Daily Insight

U.S stocks pared mid-session gains but ended the day nicely higher, marking the fourth-straight day of increase. The broad market has moved a bit closer to fully erasing the losses of the previous two weeks as yesterday’s drivers were higher profit expectations and the most meaningful decline in jobless claims since January.

The earnings optimism followed results out of aluminum maker Alcoa. We touched on this yesterday, but I’ll just state again the optimism was pretty overdone. The firm achieved better-than-expected results only from a combination of major cost-cutting* (comment below) and China’s still voracious appetite for commodities as they seek to protect again dollar weakness. This sent average selling prices of aluminum higher by 24% for the quarter. The cash-for-clunkers program also provided a boost to Alcoa. Some are beginning to share this view this morning, fretting over the absence of aggregate demand, but yesterday the optimism over the company’s results definitely played a role in the rally.

What was more justified was the market’s rally on the jobless claims news. However, the 60% rebound from the March depths already reflect this degree of improvement in claims – let’s face it, it’s not like claims have moved down to 450K, which would still be elevated from a historical perspective – claims fell to 525K from 554K.

The leaders yesterday were energy, basic material, consumer discretionary and industrial shares. Telecom and health-care stocks were the laggards.

Volume showed there was a little more conviction in yesterday’s activity as roughly 1.2 billion shares traded in the NYSE Composite. This is still 8% below the six month daily average, but meaningfully better than the especially weak volume that accompanied the prior three-day rise in prices.

Longer-dated Treasury securities sold off yesterday (yields rose) after the $12 billion 30-year auction was not well bid. Investors had expected strong demand to meet this auction, particularly following very strong interest in Wednesday’s 10-year auction. The bid-to-cover ratio (gauge of demand) came in at 2.37, compared to 2.63 from the previous four auctions. Indirect bids (demand from foreign central banks) was just 34.5%, compared to 48.5% for the last four auctions.

One auction does not a trend make, but this is just something to keep our eyes on.

Market Activity for October 8, 2009
Jobless Claims

The Labor Department reported that initial jobless claims fell more than expected last week, down 33,000 to 521,000 (much better than the 19,000 decline forecasted). The previous week’s reading was revised a bit higher to show 554,000 in initial claims, 3,000 more than originally reported.

The four-week average fell to 539,750, the lowest level since the second week of January.

Continuing claims fell 72,000 to 6.04 million, but those moving to benefit extensions rose 67,000 – so this almost completely offsets the decline in the traditional measure of continuing of claims.

Just to touch on these extensions for new readers, when jobless benefits run the normal 26-week course there is a 20-week extension known as Emergency Unemployment Compensation (EUC). When those benefits run out there is an additional 13-week extension for most states. So this brings the total to 59 weeks.

(On top of that, the House passed an additional 13-week extension for people in states in which unemployment rates have hit at least 8.5%. This isn’t every state, a little more than half, but from a population perspective, this will cover the vast majority of the jobless who fail to find employment by the time benefits expire. The bill had ran into trouble in the Senate, not because members view more than a year of jobless benefits as a bad thing, but because 17 senators are objecting because their states would be excluded. I believe the Senate passed a measure last night that would provide extensions now to all states, but this will have to be reconciled with the House – I don’t it will run into a roadblock. Maybe I should start referring to Congress as parliament – this sounds a heck of lot more like France than the USA.)

What this jobless data for the first week of October tells us is that the pace of job cuts fell from the previous month, but firms remain reluctant to hire. The uninterrupted march higher in continuing claim extension rolls makes this abundantly clear.

Same-Store Retail Sales

Same-store sales (year-over-year sales results for stores open at least a year) rose 0.1% in September, marking the first increase in 14 months. The fact that same-store sales results have been in decline for this length of time is important to keep in mind as it means the comparisons to year-ago levels were quite easy.

