The Wall Street Journal reports that Boeing (BA) may purchase the 787 Dreamliner operations of Vought Industries. The purchase would bring more of the manufacturing process back in-house, but also marks a first step towards establishing a second assembly line for the Dreamliner.
One of Credit Suisse’s analyst is viewing the transaction as a negative, but I see just the opposite. Sure, the purchase signals to the investment community that Boeing is struggling with their complete change in their manufacturing stragey, but the price of Boeing shares already reflects these difficulties. This negative analyst outlook may, in fact, represent an excellent buying opportunity for the long-term investor.
What I see are growing pains that have to be expected with a drastic shift in strategy. For Boeing, the 787 Dreamliner represents the beginning of a new era that includes the first ever streamlined manufacturing process that reminds many of the assembly line process that revolutionized automobile manufacturing forever.
The most significant change – an in my opinion the biggest reason for the many delays – might be Boeing’s increased use of outside suppliers from Japan, Italy, and the U.S. for the development and manufacturing of the aircraft. This change made Boeing more of a systems integrator instead of a manufacturer. Consequently, this transformation has been met with many unexpected challenges in the design and engineering processes as well as the way it manages its global supply chain.
What makes me bullish on the Boeing (BA) over the next several years?
First, the purchase of Vought’s 787 unit helps Boeing regain more control over its supply chain and manufacturing process. Second, and more importantly, the purchase sets the stage for Boeing to create a second assembly. A second assembly line will help Boeing ramp up production and fill orders that would have otherwise been delayed – and delayed orders lead to a financial penalty against Boeing. A second assembly line that would be outside of Seattle would also send a strong message to the aerospace unions in Seattle.
What makes me more bullish is that Boeing’s order backlog suggests the aircraft has been highly successful. Despite deferrals and cancelations related to the global recession, Boeing’s order backlog equals about seven years of production – that provides a lot of revenue and earnings visibility once production ramps up.
Of course, the problem in the near-term is determining when Boeing will reach full production. On the bright side, patient investors can collect Boeing’s hefty 4% dividend until production gets going at full tilt. With shares trading at just under 9 times future earnings, the pessimism surrounding Boeing may be overdone and we are beginning to reach levels that represent an excellent entry point for long-term investors.
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Peter J. Lazaroff
Thursday, July 2, 2009
Daily Insight
U.S. stocks caught a bid yesterday as the key domestic manufacturing report hit it highest level since August offset a weaker-than-expected preliminary report on the job market for June. Stocks did give back much of their early-session gains as traders likely questioned getting to aggressive in front of this morning’s official monthly jobs figure.
The late-session release of U.S. car sales also caused some hesitation as wishful expectations for consumer activity hit the wall of reality, again. Many expected sales volumes to hit what the auto industry calls the break-even point of 10 million units (at an annual rate). Actual sales volume for June failed to hit that number, in fact coming in even weaker than the May results.
Eight of the 10 major industry groups closed the session higher, financial and health-care shares being the only losers, as utility and consumer staples led the broad market higher. One wouldn’t think the traditional areas of safety to lead the way on a day that the factory data hit its highest reading since the economy went into a tailspin in September – that’s a significant development. But that jobs data is weighing on people and causing a lack of conviction. So long as monthly jobs losses of at least 400K is seen as a distinct possibility (this is a level that, if even touched during a recession, is a one month deal, not the eight-month reality we’ve been hit with) investor certitude is going to be slight.
A great indication of this lack of conviction is trading volume, which has been weak for about three weeks now. Yesterday was one of the lightest days we’ve seen as just 905 million shares traded on the NYSE Composite, that’s 35% below the three-month average. This is summer, but levels this low are generally not seen until August when most traders are off to the beach; we should be hovering around the three-month average of 1.4 billion shares per day at this stage.
Market Activity for July 1, 2009
Mortgage Applications
The Mortgage Bankers Association reported its index of mortgage activity fell 18.9% in the week ended June 26 as refinancings declined 30% and home purchases dropped 4.5%. Refinancing activity, as a percentage of total applications, has plunged to 45% from 75% back in April. This shows the degree to which refi activity has cooled and is a direct result of the rise in mortgage rates.
Purchases haven’t looked too bad on a relative basis even as they fell last week; they are coming off of a nice 7.3% rise in the prior reading. It’s tough though to see this segment go on a multi-week run if the 30-year fixed rate remains above 5.00% -- it settled in at 5.34% last week – as the labor market weighs heavily on the housing market and it may very well take (we’re getting technical here) super-duper low rates to partially offset this factor.
125%? How Special!
And while we’re on the subject of the mortgage market, we see Fannie and Freddie will begin refinancing mortgages with loan-to-value (LTV) ratios of as much as 125% as the visible hand of the Obama administration (all of you Adam Smith fans should appreciate that snide remark) seeks to slow the foreclosure rate via their Refinancing Program. This LTV requirement (gosh it feels bizarre to even term this as a “requirement”) is up from the previously adjusted 105% and the historic level (the sane level) of 80%.
You see, the prior program was not getting much participation, even in this interest-rate environment. Why not? Because too many borrowers had a LTV of greater than 105%, apparently. Well, let’s see if 125% does the trick. But wait, even if it does allow more to refi, does it mean that all is well? Will the horribly underwater borrowers have the fortitude to tough it out and make that payment no matter the sacrifice?
Oh dear taxpayer, I fear this is not going to end well. And this will only delay the foreclosure reality that is currently making its way through the system, which means it may very well delay the recovery.
The Preliminary Jobs Reports
The Challenger Job Cuts survey (a measure of layoff announcements via the outplacement firm Challenger, Gray & Christmas) showed another month of substantial improvement in June. The survey measured that layoff announcements actually fell for the first time since February 2008 – down 9.0% from the year-ago period.
Planned firings fell to 74,393 from 81,755 in June 2008. It appears that employers have accomplished the payroll levels they feel is needed to get through this period, which is something we’ve talked about for a couple of months now.
Nevertheless, it will take additional time for this decline in layoff announcements to flow into the monthly payroll declines. Firms have slashed and burned expenses, and payrolls are the largest expense, ever since the shock of the Lehman collapse/credit market chaos that ensued. The monthly job readings will continue to record big losses, as the ADP report illustrates (touched on below), but one would think we’ll move back to a more normal labor-market recession of 150,000-200,000 in monthly job losses as we enter the fourth quarter. While this level of decline will illustrate that the labor market remains fragile, it’s a massive improvement from the currently outsized payroll losses.
In a separate report, the ADP Employment report, a survey that is more appropriate to gauging the official monthly jobs data, measured that 473,000 payroll positions were cut in June. This gauge has done a really good job of tracking the official jobs data, as compiled by the Bureau of Labor Statistics (and a reading we’ll get this morning) – although ADP’s May reading did overstate the degree of decline (ADP said -485K and Labor Department recorded -365K) unless today’s release shows a downward revision to that May data.
This level of decline out of ADP pretty much matches what the jobless claims data is suggesting – monthly payrolls declines of at least 400K will remain the rule for June and possibly July.
From a stock market perspective, it’s a bit concerning that the consensus estimate has payrolls falling just 365,000 – if the ADP number is gauging things accurately for June, the market is going to be quite disappointed. This is very short-term activity we’re talking about here, but I feel it’s worth mentioning.
According to ADP, service-producing industries shed 223,000 positions in June and goods-producing cut 250,000 jobs – both of which are right at the average level of decline we’ve seen in the official data over the previous three months. Large firms cut 91,000 positions in June; medium-sized firms (50-499 employees) cut 205,000 positions: and small firms reduced payrolls by 177,000.
Within a couple to three months we should see monthly job losses ease to a level that resembles the normal recession, as expressed above I’m thinking we’ll move to a range of 150,000-200,000. However, we’re not there yet and the data for the next couple of readings may show we’re stuck in this 400K-450K range.
ISM Manufacturing
The Institute for Supply Management (ISM) reported that its nationwide factory gauge showed another month of improvement. The index rose to 44.8 for June from 42.8 registered in May. While the measure remained in contraction mode for the 17th straight month (a figure below 50 means activity continues to decline), it is doing so at a reduced rate. This is the highest level since the economy spun out of control in September.
