Daily Insight

U.S. stocks bounced into positive territory on two separate occasions Wednesday after beginning the session lower on sovereign credit concerns. However, the final push above the cut line occurred in the final hour of trading so the numbers posted a resplendent green by the close.

A bounce in basic material and technology stocks led the market higher. A turn down in the U.S. dollar helped the commodity-related material shares. Technology shares seemed to get a boost from Hewlett-Packard shares as the company announced it will cancel its normal two-week holiday break for the sales staff (normally begins December 21) in order to spend the time closing deals – obviously this it the kind of alacrity investors like to see.

Advancers just edged out decliners on the NYSE Composite by a margin of 9-to-8. Volume was weak at just over one billion shares traded.

The 10–year Treasury auction, a re-opening of the November issue, was a bit weaker than we’ve seen as the yield was about 4 basis points above where the when issued was trading and the bid-to-cover of 2.62 was below the 2.80 average of the last four auctions – not concerning though. The weakest aspect of the auction was that just 32.9% went to indirect bidders (a gauge of foreign central bank demand), meaningfully lower than the recent average of 45.6%. Tomorrow we get a $13 billion 30-year re-open and we’ll see if the heightened concerns that a sovereign default will occur (troubles in Dubai and Greece have garnered the headlines but Spain and Italy have been included in the mix – frankly I could see Russia as the next default; Abu Dhabi will bail out Dubai and the EU will make sure one of their members doesn’t actually default) may make for a more difficult auction.

For the U.S. no one has to worry about default, but higher interest rates are bound to become an issue with all of this debt issuance. Those lending money for 10 and 30 years at 3.4% and 4.4%, respectively, is where the major risk lies. Then again, if the economy runs into trouble in short order (and lower coverage ratios even as non-performing loans continue to grow has me quite concerned about another wave of bank trouble), 3.4% for 10 years may not look all that bad.

This is a strange environment, a tough environment – one can see several situations affecting rates, in either direction. Still, this is no time to increase risk levels whether it be by becoming more aggressive on the equity side of things or extending out in an attempt to reach for a little more yield.


Mortgage Applications

The Mortgage Bankers Association reported their application index rose for a second-straight week, up 8.5%. This follows a 2.1% increase in the week ended November 27 and broke a string of six weeks of decline. Applications to purchase a home rose 4.0%, just about matching the previous week’s 4.1% rise. The difference this week was that refinancing activity picked up, jumping 11.1% after a very mild 1.7% rise in the previous week. The 30-year fixed-rate mortgage held below 5% for a sixth-straight week, averaging 4.88% for the week ended December 4.

We saw the purchases index decline for six weeks that ended November 13 as potential buyers were uncertain as to whether the tax credit would be extended. Now that it has officially been extended to April 30 (and beyond just first-time buyers as those who have owned a home for five years will be offered a $6500 credit to buy a new or existing home) sales have picked up again. I continue to believe that the affect the credit has on sales will be less robust than it was back during the traditional buying season, but we will see. No matter how it turns out, the home-buyers tax credit will expire and at that point it is likely sales will retrench.

Wholesale Inventories

Distributors’ inventories rose for the first time in 14 months, increasing 0.3% in October from September’s 0.8% decline – the estimate was for a 0.5% decline. The increase was boosted by higher stockpiles of motor vehicles, nondurable goods (such as clothing) and petroleum products (recall the weekly energy reports we’ve been touching on in which very low demand has pushed crude and gasoline stockpiles higher – and yesterday’s report showed no sign of improvement has presented itself). Stockpiles of durable goods ex-autos were down 0.4% for the month. From the year-ago period, total wholesale inventories are down 13.5%

So while there is some evidence that this overall inventory rebuilding is a function of the affects from clunker cash sales and low energy demand, this does get the first month of the final quarter of 2009 off to a good start – we’ll need to see some inventory building in order to get the next GDP reading above 2.5% in my view, based on what we currently know for the quarter. (For clarity on the clunker-cash comments, auto inventories fell for eight straight months, but began to build again in September following the big August sales gain related to the clunker program.)

Even if a full-blown inventory dynamic does not ensue, this segment of the economy will at least add somewhat to GDP as the three-month annualized change has moved to -$27 billion from -$56.8 billion in the prior month – and all it takes is a slower rate of decline to add to GDP.

The sales data within the report showed its sixth month of increase, up 1.2% for October – down 9.6% from the year-ago period. This is a nice trend we’ve got going here and it will have to be maintained to keep factory production on an upward trajectory.

The inventory-to-sales ratio has come crashing lower, down to 1.16 months worth (this measures how long it would take to sell off all inventories based on the current sales pace) from 1.34 months worth in January – the cycle high.

This shows just how effectively the private sector adjusts to new economic realities. While it is an unpleasant process, to say the least, the adjustment occurs quickly and fosters an environment in which we can begin producing goods again, on a net basis of course. Again, sales will have to remain on the current glide path or firms will simply keep stockpiles at rock-bottom levels.

We’ll receive the broader business inventories report for October tomorrow.

The Un-stimulus

Everyone is talking about Britain’s decision to slap a 50% tax rate on bank bonuses above $41,000 – Chancellor of the Exchequer Alistair Darling explained to Parliament that this tax will be borne by the banks, not the employees. You’ve got to be kidding; are these people really this clueless?

But the big news is Britain’s decision to raise income tax rates on bank employees making over $240,000 -- a 10 percentage points increase to 50%. Add this to the national insurance tax and the London city income tax and you’re honing in on 55%. (The 50% tax on bonuses is only in effect until April 5, 2010 so banks will either defer bonuses or come up with some other way around this onerous tax, which is why the top income-tax rate hike is the larger issue.) Keep in mind that the financial services industry is the best thing London has going for it –for now at least. In many Asian financial centers, tax rates on incomes of similar size are set around 20%. What do you think is going to happen?

Now we have Prime Ministers Brown (Britain) and Sarkozy (France) in an Op/Ed this morning explaining how economies across the globe need to increase regulations and tax rates. These are about the only two things a Frenchman and a Brit can ever agree upon.

Well, Messrs Brown and Sarkozy, at least here in the U.S. we’re importing enough of your Western European socialism. Those Americans that will be looking for work or fighting to move up the economic ladder don’t need anymore of it, thank you.


Have a great day!


Brent Vondera, Senior Analyst