The increase was helped by the discount retail components and drug sales. Wholesale club results (ex fuel sales) jumped 4.2%, drug-store retailers saw sales increase 3.7% and typical discount stores reported a 0.5% increase. The drags came from department stores, reporting a 2.3% decline; apparel stores, where sales fell 4.5%; and luxury stores that remain in a world of hurt, sales slid 8.5%. Still, with apparel results being the exception, September’s figures were an improvement from the large declines witnessed in previous months.

Wholesale Inventories

The Commerce Department reported that wholesale inventories fell 1.3% in August (the expectation was for a 1.0% decline). The July figure was revised lower to show a 1.6% contraction in stockpiles vs. the 1.4% drop initial estimated. This measure of inventories has declined for 13 consecutive months -- wholesale inventories account for roughly 25% of total business inventories.

The sales data did rise though, marking the fourth month of increase after a collapse that ran June 2008-March 2009. Excluding petroleum, sales rose for a second-straight month.

As a result, the inventory/sales ratio fell to 1.20 months worth from 1.23 months in July – down from the eight-year high of 1.34 months hit in January. The all-time low of 1.11 was hit in June 2008.

This is very good work on the inventory front, yet it does spell some issues for the third-quarter GDP report. Many had still been expecting the inventory dynamic to help catalyze GDP, but as we’ve been mentioning for a month now, that will probably be delayed, not showing up in earnest until the current quarter’s GDP reading is released.

Third-quarter GDP will get a boost from export activity and personal consumption (due to clunker-cash and back-to-school season) but little boost will arrive from the inventory side. That inventory dynamic should be quite robust for the fourth-quarter GDP report.

Bernanke’s Siren Song

Chairman Bernanke sang sweet sweet music to the equity markets last night by stating that there is no reason to even mildly raise rates. He offered the U.S. dollar lip service by stating that the central bank will be prepared to tighten when the outlook for the economy has “improved sufficiently.” However, his overriding statement was, “[m]y colleagues at the Federal Reserve and I believe that accommodative policies will likely be warranted for an extended period.” This was a shot across the bow to those Fed officials who have recently given speeches and written Op/Eds on the need for the FOMC to aggressively tighten policy in short order. This also flashed the green light to the easy-money trade.

The first 35% move of this stock-market rally from the depths of last March was completely justified; it was a typical move off of the oversold levels of March 9, 2009. However, the last 25% of this surge has purely been a zero interest-rate policy trade. It has nothing to do with economic fundamentals and the lurch forward from here makes the situation that much more dangerous for those attempting to trade this thing and wring evermore return.

Just as in Greek mythology, the Sirens (the seductive bird-women of Anthemusa) would entice sailors to the shores of their island with their enchanting music and voices, the comments from Bernanke were equally alluring. But the island was rocky and the shore abruptly shallow; the undisciplined sailors would shipwreck on the jagged coast.

Thus the term “siren song,” an appeal that is tough to resist, and if not repelled will lead to…well, a less than desirable result.



*Just to explain on the cost-cutting comment above. I would normally view this as a good thing; this is a beneficial effect of recessions as it causes firms to streamline. When the business cycle rebounds and sales come back firms are then more profitable. Long-term readers may remember me expressing optimism over the cost-cutting that occurred during the 2001-2002 downturn. But this time is vastly different. The aggressive nature of cost-cutting, particularly the slashing of payrolls, will make the rebound in final demand much more delayed. Further, we are dealing with much higher debt levels that will have to be worked down. The combination of high debt levels and abnormally high unemployment will keep final demand weak, which will very likely put pressure on profit growth after a two-quarter rebound coming off of very low levels.

Have a great weekend!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks bounced between gain and loss several times Wednesday, but the broad market rallied in the final hour of trading to close higher. The Dow Average failed to follow suit as telecom names AT&T and Verizon, along with shares of 3M held the index back.

Financial, energy and technology shares were the leaders, with telecoms, industrials and utilities the laggards.