Further, the fact that the gauge darned-near made it to 45 very likely shows the weak readings we’re getting out of Chicago PMI (the most important regional factory survey) is vastly due to auto-sector troubles and not necessarily from heavy weakness in other areas.
ISM economists like to say that a reading of 42 over a period of time on their survey is commensurate with mild real GDP growth. The figure averaged 42.5 for the entire second quarter, but if we continue to see mild improvements, this reading will help support our view that the first positive GDP print in five quarters will occur in the third quarter.
Seven of the 18 industries tracked by the index reported business growth in June, that’s up from five in May and one in April – now this is meaningful progress, let’s hope policy decisions don’t ruin it..
Results remained mixed with regard to the sub-indices within the report.
The most encouraging was the production measure, which moved to 52.5 from 46.0 (and has jumped 12 points in two months). The supplier deliveries index also moved to expansion mode, hitting 50.6 from 49.8 in May. But these were the only sub-indices to make it above 50, which does raise some doubts about continued progress over the next two months.
The new orders index, the best leading gauge within the report, fell to 49.2 from 51.1; the backlog of orders index fell slightly to 47.5; the inventories index fell to 30.8 from 32.9 (lowest level since 1982) – this raises doubts firms are on the cusp of boosting inventories after two quarters of slashing stockpiles at a record pace.
The employment index did jump to 40.7 from 34.3, nice move but it will be a while before factories begin to boost workers. We generally have to see two meaningful quarters of GDP growth before the factory sector begins to add jobs again.
This morning we get jobs data overload as both jobless claims for the week ended June 27 and the employment report for June are out. This data will set the stage for trading as we come back from a holiday weekend. I guess what has become North Korea’s own fireworks display could have an affect on trading as well. We shall see.
Have a great weekend and a great July 4!
Brent Vondera
The late-session release of U.S. car sales also caused some hesitation as wishful expectations for consumer activity hit the wall of reality, again. Many expected sales volumes to hit what the auto industry calls the break-even point of 10 million units (at an annual rate). Actual sales volume for June failed to hit that number, in fact coming in even weaker than the May results.
Eight of the 10 major industry groups closed the session higher, financial and health-care shares being the only losers, as utility and consumer staples led the broad market higher. One wouldn’t think the traditional areas of safety to lead the way on a day that the factory data hit its highest reading since the economy went into a tailspin in September – that’s a significant development. But that jobs data is weighing on people and causing a lack of conviction. So long as monthly jobs losses of at least 400K is seen as a distinct possibility (this is a level that, if even touched during a recession, is a one month deal, not the eight-month reality we’ve been hit with) investor certitude is going to be slight.A great indication of this lack of conviction is trading volume, which has been weak for about three weeks now. Yesterday was one of the lightest days we’ve seen as just 905 million shares traded on the NYSE Composite, that’s 35% below the three-month average. This is summer, but levels this low are generally not seen until August when most traders are off to the beach; we should be hovering around the three-month average of 1.4 billion shares per day at this stage.
Market Activity for July 1, 2009
Mortgage ApplicationsThe Mortgage Bankers Association reported its index of mortgage activity fell 18.9% in the week ended June 26 as refinancings declined 30% and home purchases dropped 4.5%. Refinancing activity, as a percentage of total applications, has plunged to 45% from 75% back in April. This shows the degree to which refi activity has cooled and is a direct result of the rise in mortgage rates.
Purchases haven’t looked too bad on a relative basis even as they fell last week; they are coming off of a nice 7.3% rise in the prior reading. It’s tough though to see this segment go on a multi-week run if the 30-year fixed rate remains above 5.00% -- it settled in at 5.34% last week – as the labor market weighs heavily on the housing market and it may very well take (we’re getting technical here) super-duper low rates to partially offset this factor.
125%? How Special!
And while we’re on the subject of the mortgage market, we see Fannie and Freddie will begin refinancing mortgages with loan-to-value (LTV) ratios of as much as 125% as the visible hand of the Obama administration (all of you Adam Smith fans should appreciate that snide remark) seeks to slow the foreclosure rate via their Refinancing Program. This LTV requirement (gosh it feels bizarre to even term this as a “requirement”) is up from the previously adjusted 105% and the historic level (the sane level) of 80%.
You see, the prior program was not getting much participation, even in this interest-rate environment. Why not? Because too many borrowers had a LTV of greater than 105%, apparently. Well, let’s see if 125% does the trick. But wait, even if it does allow more to refi, does it mean that all is well? Will the horribly underwater borrowers have the fortitude to tough it out and make that payment no matter the sacrifice?
Oh dear taxpayer, I fear this is not going to end well. And this will only delay the foreclosure reality that is currently making its way through the system, which means it may very well delay the recovery.
The Preliminary Jobs Reports
The Challenger Job Cuts survey (a measure of layoff announcements via the outplacement firm Challenger, Gray & Christmas) showed another month of substantial improvement in June. The survey measured that layoff announcements actually fell for the first time since February 2008 – down 9.0% from the year-ago period.
Planned firings fell to 74,393 from 81,755 in June 2008. It appears that employers have accomplished the payroll levels they feel is needed to get through this period, which is something we’ve talked about for a couple of months now.Nevertheless, it will take additional time for this decline in layoff announcements to flow into the monthly payroll declines. Firms have slashed and burned expenses, and payrolls are the largest expense, ever since the shock of the Lehman collapse/credit market chaos that ensued. The monthly job readings will continue to record big losses, as the ADP report illustrates (touched on below), but one would think we’ll move back to a more normal labor-market recession of 150,000-200,000 in monthly job losses as we enter the fourth quarter. While this level of decline will illustrate that the labor market remains fragile, it’s a massive improvement from the currently outsized payroll losses.
In a separate report, the ADP Employment report, a survey that is more appropriate to gauging the official monthly jobs data, measured that 473,000 payroll positions were cut in June. This gauge has done a really good job of tracking the official jobs data, as compiled by the Bureau of Labor Statistics (and a reading we’ll get this morning) – although ADP’s May reading did overstate the degree of decline (ADP said -485K and Labor Department recorded -365K) unless today’s release shows a downward revision to that May data.
This level of decline out of ADP pretty much matches what the jobless claims data is suggesting – monthly payrolls declines of at least 400K will remain the rule for June and possibly July.From a stock market perspective, it’s a bit concerning that the consensus estimate has payrolls falling just 365,000 – if the ADP number is gauging things accurately for June, the market is going to be quite disappointed. This is very short-term activity we’re talking about here, but I feel it’s worth mentioning.
According to ADP, service-producing industries shed 223,000 positions in June and goods-producing cut 250,000 jobs – both of which are right at the average level of decline we’ve seen in the official data over the previous three months. Large firms cut 91,000 positions in June; medium-sized firms (50-499 employees) cut 205,000 positions: and small firms reduced payrolls by 177,000.
Within a couple to three months we should see monthly job losses ease to a level that resembles the normal recession, as expressed above I’m thinking we’ll move to a range of 150,000-200,000. However, we’re not there yet and the data for the next couple of readings may show we’re stuck in this 400K-450K range.
ISM Manufacturing
The Institute for Supply Management (ISM) reported that its nationwide factory gauge showed another month of improvement. The index rose to 44.8 for June from 42.8 registered in May. While the measure remained in contraction mode for the 17th straight month (a figure below 50 means activity continues to decline), it is doing so at a reduced rate. This is the highest level since the economy spun out of control in September.
Further, the fact that the gauge darned-near made it to 45 very likely shows the weak readings we’re getting out of Chicago PMI (the most important regional factory survey) is vastly due to auto-sector troubles and not necessarily from heavy weakness in other areas.
ISM economists like to say that a reading of 42 over a period of time on their survey is commensurate with mild real GDP growth. The figure averaged 42.5 for the entire second quarter, but if we continue to see mild improvements, this reading will help support our view that the first positive GDP print in five quarters will occur in the third quarter.Seven of the 18 industries tracked by the index reported business growth in June, that’s up from five in May and one in April – now this is meaningful progress, let’s hope policy decisions don’t ruin it..
