely focused to the wording and clues as to when Bernanke & Co. will shift from their ZIRP “for an extended period” to simply a policy that is just accommodative. That is, shifting from the current emergency level of fed funds to something closer to 1%-2% over the next several months to a year. It’s easy to forget, I guess, as the Fed has kept the pedal to the metal, but 1%-2% FF is still amazing accommodative.

This ZIRP policy that has been in place for almost a full year now, and will have extended beyond a year by the time it is removed, is arguably justified based on the troubled state of the economy but it is also destructive as well. The Fed needs to be very careful not to extend this for too long – besides we need to know if the economy can stand without it. If it can’t manage to grow at 1%-2% FF, then the market has some valuation adjustments to get on with – for sure, the distorting effects of the Fed’s policy needs to end for it will only cause a more severe blowback the longer they wait.

For instance, the ZIRP has devolved the U.S. dollar into a carry trade currency – traders borrow at the exceptionally low U.S. interest rates and invest in higher return vehicles; the occurrence of this is obvious as virtually all asset classes (and even those that are not official asset classes) are moving in the same direction. Stocks, bonds, gold, oil, industrial metals, they are all moving in tandem – a very unusual occurrence. When the Fed does turn course and eventually moves to increase rates (and removes the carry trade) the mad dash for the riskier-asset exit door will ensue and that more than likely means a simultaneous decline among many different asset classes. The longer the Fed waits, the more damaging this run for cover will be on asset prices.

The Fed has backed itself into a corner, and it began with their mistakes all the way back in the 2002-2005 period, which was a primary cause of this entire mess. The longer they remain in the corner, the more head shots the economy will take when they step out. As a result, the Fed meetings, and comments that follow, will become intensely important events.

I’ll tell you this, the Fed is keeping a close eye on the banking industry now and may see the challenges to the financial system as still so great that they feel compelled to keep ZIRP in place. If the members of the FOMC cannot decide to even mildly remove some of this aggressive accommodation, then that should be a crystal clear signal to all that they see loan portfolios are continuing to erode at an alarming rate. What else would justify this emergency level of rates and the consequences that follow?

Factory Orders

The Commerce Department reported that factory orders rose a healthy 0.9% in September, slightly more than expected, after a 0.8% decline in August. Bookings for durable goods orders (which currently make up half of factory orders) jumped 1.4% after a 2.7% decline in August. Machinery orders fueled the gain in durables as mining, construction and power transmission companies ordered new equipment. Bookings for non-durable goods (such as food, petroleum, clothing, paper products, etc.) rose 0.5% in September. Food, petro and paints and coating (autos) led non-durable shipments higher. Beverage & tobacco, apparel and paper products dragged on non-durables.

The proxy for business-equipment spending rose 1.8%, after a 1.0% decline in August; the figure has been absolutely crushed over the past year, down 16% -- although an improvement from the year-over-year 21% decline as of August.

Unfilled orders fell for a 12th straight month (longest stretch of decline since records began in 1992), down 0.3% in September, which shows factories (even with much lower payroll levels) are having no problem meeting orders.

Inventories fell for a 13th straight month, down 1.0% for the month. The inventory-to-shipments ratio fell for a fourth straight month to 1.36 (from 1.38) but remains well-above the record low of 1.13 hit in December 2005.

The gain in factory orders marks the fifth increase in six months. From here we will see if it is sustainable, it will all depend on the timeline with which final demand arrives. If it is lacking, due to a persistently high jobless rate, we won’t get that full-blown inventory dynamic we’ve been waiting for and that will show up in the production numbers.

October Auto Sales

Late in the day yesterday we got the October auto sales figures, which bounced a bit from September’s very weak 9.20 million units. Vehicle sales rose to 10.45 million at an seasonally-adjusted annual rate (SAAR).



Have a great day!


Brent Vondera, Senior Analyst