The weakness mid-day came on reports that homebuilders are worried that Congress has yet to signal an extension of the homebuyers tax credit. We all know that the housing market needs this credit (along with FHA-backed originations this is just another crutch), although I’m skeptical the beneficial impact its had on home sales will continue as the duration of joblessness continues to climb – having a job is sort of a big factor in buying a home. But you can’t keep a good market down, the performance chasers have come to town.

Volume was fragile again, with just 978 million shares traded on the NYSE Composite, roughly 25% below the three-month average. Got conviction?

Yesterday’s $20 billion auction of reopened 10-year Treasury notes went off without a hitch again. In fact, this is an understatement. The bid-to-cover ratio (gauge of demand) was through the roof at 3.01 (2.56 is the average over the past eight auctions). At this heightened level of over-subscription one would think the government was paying 6, 7 or 8% for 10-year money, instead of the 3.18% locking in for 10 years currently offers.

The Fed was in there again, buying $1.3 billion in Treasury securities, but even so these yields illustrate a view within the bond market that is quite removed from the euphoric optimism currently exhibited within the equity markets. In time we’ll find out which market is correct. It may be that neither are viewing things accurately, but no time to get into this take right now.

Market Activity for October 7, 2009
Mortgage Applications

The Mortgage Bankers Association’s index of applications jumped 16.4% in the week ended October 2 after declining 2.8% in the prior week.

Purchase leapt 13.2% as the rush is on to get in before the first-time homebuyers tax credit expires on November 30 (the contract has to close by that date). This buying is also being helped by FHA-backed loans, which now make up 23% of all originations, up from just 3% in 2006. A borrower need to only put down 3.5% of an FHA-backed purchase.

I guess I don’t have to say what this means for foreclosures if home prices dip again – at the end of June, 8% of FHA-backed loans were 90 days late; 15% are 30 days past due. The writing is on the wall.

Refinancing activity also surged, up 18.2% for the week – this segment made up 66.3% of the mortgage apps index, up from 65.3% the week prior. A 30-year fixed-mortgage rate of 4.89% for the week (lowest level since late May) certainly provided some jet fuel to contract signings and refis.

Weekly Energy Report

The price of oil pulled back a bit yesterday after the Energy Department reported that gasoline and distillate stockpiles jumped last week. Gasoline supplies rose 2.94 million barrels, a build of one million barrels was expected. Distillate inventories (diesel and heating oil) climbed 679,000 barrels, 70% more than the 400,000 expected. The 171.8 million barrels of distillates in inventory is the highest since January 1983 – although if the current temperature track holds it will soon boost demand for heating oil.

Crude stockpiles fell one million barrels, but the current level of inventories is 5% above the five-year average.

The fact that crude prices barely budged on the gasoline and distillate news shows the oil trade is not about supply/demand fundamentals and all about a hedge against a falling dollar and an overall move into commodities fostered by aggressive global monetary easing.

Consumer Credit

The Federal Reserve reported that consumer credit fell in August for a seventh-straight month (down 10 out of the past 11), matching the record streak of decline. The last time consumer credit (which includes both revolving – such as credit cards – and non-revolving – like auto loans) fell for seven-straight months was 1991, although the degree of decline this go around is three times greater. The data goes back to 1943, but it wasn’t really of much significance until the 1970s.

Consumer credit fell $12 billion, or 5.8% at a seasonally-adjusted annual rate, in August after the largest decline on record of $19 billion in July, according to the Fed. A median forecast of 36 economists estimated the figure to drop by $10 billion; projections ranged from an increase of $6.2 billion to a decline of $15 billion. The plunge in July was actually an upward revision from the initial estimate of -$21.6 billion when it was released last month.

The driver of the decline was a $9.9 billion, or 13.1%, drop in revolving credit as credit card lines have been slashed due to rising default rates and consumers pulling back and paying down balances. This is a necessary condition to a meaningful rebound in consumer activity 18-24 months out and is just something we’ll have to work through so long as the labor market remains mired.