Results remained mixed with regard to the sub-indices within the report.
The most encouraging was the production measure, which moved to 52.5 from 46.0 (and has jumped 12 points in two months). The supplier deliveries index also moved to expansion mode, hitting 50.6 from 49.8 in May. But these were the only sub-indices to make it above 50, which does raise some doubts about continued progress over the next two months.
The new orders index, the best leading gauge within the report, fell to 49.2 from 51.1; the backlog of orders index fell slightly to 47.5; the inventories index fell to 30.8 from 32.9 (lowest level since 1982) – this raises doubts firms are on the cusp of boosting inventories after two quarters of slashing stockpiles at a record pace.
The employment index did jump to 40.7 from 34.3, nice move but it will be a while before factories begin to boost workers. We generally have to see two meaningful quarters of GDP growth before the factory sector begins to add jobs again.
This morning we get jobs data overload as both jobless claims for the week ended June 27 and the employment report for June are out. This data will set the stage for trading as we come back from a holiday weekend. I guess what has become North Korea’s own fireworks display could have an affect on trading as well. We shall see.
Have a great weekend and a great July 4!
Brent Vondera
Bond Recap
Fed comments yesterday sent the short end screaming lower as recent expectations for higher short term rates are proving to be too much too soon. The Fed has hinted at nothing but doing everything they can to stimulate growth in the economy, so one must question where the rate hiking expectations originated from. Regardless, the recent spike in short term Treasuries in anticipation of a Fed reversal was unjustified in our view and yesterday’s movement has brought all but brought us back to early June levels, (2-year was .95% on June 4).
Cliff Reynolds
Wednesday, July 1, 2009
Obama Expands LTV Limits to 125%
WASHINGTON, July 1 (Reuters) - Mortgage finance companies Fannie Mae and Freddie Mac will expand their efforts to prevent foreclosures, and refinance borrowers whose loan-to-value ratio is as high as 125 percent, an administration official said on Wednesday.
Under current rules, the mortgage finance companies may only refinance borrowers whose mortgage loan-to-value ratio is no greater than 105 percent. The new policy is intended to aid more struggling borrowers who have seen their property lose value in the recent years of a housing crisis.
The new program expands a housing rescue plan first outlined by the Treasury Department in February and was meant to lower the costs of home ownership for borrowers who are making timely payments.
Refinancing up to 125% is only available to loans that are already owned or guaranteed by Fannie and Freddie, so the move doesn’t expose the government run companies to any additional risk initially. However, this doesn’t really solve any of the pressing issues in today’s housing market. Mortgage rates have risen roughly .75% in the past month, making a refi a much less meaningful in terms of saving money on monthly payments. In order to qualify for the program the borrower must be current on their mortgage. So it really misses the trouble areas completely. The impact of the program expansion is expected to have little effect considering this only includes 10% of the mortgage market.
Cliff J. Reynolds Jr., Junior Analyst
Under current rules, the mortgage finance companies may only refinance borrowers whose mortgage loan-to-value ratio is no greater than 105 percent. The new policy is intended to aid more struggling borrowers who have seen their property lose value in the recent years of a housing crisis.
The new program expands a housing rescue plan first outlined by the Treasury Department in February and was meant to lower the costs of home ownership for borrowers who are making timely payments.
Refinancing up to 125% is only available to loans that are already owned or guaranteed by Fannie and Freddie, so the move doesn’t expose the government run companies to any additional risk initially. However, this doesn’t really solve any of the pressing issues in today’s housing market. Mortgage rates have risen roughly .75% in the past month, making a refi a much less meaningful in terms of saving money on monthly payments. In order to qualify for the program the borrower must be current on their mortgage. So it really misses the trouble areas completely. The impact of the program expansion is expected to have little effect considering this only includes 10% of the mortgage market.
Cliff J. Reynolds Jr., Junior Analyst
June 2009 Recap
(Click image to enlarge)
Following several months in which the market moved steadily higher in anticipation of an economic recovery, the stock market largely traded sideways as investors searched for actual signs of growth rather than second derivative improvement. Still, the S&P 500 managed to push its winning streak to four months and finished June with a quarterly gain of 15.93 percent.
Despite the lack of obvious indicators that the economy is recovering, the VIX index dropped to the lowest level since the Lehman Brothers collapse, which suggests that investor fear has subsided. The VIX index is often used to gauge fear and volatility in the market via the prices investors are willing to pay for protective options. The VIX averaged 20.18 in its history stretching back to the start of 1990, but topped 80 during the height of the financial crisis. Today the VIX is about 25.
All domestic asset classes posted gains led by the utilities, technology, and healthcare sectors. Utilities advanced as the U.S. House of Representatives passed a comprehensive energy policy and helped clear uncertainties surrounding the sector – although it will likely change in the Senate. Technology continued to rise on the expectation that businesses will loosen their purse strings first for technology spending, which enhances efficiency and productivity. Sentiment towards the healthcare sector improved as details about healthcare reform have not implied the draconian consequences as originally thought.
Developed and emerging international markets pulled back after outperforming in recent months – especially in the case of emerging markets. Alternative asset classes also recorded declines in June. The Greenhaven Continuous Commodity Index, which represents a broad range of commodities, fell more than the energy-heavy S&P GSCI Commodity Index. Meanwhile, global REITs managed to squeak out a minor gain and domestic finished the month in the red.
Treasury yields whipsawed during the month of June. Then ten-year reach an intraday high of 4 percent on June 11 as inflation fears really began to envelop the market, but finished the month yielding 3.53 percent. Inflation concerns have subsided, but such volatility can be expected to continue with so many non-traditional factors (Fed buying Treasurys/MBS, Fed Funds at zero) at work in the market.
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Peter J. Lazaroff, Investment Analyst
Cliff J. Reynolds Jr., Investment Analyst
Daily Insight
U.S. stocks lost some ground Tuesday, trimming the S&P 500’s quarterly advance, as the latest manufacturing report illustrated activity remains in pretty deep contraction mode and the latest consumer confidence reading moved back below a key level. The Case/Shiller home price index showed some really nice improvement, still ugly but by far the best progress recorded thus far; however, it was not enough to offset the aforementioned drags.
Telecom, basic material, financial and industrial shares led the market’s decline. Consumer discretionary and tech were the relative winners. These are two of the three best performing industries for the quarter so maybe a little window dressing helped buoy those shares.
For the quarter, the S&P 500 jumped 15.22%; the Dow average gained 11.01%; and the NASDAQ Composite surged 20.05% after two quarters of treacherous descent (down 11.67% in the first quarter and 22.56% in the fourth for the S&P 500) and six-straight quarters that had sent the broad market lower by 50%.
Mid cap stocks, as measured by the S&P 400, jumped 18.23% and small caps, as measured by the Russell 2000, rallied 22.19%. Developed-nation international stocks leapt 26.82% and the emerging market index soared 33.57% (this marked the second quarter of increase for the emerging market group after back-to-back 27% declines; the index plunged 68% in 2008)
Market Activity for June 30, 2009
Prime Mortgages Continue to Show Cracks
The Office of Thrift Supervision reported that delinquency rates on prime mortgages more than doubled in the first quarter from the year-ago period. This is not exactly new information as rising prime default rates have been evident for some time, but thought it was worth a mention as this specific report is a new release.
Prime mortgages 60 days or more past due rose to 2.9% of such loans from 1.1% a year ago, according to this report. First-time foreclosure filings for these loans jumped 22% from the previous quarter. One can expect this number to jump again for the quarter that just ended. The Mortgage Bankers Association, which doesn’t provide a 60-day delinquency but does report a seriously delinquent (90-days+) rate had this number at 4.70% at the end of the first quarter. Their straight delinquency rate (just 30-days past due) is up to 6.06%.
And the modifications aren’t working out well either. Mortgages that have been modified to help struggling borrowers stay in their homes fail within the first nine months more than half of the time and increases to 63% after a year, according to the report.
It’s all about the job market. Those, and they are many, who have constantly exhorted that the housing market must come back before the overall economy can stage a rebound have it exactly backward. What is needed is a level of broad economic growth that brings back capital spending and pulls jobs along with it. This is why we harped on the need for aggressive broad-based tax rate reductions and higher current-year write-off allowances and bonus depreciation schedules last fall. This is the quickest route to labor market improvement, which is essential to a marked improvement in the mortgage market and home sales.
