Daily Insight

U.S. stocks sold off in the final hour of trading after spending the entire session higher by about 1.5%. By the time the bell rang the Dow closed up just 0.30% and the broad S&P 500 just 0.10%. I guess it was the old story “buy on the rumor sell on the news” as Fed policy makers kept their aggressive easing campaign in place.

Financial, industrial and energy were the worst performing groups on the session. The fact that energy was down seemed a bit strange on a day in which the price of crude rose back above $80. But think about it. The Fed keeps the pedal to the metal, that doesn’t exactly give the impression that the economy is at all able to stand on its own – as a result, these sectors will lead to the downside. The credit-card regulations coming out of Washington certainly also put pressure on the financials.

The dollar got Bernanke’d, giving up the little progress it had made over the previous six sessions.

Market Activity for November 4, 2009
Mortgage Applications

The Mortgage Bankers Association reported that applications rose 8.2% in the week ended October 30, the first increase in four weeks. Purchases continued to fall though as the homebuyers’ tax credit has effectively expired and potential buyers were uncertain as to the extension.

Refinancing activity rose 14.5% after three weeks of decline (outsized declines over the previous two weeks) as the 30-year fixed mortgage rate moved below 5.00% again.


Challenger Layoffs Announcements

The job-cuts survey from executive outplacement firm Challenger, Gray & Christmas estimated that layoff announcements declined 50.7% to 112,884 last month from October 2008. On a month-over-month basis, layoffs fell 10,725, or 16%, to 55,679.

In terms of region, the South endured the heaviest level of coming layoffs last month as employees announced 22,818 cuts. There were 17,187 announced layoffs in the West, 10,453 in the Midwest, and 5,221 in the East.

The October reading is the lowest level of monthly announced layoffs in 17 months, so things are moving in the right direction. This is a vital first step. The next step is obviously payroll additions but firms are very likely to squeeze more work out of existing employees before adding jobs. There is a lot of slack out there. Just as we talked about yesterday by way of the factory orders reports, unfilled orders continued to decline and that means the existing workforce is having no problem keeping up with orders. Until existing workers become quite stretched, firms are not going to rush to hire more workers in this environment.

Additionally, small and medium-sized businesses will lead job creation, as is always the case. But these firms are having trouble getting financing as the banking industry remains saddled with poor credit quality and loan defaults. Thus they are preserving their capital positions and holding back from providing the financing to small business. There is nothing terribly unusual about this in general, it is the reality when loan delinquencies rise. But the current environment has seen an abnormally high level of delinquency rates, and that means financing is that much harder to come by for the smalls and mediums.

ADP Employment

U.S. companies eliminated 203,000 in October, according to business outsourcing solutions firm ADP, down from the 227,000 estimated by the firm during September (the official government jobs report showed a loss of 263,000 jobs for that month – we get the official October reading tomorrow). This marks the 21st straight month of job losses.

This level of job losses remains in line with pretty heightened level of monthly job losses during the typical recession. We’ve seen the level of losses fall from extreme levels, but they will have to move to the minus 100k-150K level per month before we begin to get excited that firms have moved past this very damaging job slashing phase.

Small and medium firms led the job cuts last month, again not official but according to this survey, as both reduced payrolls by 75,000 a piece. Small firms are defined as those with less than 50 employees and medium firms as those with between 50-499 employees. Large firms shed 53,000 positions.

ISM Non-manufacturing

The Institute for Supply Management reported that the service sector expanded for a second-straight month in October. Although, the pace of expansion eased a bit as ISM non-manufacturing slipped to 50.6 from 50.9 in September. A reading above 50 marks expansion, so you can see service-sector growth is pretty tenuous.

Most of the sub-indices moved in the right direction. Overall business activity picked up to 55.2 from 55.1; new orders rose more than one point to 55.6 from 54.2; backlog of orders rose to 53.5 from 51.5.

However, the measures that are most in sight right now slipped. The inventory measure fell 4.5 points to 43.0 (been in contraction mode for 14 months). The inventory sentiment figure rose to 63.5 from 62.0 (a reading over 50 on this one means that firms view stockpiles are still too high). And the employment gauge fell to 41.1 from 44.3 on September.

Nine of the 18 industries tracked reported expansion, and that is up from five in September.

What respondents were saying:
“Cost-cutting efforts continue.” (Transportation & Warehousing)
“Overall business activity increasing – forecast even better market conditions in the coming months.” (Construction)
“Business climate remains encouraging, but recovery will remain slow in rebounding.” (Professional, Scientific & Technical Services)
“The weakening U.S. dollar contributing to upward pressure on commodity prices.” (Wholesale Trade)

FOMC – ZIRP Lives

The FOMC (rate-setting and policy decision-making committee of the Federal Reserve) kept their statement essentially unchanged from that of the September meeting as the “exceptionally” low level of fed funds for an “extended period” phrases remained. As touched on yesterday, this is a clear signal to all that the banking system remains in a tough spot – credit quality is deteriorating and lending continues to contract. Therefore, the Fed feels the need to continue recapitalizing the banks, the main goal of the zero interest-rate policy (ZIRP), and whatever it can do to juice the housing market.

In terms of these key comments the statement was a carbon copy of the previous meeting’s wording. But there were some changes in other regards:

• The Fed will purchase just $175 billion of agency debt now, versus the $200 billion in the previous plan. (For clarity, they will complete their $1.25 trillion of agency mortgage-backed securities by the end of the first quarter 2010. They’ve completed the $300 billion purchase of Treasury securities.)
  
• Household spending appears to be expanding. The previous statement said that household spending seems to be stabilizing.


• The Fed stated three conditions that will determine how long they keep policy accommodative: elevated resource slack (a high unemployment rate), subdued inflation trends and stable inflation expectations.

Mainstream economists, in their reaction to the FOMC statement, sang in unison about the Fed’s three stated criteria. As if from a choir, they acted as if this is some new revelation. It is not. Anyone who has paid attention and studied the Fed’s mindset for decades now knows that the unemployment in particular is what the Fed focuses on. Long-time readers know that this has been my main critique of the Fed for several years now. It’s nothing more than the same old Phillips Curve nonsense that has gotten the Fed, and the rest of us, in trouble so many times -- and none greater than their previous policy mistakes (2002-2005 when they kept real rates negative) that led to the housing bubble and the over-leveraged nature of households and institutions.

Many may have suspected it, these latest statements remove any doubt. Bernanke is not going to remove the spike punchbowl for some time. The unemployment rate is a lagging indicator, and so are the traditional measures of inflation. Therefore, they will extend the aggressive accommodation for much longer than is warranted – nothing new there. This means the unwinding of this policy, the tightening, is likely to be severe and harsh. Better to mildly remove the emergency level of fed funds, bringing it 0.75%-1.00%, than to keep things floored like this. If the economy cannot deal with a 1.00% FF, then stocks have gotten ahead of the economic state of things by a larger degree than I have thought.

What Bernanke & Co. needs to focus on is credit expansion. When this begins to kick up, that’s when the money-pumping agenda explodes into inflation. Instead, they just cannot bring themselves to shed the flawed Keynesian models that cause them to make harmful mistakes. This latest FOMC statement does nothing to increase my level of confidence in this Fed.

Have a great day!


Brent Vondera, Senior Analyst