Non-revolving credit eased just $2.1 billion, or 1.6% -- it had crashed during the previous two months, falling 12.6% in July and 8.0% in June. The cash-for-clunkers program clearly provided a respite to this continued decline, but like any scheme to boost activity when the consumer needs to repair the aggregate balance sheet, this only delays what is inevitably going to occur.

I suspect large declines in borrowing will continue over the ensuing months, and its natural effect on retail sales figures, now that Uncle Sugar is no longer distributing clunker cash. Domestic auto sales fell back to their pre-clunker cash levels in September, as the chart below illustrates, so next month’s reading on consumer credit won’t get help from the non-revolving side of things – it was a one and done event.

The clunker-cash program is a microcosm of what will occur when the various other types of government stimulus are removed – when the crutches are taken away. And if they are not taken away in an appropriate manner…well, reflation experiments always carry huge costs that must be borne down the road. We seem to live in a world in which more and more people are unaware of this reality and this does have an effect on one’s near-term (call it 18-24 month) expectations. Just as one has to come down from gorging on energy drinks, NoDoz (dang, two 1980s references in two days), or a sugar high (as is PIMCO’s El-Erian’s famous phrase), it must also come down from easy money policy – how quickly we forget.

Futures

Stock-index futures are off to the races this morning, juiced by Alcoa’s earnings results last night. Sales plunged 34% from the year-ago period, but were up 8% sequentially – that is, from the previous quarter. The market generally does not view revenue trends on a quarter-over-quarter basis because they are not good comparisons from a seasonal perspective, but that is all the market has to go on right now as the same-quarter year-ago comparisons remain abysmal.

Earnings came in much better-than-expected, posting a 4-cent profit vs. estimates for an 8-cent loss. The quarter was helped by a 24% jump in the average price of aluminum relative to the pervious quarter. China’s desire for metals has yet to be sated. And the Chinese will remain voracious with regard to their commodity purchases as they seek to offset the damage they are seeing in purchasing power via their U.S. dollar assets.

The firm engaged in another round of massive cost-cutting, slashed its smelting capacity as the firm said prices aren’t yet high enough to warrant restarting these plants. The company stated that global demand remained weak, with the exception of China.

Whether or not the rally we’re seeing in pre-market activity flows into the trading session may very well depend on how the weekly jobless claims data plays out. If claims can break the 540K level, the rally will rumble; if not, it will stumble. We get the number at 7:30 CT.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

It’s a Rick Ocasek market, “let the good times roll,” as stocks engaged in another significant rally yesterday. This brings to mind another song from the Cars: “Don’t Cha Stop.” The great reflation of asset prices continues as the Fed keeps easy-money policy floored.

The broad market has nearly erased the decline of the previous two weeks as investors appear pretty upbeat regarding the third-quarter earnings season, which will officially get underway today, but not in earnest until next week. The market is sanguine that we’ll see revenue growth for the quarter. I think it is more likely that the bottom line will be assisted via aggressive cost-cutting, mostly through the slashing of payrolls – just as was the case with second-quarter earnings (still profits will be down at least 15-20%).

If we do fail to get top-line improvement, which depends upon final demand, I think the music’s going to run out on this leg of the rally – but I’ve been saying that for 150 S&P 500 points now; as the Fed keeping the pedal to the metal, one never knows another asset bubble may just ensue. One thing is pretty clear, a prolonged period of cost-cutting via payrolls today means a lack of aggregate demand tomorrow.

Another weak session in terms of volume as less than 1.2 billion shares traded in the NYSE Composite. One would like to see these rallies exhibit more conviction, say 1.5 -1.8 billion shares, but no one seems to be too concerned about it.

Energy and basic material stocks led the rally as the surprise hike in rates by the Reserve Bank of Australia (their central bank) delivered yet another body blow to the greenback, which we’ll discuss below. Tech, consumer discretionary and financials performed very well too.