Case/Shiller
The S&P Case/Shiller home-price index registered another decline for April (yes, there’s a huge lag to this data), the 32nd straight monthly decline and the seventh-consecutive year-over-year drop of at least 18%. However, the figure recorded the most significant level of improvement since the respite from large monthly losses that occurred last summer.
(As always, I’ll repeat that there is a high likelihood that this home-price index overstates the downside. Roughly 40% of the cities captured in this survey witnessed the greatest level of speculation during the boom years. As a result, these are also the areas currently burdened with the highest foreclosure rates and thus the steepest price declines)
While the index recorded an 18.12% decline from the year-ago level, the measure fell just 0.56% for April and the three-month annualized rate of change fell to 18.18% after five-consecutive months of mid-20% declines.
This data is far from showing a rebound in housing is upon us, let’s face it housing isn’t coming back until the labor market shows significant improvement, but we may have finally gotten past these really large declines.
Eight of the 30 cities measured posted an increase on a monthly basis, last month it was only two. Dallas, Denver and Cleveland posted strong gains in April. Cities such as San Francisco, Boston, Atlanta and Seattle showed gains as well; while they were mild, it’s quite a shift from deep declines of the previous months. Even San Diego, Charlotte, Portland, Minneapolis and Tampa (areas that have shown some of the deepest contraction) posted more moderate declines.
Detroit, New York, Miami, Phoenix and Las Vegas remain pretty mired. These cities registered 1.5%-3.5% monthly declines and, save New York, posted prices declines of at least 25% from the year-ago period.
The recent increase in mortgage rates will add another challenge to the housing market for the next couple of months. The current 30-year fixed rate of 5.35% is certainly an extreme low from a historical perspective, but the market became attracted to that sub-5.00% level in late-April and May and we may find it difficult to extend on this improvement as a result of the rise in rates. Nevertheless, this latest reading is the best we’ve seen in quite a while.
Chicago PMI
The Chicago Purchasing Managers Index rose to 39.9 in June (a bit better than the 39.0 expected) from the May reading that saw the figure hammered back down to 34.9. All sub-indices managed to improve from the previous month’s level, but only the production component managed a move above 40, coming in at 41.6 from 37.3 in May. Employment was the laggard, rising but only to 28.9 – although this isn’t a surprise as this will be the last component to show meaningful improvement.
A rebound from last month’s reading, which was beaten back below the average reading of the deep level of contraction that took place in the previous two quarters, means nothing to me as the figure failed to make it above 40. As we discussed yesterday, no one should be under the illusion that Chicago is about to hit 50 (the break-even point, dividing expansion from contraction) due to the auto-sector woes, but still if a meaningful rebound in factory activity is upon us the measure should have been able to make it to 42-43.
We’ll get ISM (the nationwide factory gauge) this morning. The market expects the measure to rise above 43 for the first time since the economic world changed in September. It needs to hit 45 to show the next leg of improvement has really occurred. If so, it will illustrate that Chicago’s inability to move above 40 is solely due to the auto sector’s problems instead of an overall weakened state within the manufacturing arena.
Consumer Confidence
The Conference Board’s consumer confidence reading fell in June to 49.3 from the 54.9 hit in the previous month. (The overall is an average of respondents appraisals of current business conditions, business conditions six months out, current employment conditions and employment conditions six months out)
The present situation index moved back to 24.8, from an already low 29.7, on a less favorable assessment of business conditions and employment
The expectations index (for the next six month) fell to 65.5 from 71.5.
The jobs “plentiful” minus “hard to get” differential retreated to -40.3 from -38.1. This is probably the most important aspect of the report to watch as consumers will not feel right about things until they get a sense that the labor market has turned. (The differential is in the lower part of the chart below)
Have a great day!
Brent Vondera
Telecom, basic material, financial and industrial shares led the market’s decline. Consumer discretionary and tech were the relative winners. These are two of the three best performing industries for the quarter so maybe a little window dressing helped buoy those shares.
For the quarter, the S&P 500 jumped 15.22%; the Dow average gained 11.01%; and the NASDAQ Composite surged 20.05% after two quarters of treacherous descent (down 11.67% in the first quarter and 22.56% in the fourth for the S&P 500) and six-straight quarters that had sent the broad market lower by 50%.
Mid cap stocks, as measured by the S&P 400, jumped 18.23% and small caps, as measured by the Russell 2000, rallied 22.19%. Developed-nation international stocks leapt 26.82% and the emerging market index soared 33.57% (this marked the second quarter of increase for the emerging market group after back-to-back 27% declines; the index plunged 68% in 2008)
Market Activity for June 30, 2009
Prime Mortgages Continue to Show CracksThe Office of Thrift Supervision reported that delinquency rates on prime mortgages more than doubled in the first quarter from the year-ago period. This is not exactly new information as rising prime default rates have been evident for some time, but thought it was worth a mention as this specific report is a new release.
Prime mortgages 60 days or more past due rose to 2.9% of such loans from 1.1% a year ago, according to this report. First-time foreclosure filings for these loans jumped 22% from the previous quarter. One can expect this number to jump again for the quarter that just ended. The Mortgage Bankers Association, which doesn’t provide a 60-day delinquency but does report a seriously delinquent (90-days+) rate had this number at 4.70% at the end of the first quarter. Their straight delinquency rate (just 30-days past due) is up to 6.06%.
And the modifications aren’t working out well either. Mortgages that have been modified to help struggling borrowers stay in their homes fail within the first nine months more than half of the time and increases to 63% after a year, according to the report.
It’s all about the job market. Those, and they are many, who have constantly exhorted that the housing market must come back before the overall economy can stage a rebound have it exactly backward. What is needed is a level of broad economic growth that brings back capital spending and pulls jobs along with it. This is why we harped on the need for aggressive broad-based tax rate reductions and higher current-year write-off allowances and bonus depreciation schedules last fall. This is the quickest route to labor market improvement, which is essential to a marked improvement in the mortgage market and home sales.
Case/Shiller
The S&P Case/Shiller home-price index registered another decline for April (yes, there’s a huge lag to this data), the 32nd straight monthly decline and the seventh-consecutive year-over-year drop of at least 18%. However, the figure recorded the most significant level of improvement since the respite from large monthly losses that occurred last summer.
(As always, I’ll repeat that there is a high likelihood that this home-price index overstates the downside. Roughly 40% of the cities captured in this survey witnessed the greatest level of speculation during the boom years. As a result, these are also the areas currently burdened with the highest foreclosure rates and thus the steepest price declines)
While the index recorded an 18.12% decline from the year-ago level, the measure fell just 0.56% for April and the three-month annualized rate of change fell to 18.18% after five-consecutive months of mid-20% declines.
This data is far from showing a rebound in housing is upon us, let’s face it housing isn’t coming back until the labor market shows significant improvement, but we may have finally gotten past these really large declines.
Eight of the 30 cities measured posted an increase on a monthly basis, last month it was only two. Dallas, Denver and Cleveland posted strong gains in April. Cities such as San Francisco, Boston, Atlanta and Seattle showed gains as well; while they were mild, it’s quite a shift from deep declines of the previous months. Even San Diego, Charlotte, Portland, Minneapolis and Tampa (areas that have shown some of the deepest contraction) posted more moderate declines.
Detroit, New York, Miami, Phoenix and Las Vegas remain pretty mired. These cities registered 1.5%-3.5% monthly declines and, save New York, posted prices declines of at least 25% from the year-ago period.
The recent increase in mortgage rates will add another challenge to the housing market for the next couple of months. The current 30-year fixed rate of 5.35% is certainly an extreme low from a historical perspective, but the market became attracted to that sub-5.00% level in late-April and May and we may find it difficult to extend on this improvement as a result of the rise in rates. Nevertheless, this latest reading is the best we’ve seen in quite a while.