More positive comments from analysts/economists helped yesterday’s extension. A top executive at Fidelity International stated sustainable economic growth and low interest rates worldwide will spur a “multi-year” bull market in equities. Also, Deutsche Bank’s chief U.S. economist appeared to reverse course after being pretty pessimistic over the past few months by stating, “[t]he momentum in the economy is moving forward” and “housing is poised for a rebound.”

Market Activity for October 6, 2009
Interest-Rate Differentials – a Driving Force Again

The Australian central bank unexpectedly increased their cash-rate yesterday, becoming the first G-20 nation to begin tightening. This will keep the Aussie dollar in rally mode, and have the opposite effect on the greenback. The USD got hammered again yesterday, resulting in another rally for metals and oil – gold hit $1,040 per oz.

One-month Aussie bills now yield more than our 10-year Treasury note. The fact that U.S. long-term interest rates are so low is not only because the Fed has pushed short-term rates to zero and have engaged in actually purchasing bonds (quantitative easing). It is also because we continue to enjoy huge global demand for U.S. government debt. How long will this continue at the current level of U.S. rates? That’s a big question.

I think we’re going to see interest-rate differentials become a driving force again for currency values as foreign central banks begin to de-link their policy from the super-aggressive easing campaign that the Federal Reserve is currently engaged – something we talked about last week. If other central banks begin to tighten (raise rates), even mild increases, this is going to put intense pressure on the U.S. dollar and may force Bernanke’s hand more quickly than the market currently expects.

Trying to gauge these things is impossible, but it appears things may be moving in this direction. The U.S. has the luxury of enormous levels of liquidity that allow us to get by with lower rates on government bonds than other regions of the globe, but with gold tracking to $1,050, copper back on its horse toward $300/lb and oil back above $71/barrel (even though energy demand remains weak) one wonders when the trade will change full-blown to commodities and away from the USD.

While the Federal Reserve decides nary a mention of the dollar in any of their statements (which is strange considering they have a monopoly on dollar creation), they will not be able to sit by and idly watch a greenback in freefall – if that happens to occur. This would have huge ramifications for stocks, as the current rally is more a function of easy money (extremely low rates that keep money flowing into stocks as there are very little alternatives -- at least from an attractive interest-rate perspective -- in the bond market. That will all change if the Fed is forced to change course in order to throw a lifeline to a drowning dollar and begins to increase U.S. rates.

What will the Recovery Look Like?

This is a big question and something I think about on a daily basis. I had been assuming, even if I’ve carried a pessimistic tone since May, that we’ll get a decent upturn in GDP – even if it is a short-lived expansion as the Fed reversal alone will crush it – as the inventory dynamic and infrastructure spending combine to catalyze activity. However, I am really beginning to question even half the bounce we usually get from such deep levels of contraction. Sure, we are likely to see a two-quarter bounce in economic activity from these low levels but I’m not sure government spending will be able to fully offset consumer weakness. And there is also a payback effect to this government intervention as the private sector holds back – we’ve got to pay for this spending and businesses have seen this game before, they know what follows – one gets this sense that the business community will remain cautious for a prolonged period.

The drag from the consumer side of things (currently 70% of GDP and on its way to the historic average of 65%) will be quite large. How is consumer activity supposed to get going? The jobless rate is sky-high, the duration of unemployment is at record lengths and we don’t have credit to fall back on this time as consumer credit is in decline – a high level on unemployment is unlikely to change this reality as default rates will remain high and this will keep both the supply of and demand for loans moving lower.

And then we have consumer confidence (CC), which many people have pointed to as a bright spot. Bright spot? The reading only looks good next to near-record lows. There has never been a meaningful economic expansion when CC is below 60 without an ability to extend on the credit side (at least going back to 1967). The long-term average on the main confidence reading is 95.6 – it currently sits at 53.1.