Chicago PMI
The Chicago Purchasing Managers Index rose to 39.9 in June (a bit better than the 39.0 expected) from the May reading that saw the figure hammered back down to 34.9. All sub-indices managed to improve from the previous month’s level, but only the production component managed a move above 40, coming in at 41.6 from 37.3 in May. Employment was the laggard, rising but only to 28.9 – although this isn’t a surprise as this will be the last component to show meaningful improvement.
A rebound from last month’s reading, which was beaten back below the average reading of the deep level of contraction that took place in the previous two quarters, means nothing to me as the figure failed to make it above 40. As we discussed yesterday, no one should be under the illusion that Chicago is about to hit 50 (the break-even point, dividing expansion from contraction) due to the auto-sector woes, but still if a meaningful rebound in factory activity is upon us the measure should have been able to make it to 42-43. We’ll get ISM (the nationwide factory gauge) this morning. The market expects the measure to rise above 43 for the first time since the economic world changed in September. It needs to hit 45 to show the next leg of improvement has really occurred. If so, it will illustrate that Chicago’s inability to move above 40 is solely due to the auto sector’s problems instead of an overall weakened state within the manufacturing arena.
Consumer Confidence
The Conference Board’s consumer confidence reading fell in June to 49.3 from the 54.9 hit in the previous month. (The overall is an average of respondents appraisals of current business conditions, business conditions six months out, current employment conditions and employment conditions six months out)
The present situation index moved back to 24.8, from an already low 29.7, on a less favorable assessment of business conditions and employment The expectations index (for the next six month) fell to 65.5 from 71.5.The jobs “plentiful” minus “hard to get” differential retreated to -40.3 from -38.1. This is probably the most important aspect of the report to watch as consumers will not feel right about things until they get a sense that the labor market has turned. (The differential is in the lower part of the chart below)Have a great day!
Brent Vondera
Bond Recap
Treasuries began the day down slightly but really dipped after April’s Case-Shiller Home Price Index came in better than anticipated. The market was anticipating a 18.63% drop in the index that contains the 20 biggest housing markets in the U.S., yesterday’s reading for the month of April showed a drop of only -18.12% from the same period a year ago. It’s kind of interesting to see how little it takes people to get excited these days. The ten-year yield got as high as 3.57% before Consumer Confidence disappointed and Treasuries rallied.The long end was the underperformer on the day, a change in recent trend, as the curve steepened by 4 bps, the biggest one day steepening since June 18. The Fed will purchase Treasury notes again today, this time in the 10-17 year area. Look for a short term rally in bonds if the auction shows stronger results compared to yesterday.
Cliff J. Reynolds Jr., Junior Analyst
Tuesday, June 30, 2009
Are you chasing performance?
Many investors unknowingly chase performance when making investment decisions. This type of investing is often seen as irrational as decisions are based on emotion instead of careful analysis of the value of the investment.
One of the most common examples of performance chasing is when investors use performance over the last one, three, or five years as the sole criteria for selecting investments in their retirement accounts. Historically, a period of above-market performance for a given fund will be followed by a period of below-market performance.
This is because it is virtually impossible to consistently predict the next direction of the market as a whole. Timing the purchase or sale of investments in an attempt to “beat the market” is highly unlikely to increase long-term investment performance.
Notice the first graphic below (you may want to click to enlarge). If an investor looked at this table in the year 2000, he/she might have concluded that Information Technology was a sure-fire way to make money. Unfortunately for those performance chasers following this logic, the Information Technology sector was one of the worst performing sectors for the next three years.
Of course, the same holds true for asset classes as you can see in the graphic below (click to enlarge).
One of the most common examples of performance chasing is when investors use performance over the last one, three, or five years as the sole criteria for selecting investments in their retirement accounts. Historically, a period of above-market performance for a given fund will be followed by a period of below-market performance.
This is because it is virtually impossible to consistently predict the next direction of the market as a whole. Timing the purchase or sale of investments in an attempt to “beat the market” is highly unlikely to increase long-term investment performance.
Notice the first graphic below (you may want to click to enlarge). If an investor looked at this table in the year 2000, he/she might have concluded that Information Technology was a sure-fire way to make money. Unfortunately for those performance chasers following this logic, the Information Technology sector was one of the worst performing sectors for the next three years.
Of course, the same holds true for asset classes as you can see in the graphic below (click to enlarge).
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Peter J. Lazaroff
Fed Buys Treasuries
Today’s purchases in the 7-10 year sector were less than impressive. The Fed bought $7 billion in bonds on $23.5 billion in bonds submitted for sale. This larger than average difference between the amount that primary dealers would like to sell and the amount the Fed is willing to buy is a negative for the market. The whole point of the Fed buying program was to create the additional demand for Treasuries that is needed to keep longer term rates low. As today’s operation shows, the program is overwhelmed and without a significant increase in the amount the Fed is willing to buy it won’t have much impact.
Cliff J. Reynolds Jr., Junior Analyst
Cliff J. Reynolds Jr., Junior Analyst
Fixed Income Recap
Last week’s rally in Treasuries continued on Monday, driving yields lower as the ten-year finished below 3.5% for the first time since May 29. The long end of the curve continues to outperform and the flattening trend that has persisted since the beginning of June is showing no sign of stopping. The benchmark curve, the difference between the yield on the 2-year and 10-year Treasuries, finished yesterday at 238 bps, down from 275 bps on June 4.
Inflation expectations have pulled back recently. The Ten year TIPS Breakeven Rate, a number derived from the difference in yield between the ten-year inflation protected Treasury and the nominal Treasury that is used as a proxy for inflation expectations over the next ten years, has fallen to 1.7% from 2.08% just three weeks ago. As traders feel inflation expectations are overblown, they move into long term Treasuries, forcing prices up and yields down.
There is no Treasury supply coming this week but the Treasury will hold auctions every day but Friday next week. Expectations are for $65 billion in nominal coupon supply, pretty light by today’s standards, plus a TIPS auction on Monday. Official auction sizes are not yet available on Bloomberg.
Cliff J. Reynolds Jr., Junior Analyst
Inflation expectations have pulled back recently. The Ten year TIPS Breakeven Rate, a number derived from the difference in yield between the ten-year inflation protected Treasury and the nominal Treasury that is used as a proxy for inflation expectations over the next ten years, has fallen to 1.7% from 2.08% just three weeks ago. As traders feel inflation expectations are overblown, they move into long term Treasuries, forcing prices up and yields down.
There is no Treasury supply coming this week but the Treasury will hold auctions every day but Friday next week. Expectations are for $65 billion in nominal coupon supply, pretty light by today’s standards, plus a TIPS auction on Monday. Official auction sizes are not yet available on Bloomberg.
Cliff J. Reynolds Jr., Junior Analyst
Daily Insight
U.S. stocks rose on Monday, extending the best quarterly performance for the S&P 500 since the final three months of 1998. The index has jumped 16.2% over the past three months, following five-straight quarters of decline and at its worst was down 57% from the October 2007 peak.
The broad market ended its first consecutive weekly decline since the market doldrums of February and those who want in found that mild move lower as an opportunity. We also have the second quarter coming to a close tomorrow so one certainly can’t rule out some window dressing among mutual fund managers – one wouldn’t want to appear underweight stocks during such a strong quarter, now would they.
Financials, energy and utility shares led yesterday’s market higher. All 10 major industry groups gained ground; health-care and consumer staples, while up, were the laggards.
Even as the major indices posted nice gains, lackluster volume remains the trend as just 1.02 billion shares traded on the Big Board; there is certainly a lack of conviction out there as volume has been particularly weak for three weeks and trading has been sideways since May 8. A period of low volume should remain the rule as is usually the case for the summer months.
The dream shoots, I’m sorry the green shoots, better begin to show themselves in a pronounced manner or this market is going to have another rough period some time in the near future even with the liquidity trade that remains in play. We’ve yet to see anything that resembles a normal business cycle turnaround. One would certainly think we’re to have a robust economic rebound on our hands very soon with the massive stimulus that is in the global system, but I remain concerned that government action may cause businesses to further delay capital outlays. We need the business side of the economy to step up because its going to take the consumer a while to gets things right again.
Market Activity for June 29, 2009
Activity in Crude
Oil futures for August delivery are back on the march, rising 3.3% yesterday to close the session at $71.50 per barrel. What drove yesterday’s rise? It’s tough to say for sure what causes a daily move, but I doubt it was increased optimism over global growth. Heck, it was just Friday when concerns over near-term economic prospects increased again.
One thing is pretty certain; the energy market has begun to pay attention to Nigerian militant attacks – additional attacks over the weekend forced Shell to close production wells.
There were also talks between OPEC and the European Union in which they both seemed to agree that the weakened state of the global economy can support $70-80 per barrel – why the EU offers the cartel such fodder is beyond me. It may simply have been a blanket statement from the Europeans, but you can probably bet OPEC will use it as a source to justify production cuts the moment economic activity looks set to rebound. The market realizes this and crude caught a bid as a result.
The Week’s Data
On the economic front, we received a couple of lesser watched regional manufacturing readings. Both showed factory activity improved from deep depths but remain at recessionary levels.
The market waits for more substantial data, and we’ll get it in this holiday-shortened week.
This morning the April reading on the S&P Case/Shiller Home Price Index is expected to show the seventh month of year-over-year decline of at least 18% – it’s been more than two years now since the figure has posted an increase on a 12-month basis and 2 ½ years since posting a monthly increase.
As we always point out though, this is a fairly narrow index – it includes the 20 largest metro areas, but many are those in which the greatest level of speculation took place in the boom years. As a result, these are also the areas currently burdened with the highest foreclosure rates and thus the steepest price declines.
Also today we get the Chicago Purchasing Managers Index (PMI), which is the most watched factory gauge outside of the nationwide ISM figure. This reading has been more subdued than many of the other factory indices as it is most exposed to the auto sector. Due to those auto-industry woes we shouldn’t expect Chicago PMI to make it close to 50 (the line of demarcation between expansion and contraction) but if it moves to 42-43, this will be a big plus. Conversely, if the reading remains in the 30s the market will be disappointed and may sell off even if this is the final day of a big quarter.
On Wednesday we’ll receive the preliminary employment reports in the Challenger Job Cuts Announcement index and the ADP Employment Change reading. ADP is expected to show the economy shed 390,000 payroll positions in June, which is more than is expected for the official data.
We’ll also get that ISM number, giving us the June reading on overall manufacturing activity for the nation.
On Thursday, we’ll get an overdose of employment data as the usual jobless claims reading is released, but in a rare Thursday appearance (due to the market close on Friday) we’ll receive the official monthly payroll data (June) as well. The market expects a decline of 350,000 positions, and if accurate it will mark the second-straight month of improvement from the outsized losses of 550K-740K that was the trend over the previous six months. A level of 350,000 brings us back to the peak level of losses that are seen during the more typical recession, which is the situation we currently find ourselves.
This job number is the big one and will set the stage for how the market reacts as we come back from the July 4 holiday.
Have a great day!
Brent Vondera
The broad market ended its first consecutive weekly decline since the market doldrums of February and those who want in found that mild move lower as an opportunity. We also have the second quarter coming to a close tomorrow so one certainly can’t rule out some window dressing among mutual fund managers – one wouldn’t want to appear underweight stocks during such a strong quarter, now would they.
Financials, energy and utility shares led yesterday’s market higher. All 10 major industry groups gained ground; health-care and consumer staples, while up, were the laggards.
Even as the major indices posted nice gains, lackluster volume remains the trend as just 1.02 billion shares traded on the Big Board; there is certainly a lack of conviction out there as volume has been particularly weak for three weeks and trading has been sideways since May 8. A period of low volume should remain the rule as is usually the case for the summer months.
The dream shoots, I’m sorry the green shoots, better begin to show themselves in a pronounced manner or this market is going to have another rough period some time in the near future even with the liquidity trade that remains in play. We’ve yet to see anything that resembles a normal business cycle turnaround. One would certainly think we’re to have a robust economic rebound on our hands very soon with the massive stimulus that is in the global system, but I remain concerned that government action may cause businesses to further delay capital outlays. We need the business side of the economy to step up because its going to take the consumer a while to gets things right again.
Market Activity for June 29, 2009
Activity in CrudeOil futures for August delivery are back on the march, rising 3.3% yesterday to close the session at $71.50 per barrel. What drove yesterday’s rise? It’s tough to say for sure what causes a daily move, but I doubt it was increased optimism over global growth. Heck, it was just Friday when concerns over near-term economic prospects increased again.
One thing is pretty certain; the energy market has begun to pay attention to Nigerian militant attacks – additional attacks over the weekend forced Shell to close production wells.
There were also talks between OPEC and the European Union in which they both seemed to agree that the weakened state of the global economy can support $70-80 per barrel – why the EU offers the cartel such fodder is beyond me. It may simply have been a blanket statement from the Europeans, but you can probably bet OPEC will use it as a source to justify production cuts the moment economic activity looks set to rebound. The market realizes this and crude caught a bid as a result.
The Week’s Data
On the economic front, we received a couple of lesser watched regional manufacturing readings. Both showed factory activity improved from deep depths but remain at recessionary levels.
The market waits for more substantial data, and we’ll get it in this holiday-shortened week.
This morning the April reading on the S&P Case/Shiller Home Price Index is expected to show the seventh month of year-over-year decline of at least 18% – it’s been more than two years now since the figure has posted an increase on a 12-month basis and 2 ½ years since posting a monthly increase.
As we always point out though, this is a fairly narrow index – it includes the 20 largest metro areas, but many are those in which the greatest level of speculation took place in the boom years. As a result, these are also the areas currently burdened with the highest foreclosure rates and thus the steepest price declines.
Also today we get the Chicago Purchasing Managers Index (PMI), which is the most watched factory gauge outside of the nationwide ISM figure. This reading has been more subdued than many of the other factory indices as it is most exposed to the auto sector. Due to those auto-industry woes we shouldn’t expect Chicago PMI to make it close to 50 (the line of demarcation between expansion and contraction) but if it moves to 42-43, this will be a big plus. Conversely, if the reading remains in the 30s the market will be disappointed and may sell off even if this is the final day of a big quarter.On Wednesday we’ll receive the preliminary employment reports in the Challenger Job Cuts Announcement index and the ADP Employment Change reading. ADP is expected to show the economy shed 390,000 payroll positions in June, which is more than is expected for the official data.We’ll also get that ISM number, giving us the June reading on overall manufacturing activity for the nation.On Thursday, we’ll get an overdose of employment data as the usual jobless claims reading is released, but in a rare Thursday appearance (due to the market close on Friday) we’ll receive the official monthly payroll data (June) as well. The market expects a decline of 350,000 positions, and if accurate it will mark the second-straight month of improvement from the outsized losses of 550K-740K that was the trend over the previous six months. A level of 350,000 brings us back to the peak level of losses that are seen during the more typical recession, which is the situation we currently find ourselves.This job number is the big one and will set the stage for how the market reacts as we come back from the July 4 holiday.Have a great day!
Brent Vondera
Monday, June 29, 2009
Lower rail volumes create buying opportunity in NSC
Norfolk Southern (NSC) fell along side the rest of the railroad industry as the U.S. Rail Carload Traffic Report for the week ended June 20 showed that freight traffic remained weak, down 17.7% from a year ago.
The last few weeks had showed some modest improvement, but today’s report indicates the gains were short-lived and are likely to remain at this level until there is more visible evidence of an economic recovery.
Intermodal volume, which is not included in carload data, was down 17.8% from a year ago, with container volume falling 12% and trailer volume declining 39%.
18 of 19 commodity groups tracked by the Association of American Railroads (AAR) were lower except for the “all other carloads” category, which was up 11.9% year-over-year. Lumber and wood products were down by 37.6% and motor vehicles and equipment were down by 51.6%.
Volumes and pricing in the railroad industry are not barometers of the general economy like other transportation companies like FedEx (FDX) or United Parcel Service (UPS) since railroads returns cost of capital and companies pay for their own infrastructure improvements.
Like all railroads, volumes have been in decline in recent quarters due to depressed economic activity. This has created an attractive buying opportunity in Norfolk Southern, whose strong pricing power helps the company generate about $1 billion in free cash flow per year – over 10% of revenue. As the economy recovers, strong pricing power and increasing volumes should enhance Norfolk’s earnings power and produce attractive shareholder returns.