What is typical coming out of a deep recession is for GDP to bounce back at 6%-8% real annual rates, and this seems to be what most expect. I’m sorry, but don’t see how this is possible.

What the economy needs is broad-based tax rate reductions to really cement an expansion that extends past a couple of quarters. A cut in marginal income tax rates will drive aggregate disposable income, very needed at this time of stagnant incomes and high joblessness; slashing the corporate tax would drive profits; stating that capital gains and dividend tax rates would remain at current levels would be a big help to stock prices (although at this rate it doesn’t appear stocks need much help); and higher current-year write-down allowances would spark a business spending expansion – it would also have a positive effect on job creation as the orders for plant and equipment would drive hours worked, a necessary condition for an increase in hiring that follows. In total, what broad-based tax cuts would do is help the economy to withstand the coming (even if the timing is delayed) reversal of monetary policy.

But policymakers have painted themselves into a corner. After spending their time vilifying lower tax rates, the administration can hardly turn and engage in such policy. Higher scheduled tax rates and tighter monetary policy will prove to be a deathblow to economic recovery. All they have for now, regarding the tax-rate lever, is an extension of the first-time home-buyers tax credit, which we wouldn’t be surprised to see extended to all homebuyers. But this is hardly enough, I even question if it can keep home sales going as the credit has already front-loaded sales and labor-market conditions will make it tough to keep housing activity in rebound mode.

We’re moving from what has been termed the “great moderation” of the past quarter century to a period that exhibits significantly more erratic business cycles. Going back to 1982 expansions became longer and contractions shorter – smart economic and correct (for most of this period) monetary policy were the driving forces. Returning to higher tax rates, more regulations and misguided monetary policy will bring a scenario in which recessions become more frequent.

Policy can always shift, and sometime in a fairly rapid manner; although, history shows it generally takes a significant electoral transfer to foment such a change in direction. I’ll certainly turn much more upbeat if pro-growth policies even begin to get a look from the President, but wishful thinking seems to be a wasteful and dangerous activity in this environment. For now, I would remain cautious.

Correction

Yesterday I was referring to the Cap and Trade bill as C&I – what can I say, I’m an idiot; must have had the decline in Commercial and Industrial loans on the mind. Anyway, obviously I meant to type C&T.

Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review: EMR, STJ, BA

S&P 500: +14.26 (+1.37%)

The news of the day was that Australia became the first G20 nation to raise interest rates since the start of the financial crisis. The surprise move by the Reserve Bank of Australia signals that the global economic recovery is gaining momentum and may lead to rate hikes in other countries, particularly in the Asia-Pacific region.

U.S. dollar declined in part due to Australia’s rate hike, which sent commodity prices higher.


Emerson Electric (EMR) gained 1.40% on news that they acquired Avocent Corp for $1.2 billion in cash. Avocent designs, manufactures, licenses, and sells hardware and software provides connectivity and centralized management of IT infrastructure. Half of Avocent’s 2008 revenue, which totaled $647 million, was generated outside the U.S.

Emerson intends to apply the company’s infrastructure management to its network of power systems, energy management, and precision cooling services. In addition, Emerson can now better address energy efficiency, which they cite as their data center customers’ most pressing challenge.


St. Jude Medical (STJ) fell 12.66% as the company said it would have lower than expected third-quarter sales. CEO Dan Starks said hospitals had cut device purchases in the quarter and said St. Jude also lost revenue due to changing foreign exchange rates.

Also weighing on St. Jude, as well as other medical device companies, is the expectation that medical device companies will be forced to pay fees based on market share in any healthcare reform.

Boeing (BA) finished flat after announcing delays to its 747-8 Freighter aircraft program. The announcement comes just two montsh after the aircraft maker said it would take a $2.5 billion charge to earnings because of production delays and additional costs associated with its development of the 787 Dreamliner.