For more on NSC, see my March 17 post.
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Peter J. Lazaroff
The last few weeks had showed some modest improvement, but today’s report indicates the gains were short-lived and are likely to remain at this level until there is more visible evidence of an economic recovery.
Intermodal volume, which is not included in carload data, was down 17.8% from a year ago, with container volume falling 12% and trailer volume declining 39%.
18 of 19 commodity groups tracked by the Association of American Railroads (AAR) were lower except for the “all other carloads” category, which was up 11.9% year-over-year. Lumber and wood products were down by 37.6% and motor vehicles and equipment were down by 51.6%.
Volumes and pricing in the railroad industry are not barometers of the general economy like other transportation companies like FedEx (FDX) or United Parcel Service (UPS) since railroads returns cost of capital and companies pay for their own infrastructure improvements.
Like all railroads, volumes have been in decline in recent quarters due to depressed economic activity. This has created an attractive buying opportunity in Norfolk Southern, whose strong pricing power helps the company generate about $1 billion in free cash flow per year – over 10% of revenue. As the economy recovers, strong pricing power and increasing volumes should enhance Norfolk’s earnings power and produce attractive shareholder returns.
For more on NSC, see my March 17 post.
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Peter J. Lazaroff
Earnings season is coming
Following an extended period of pessimism on Wall Street, April’s corporate earnings season beget rabid green shoot sightings. The market responded by moving higher as investors armed themselves with previously shunned equities, waiting to move in for the kill once these green shoots turned into growing profits.
First-quarter profits beat expectations, but were still down from a year earlier. Nobody expects earnings recovered during the second quarter, thus all eyes will be focused on guidance into the second half of 2009. With a second-half recovery largely priced into the market, the Street must be reassured profits are on the horizon.
At some point, however, the market will need more than a chorus “less bad” or “slowing rate of decline” to justify any move higher from here. This article in today's Wall Street Journal suggests stocks have entered “a Twilight Zone of uncertainty that leaves them vulnerable to earnings disappointments as they wait for earnings to recover.”
Once corporate earnings do recover, they will look impressive when compared to the prior year’s ruinous results. Of course, the best of the hunting season will be long over by the time this occurs because the market is forward-looking.
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Peter J. Lazaroff
First-quarter profits beat expectations, but were still down from a year earlier. Nobody expects earnings recovered during the second quarter, thus all eyes will be focused on guidance into the second half of 2009. With a second-half recovery largely priced into the market, the Street must be reassured profits are on the horizon.
At some point, however, the market will need more than a chorus “less bad” or “slowing rate of decline” to justify any move higher from here. This article in today's Wall Street Journal suggests stocks have entered “a Twilight Zone of uncertainty that leaves them vulnerable to earnings disappointments as they wait for earnings to recover.”
Once corporate earnings do recover, they will look impressive when compared to the prior year’s ruinous results. Of course, the best of the hunting season will be long over by the time this occurs because the market is forward-looking.
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Peter J. Lazaroff
Daily Insight
U.S. stocks ended pretty much flat on Friday as the financial press blamed the lack of investor commitment on a jump in the savings rates. We think it had more to do with the monthly income data that showed the vast majority of the increase came from government transfer payments, but we’ll get to that below. The NASDAQ Composite managed to post a decent gain.
Renewed concerns that consumer spending will slow hit economic forecasts and that meant pressure for energy, consumer discretionary and industrials shares, which were among the biggest losers.
I find the number of people believing the consumer is poised to bounce back pretty amazing. The job market is going to take another year, at least, before it shows net job creation (and it’s likely to take longer than that) and consumers have a debt problem to manage around right now. The level of debt incurred was manageable at 5% unemployment and rising private-sector incomes – a vastly higher stocks market also helped consumers feel less pressure from the levels of debt that very low interest rates encouraged. But now with the unemployment rate on its way to 10%, private-sector incomes flat and the stock market still 41% off of its 2007 peak…well, it’s no surprise that the cash savings rate has hit a 15-year high; it will continue to go higher too if higher gas prices don’t eat into this savings, which is another issue for the rough consumer environment.
The major indices ended mixed for the week as the broad market closed down 0.25% and the Dow Industrials lost 1.19%; the NASDAQ Composite bucked the trend, closing up 0.59%. Mid cap stocks closed down 0.22% and small caps ended mixed with the Russell 2000 up 0.10% and the S&P 600 down 0.08%.
Market Activity for June 26, 2009
Personal Income and Spending
The Commerce Department reported personal income jumped 1.4% in May, more than four times the amount expected as employers boosted wages and salaries even as they struggle to deal with very weak business conditions. Just kidding, but one would think this to be the case by the way people positively reacted to the headline increase. A look within the data shows wages and salaries fell again in May. The increase in the monthly income numbers was almost totally due to another large increase in government social benefit payments.
Government transfer payments recorded their largest monthly jump yet, up 7.8% in May after the 2.9% increase in April and a1.6% rise in March – this very European-like segment of the data is up 12.2% year-over-year and will have to be paid for at some point – higher tax rates are coming. Rental income was the only real bright spot on the private sector side, up a very strong 5.7% in May and with the housing market in the tank has rocketed up by 66.7% on a year-over-year basis.
That said, this is a very minor aspect of income, making up just $5.2 billion of last month’s $167.1 billion increase in income. Government transfer payments, on the other hand, made up a huge 97% of the income gain for May. Maybe this illustrates why we’re not exactly excited over the large increase in total income last month – the way incomes have increased is hardly sustainable.
The largest private sector aspect of the data, wages and salaries, fell 0.1% in May marking the seventh monthly decline in the past eight months. On a year-over-year basis, wages and salaries are off by 1.1%. Dividend income fell 0.7% and interest income rose 0.7%, pretty much offsetting one another as the dollar change in dividends fell $5 billion, while the increase in interest income was $7 billion.
On the other side of the data, personal spending rose 0.3% last month and followed no change for April, which was revised up from the -0.1% initially estimated. Nominal spending is down 1.8% from the year-ago period.
As incomes easily outpaced spending in May, the savings rate (the cash savings rate as I call it) jumped to 6.7%. The policy makers that believe massive government spending will boost consumer activity are surely dismayed by this reality as they need these transfer payment to be spent.
However, with the shape the labor market is in, along with the decline in consumers’ two largest savings vehicles (stocks and houses) the build in cash savings will continue over the next year or two. On a year-over-year basis, the savings rate is up 4.8%, a huge shift from levels that hovered near zero. We’re looking for this year-over-year figure to move closer to 8% before consumers feel better about their situation. Ultimately, it will take meaningful improvement in the labor market to allow a sustainable move in consumer activity.
Even with the rise in spending last month, the jump in the savings rate is evidence that consumers have cut discretionary spending to the core. I am concerned that if gasoline prices rise much further this will be too much to bear – that release valve (as Daniel Ahn at Macroeconomic Research likes to put it) of cutting discretionary spending as a way to ease the outlays at the pump is no longer there.
I continue to believe that GDP will post a slight positive reading in the third quarter and a more substantial increase in the fourth. However, if policymakers continue along the current path (massive government spending that results in a growing concern over the chances of austere future tax rates and thus less private-sector activity) we may not get the boost from the business side that we’ll need to offset some of the consumer weakness.
That savings rate figure shows that bank deposits are increasing at a robust rate. Problem is, business caution means that the demand for loans is very weak – deposits grew 7.4% faster than loans last year, the widest gap in 30 years, and that number has surely increased so far this year; commercial and industrial loans have declined 8.2% since October. This could signal two things:
One, it may take a bit longer for a positive GDP print to result.
Two, when businesses do begin to increase borrowing again the massive levels of liquidity that is currently sitting fallow will then explode through the system. Since production has been extremely subdued for three quarters now that means a whole lot of money chasing too few goods – and that ladies and gentlemen is how harmful levels of inflation comes screaming out of no where. This is a real concern with regard to the duration of the rebound when it does occur.
Cap and Trade
The Cap and Trade bill passed the House by a narrow margin on Friday night. The quixotic nature of this legislation is troubling enough – demanding that power plants produce 15% of output from “renewable sources” in a decade will not only reduce our competitiveness, it’s absent common sense. We use roughly 50 million of oil-equivalent barrels of energy per day and of this amount wind, solar and geothermal combine to make up less than one million barrels. It’s an understatement to say that this target fails to conform to reality. If people were serious we would double our amount of nuclear power plants over the next decade and remove the recycling ban so that we no longer have a waste storage issue – we seem to recycle everything else under the sun but refuse to do so with the one thing that can make the biggest difference.
But the really troubling aspect of this bill is the protectionism that was pushed into the 1200 page document. It’s a rather circuitous route to protectionism, but protectionism nonetheless.
The authors of this bill apparently understand that raising the price of emission will erode our competitive advantages so they propose to protect steel, cement and chemical manufacturers via tariffs (raising the prices of imported goods so domestic industries that will be saddled with higher costs can compete). While this trade protectionism would not kick in for a number of years, it sends the wrong message to our trading partners who will be likely to impose their own trade restrictions in advance. This is called retaliation, a trade war, and is exactly what we do not need right now.
We can get away with making mistakes from an economic policy standpoint. But when you throw a number of things together, the eventual unwind of an aggressive monetary easing, higher tax rates, the attempt to impose sanctions on imports, a substantial increase in regulations and massive deficit spending I don’t think it is time for investors to take down their guard. This may be a very tempting thing to do over the next several months as the economy will (even if it is relatively mild and short-lived) rebound from these deep depths of contraction. Concern and caution will remain a prudent mindset until we see a shift in the direction of policy.
Have a great day!
Brent Vondera
Renewed concerns that consumer spending will slow hit economic forecasts and that meant pressure for energy, consumer discretionary and industrials shares, which were among the biggest losers.
I find the number of people believing the consumer is poised to bounce back pretty amazing. The job market is going to take another year, at least, before it shows net job creation (and it’s likely to take longer than that) and consumers have a debt problem to manage around right now. The level of debt incurred was manageable at 5% unemployment and rising private-sector incomes – a vastly higher stocks market also helped consumers feel less pressure from the levels of debt that very low interest rates encouraged. But now with the unemployment rate on its way to 10%, private-sector incomes flat and the stock market still 41% off of its 2007 peak…well, it’s no surprise that the cash savings rate has hit a 15-year high; it will continue to go higher too if higher gas prices don’t eat into this savings, which is another issue for the rough consumer environment.
The major indices ended mixed for the week as the broad market closed down 0.25% and the Dow Industrials lost 1.19%; the NASDAQ Composite bucked the trend, closing up 0.59%. Mid cap stocks closed down 0.22% and small caps ended mixed with the Russell 2000 up 0.10% and the S&P 600 down 0.08%.
Market Activity for June 26, 2009
Personal Income and SpendingThe Commerce Department reported personal income jumped 1.4% in May, more than four times the amount expected as employers boosted wages and salaries even as they struggle to deal with very weak business conditions. Just kidding, but one would think this to be the case by the way people positively reacted to the headline increase. A look within the data shows wages and salaries fell again in May. The increase in the monthly income numbers was almost totally due to another large increase in government social benefit payments.
Government transfer payments recorded their largest monthly jump yet, up 7.8% in May after the 2.9% increase in April and a1.6% rise in March – this very European-like segment of the data is up 12.2% year-over-year and will have to be paid for at some point – higher tax rates are coming. Rental income was the only real bright spot on the private sector side, up a very strong 5.7% in May and with the housing market in the tank has rocketed up by 66.7% on a year-over-year basis.
That said, this is a very minor aspect of income, making up just $5.2 billion of last month’s $167.1 billion increase in income. Government transfer payments, on the other hand, made up a huge 97% of the income gain for May. Maybe this illustrates why we’re not exactly excited over the large increase in total income last month – the way incomes have increased is hardly sustainable.
The largest private sector aspect of the data, wages and salaries, fell 0.1% in May marking the seventh monthly decline in the past eight months. On a year-over-year basis, wages and salaries are off by 1.1%. Dividend income fell 0.7% and interest income rose 0.7%, pretty much offsetting one another as the dollar change in dividends fell $5 billion, while the increase in interest income was $7 billion.
On the other side of the data, personal spending rose 0.3% last month and followed no change for April, which was revised up from the -0.1% initially estimated. Nominal spending is down 1.8% from the year-ago period.
As incomes easily outpaced spending in May, the savings rate (the cash savings rate as I call it) jumped to 6.7%. The policy makers that believe massive government spending will boost consumer activity are surely dismayed by this reality as they need these transfer payment to be spent.
However, with the shape the labor market is in, along with the decline in consumers’ two largest savings vehicles (stocks and houses) the build in cash savings will continue over the next year or two. On a year-over-year basis, the savings rate is up 4.8%, a huge shift from levels that hovered near zero. We’re looking for this year-over-year figure to move closer to 8% before consumers feel better about their situation. Ultimately, it will take meaningful improvement in the labor market to allow a sustainable move in consumer activity.
Even with the rise in spending last month, the jump in the savings rate is evidence that consumers have cut discretionary spending to the core. I am concerned that if gasoline prices rise much further this will be too much to bear – that release valve (as Daniel Ahn at Macroeconomic Research likes to put it) of cutting discretionary spending as a way to ease the outlays at the pump is no longer there.I continue to believe that GDP will post a slight positive reading in the third quarter and a more substantial increase in the fourth. However, if policymakers continue along the current path (massive government spending that results in a growing concern over the chances of austere future tax rates and thus less private-sector activity) we may not get the boost from the business side that we’ll need to offset some of the consumer weakness.
That savings rate figure shows that bank deposits are increasing at a robust rate. Problem is, business caution means that the demand for loans is very weak – deposits grew 7.4% faster than loans last year, the widest gap in 30 years, and that number has surely increased so far this year; commercial and industrial loans have declined 8.2% since October. This could signal two things:
One, it may take a bit longer for a positive GDP print to result.
Two, when businesses do begin to increase borrowing again the massive levels of liquidity that is currently sitting fallow will then explode through the system. Since production has been extremely subdued for three quarters now that means a whole lot of money chasing too few goods – and that ladies and gentlemen is how harmful levels of inflation comes screaming out of no where. This is a real concern with regard to the duration of the rebound when it does occur.
Cap and Trade
The Cap and Trade bill passed the House by a narrow margin on Friday night. The quixotic nature of this legislation is troubling enough – demanding that power plants produce 15% of output from “renewable sources” in a decade will not only reduce our competitiveness, it’s absent common sense. We use roughly 50 million of oil-equivalent barrels of energy per day and of this amount wind, solar and geothermal combine to make up less than one million barrels. It’s an understatement to say that this target fails to conform to reality. If people were serious we would double our amount of nuclear power plants over the next decade and remove the recycling ban so that we no longer have a waste storage issue – we seem to recycle everything else under the sun but refuse to do so with the one thing that can make the biggest difference.
But the really troubling aspect of this bill is the protectionism that was pushed into the 1200 page document. It’s a rather circuitous route to protectionism, but protectionism nonetheless.
The authors of this bill apparently understand that raising the price of emission will erode our competitive advantages so they propose to protect steel, cement and chemical manufacturers via tariffs (raising the prices of imported goods so domestic industries that will be saddled with higher costs can compete). While this trade protectionism would not kick in for a number of years, it sends the wrong message to our trading partners who will be likely to impose their own trade restrictions in advance. This is called retaliation, a trade war, and is exactly what we do not need right now.
We can get away with making mistakes from an economic policy standpoint. But when you throw a number of things together, the eventual unwind of an aggressive monetary easing, higher tax rates, the attempt to impose sanctions on imports, a substantial increase in regulations and massive deficit spending I don’t think it is time for investors to take down their guard. This may be a very tempting thing to do over the next several months as the economy will (even if it is relatively mild and short-lived) rebound from these deep depths of contraction. Concern and caution will remain a prudent mindset until we see a shift in the direction of policy.
Have a great day!
Brent Vondera
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