Quick Hits

• Goldman: Markets Miss ‘Dramatic Improvement’ at Big Banks
• Earnings preview
  

Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks rebounded on Monday after a four-day decline, supported by positive comments from Goldman Sachs and Credit Suisse. The press seemed to focus on the latest ISM service-sector reading as the catalyst, this gauge hit expansion mode of the first time in 13 months, but it wasn’t.

The broad market rallied at the open but pulled back after the service-sector reading. While pretty decent, the reading seemed to be boosted more by promotional activity than outright demand and the employment figure remained sluggish. The market moved to its highs on the session after Goldman Sachs recommended buying large banks (egad! – they are trading at 2006 multiples, yet earnings are less than half what they were back then) and Credit Suisse strategists’ put out a report titled, “No Time to Sell.”

Financials led the rally. Commodity-related energy and basic material shares were the next best performers as another session of dollar weakness causes money to funnel directly to these sectors – metals and oil.

Advancers trounced decliners by an 8-to-1 margin on the Big Board. However, volume was weak again with just 1.07 billion shares traded on the NYSE Composite – roughly 20% below the six-month average.

Market Activity for October 5, 2009
ISM Service

The Institute for Supply Management’s gauge of service-sector activity (the respondents to this report are purchasing and supply executives) rose above 50 (the dividing line between expansion and contraction) for the first time since August 2008. While the measure moved just barely into expansion mode for September, a number of the sub-indices within the report showed really nice improvement -- although, the gains looked to be largely price driven as the prices paid component plunged to 48.8 from 63.1 in August.

The headline index rose to 50.9 for September from 48.4 in the previous reading and 13-straight months of contraction.

For the sub-indices that make up the headline number:

The new orders index rose very nicely to 54.2 from 49.9 in August and follows 11 months of contraction. I’ll note, comments from respondents pointed to “promotional activities” as the driver for new orders – this helps to back up the price-driven comment above.

Business activity rose to 55.1 from 51.3.

The employment index picked up a bit, rising to 44.3 from 43.5; still sluggish but no surprise there. Three industries reported increased employment, 12 reported decreased employment, leaving three reporting unchanged employment compared to August.

As touched on, the prices paid index fell to 48.8 from 61.3. Six industries reported an increase in prices, eight reported prices as decreasing and four unchanged.

Interestingly, even though the overall reading rose, the number of industries that reported growth fell to five out of the eighteen tracked, down from six for August. Respondents’ comments varied and remained quite mixed about business conditions and the overall economy.

The five industries that reported growth in September were: Utilities, Health-Care & Social Assistance, Retail Trade, Construction, and Wholesales Trade.

What respondents said:

• “Sale are very steady and have risen some each month in the past six months. The bottom is now here.” (Construction)
• “Economic recovery turnaround has begun in the financial services sector; however, cautious expense management is still practiced.” (Finance & Insurance)
• “Lack of available capital for new project development.” (Accommodation & Food Service)
• “Continue to see signs of slow recovery, but customers are still putting orders off until the beginning of 2010.” (Professional, Scientific & Technical Services)
  

Government Induced Rise in Energy Prices

The Cap and Trade (C&I) agenda seems dead right now, but never underestimate Congress’ ability to do something really stupid even when the public outcry hit its crescendo. The WSJ reported yesterday on last weeks’ coordinated release of the EPA’s new rules that make carbon dioxide a “dangerous pollutant” (I guess that means we should all stop breathing) and the John Kerry-sponsored energy-tax bill.

As the EPA has now promulgated its decision to label CO2 a pollutant, even if the C&I bill is voted down, the EPA is coming to punish the utility companies (which means the consumer will bear the cost of these regulations). The strategery, to bring back a Bushism, is to get utility companies to back the C&I bill, in which they’ll be better off than the EPA running roughshod over them, as C&I would grant emissions allowances (permits) that they can sell to offset the cost of the EPA’s stricter regulations.

Surely everyone understands that once the EPA designates a chemical compound as a pollutant it has the legal authority to regulate it under the Clean Air Act. If the agenda can’t pass Congress, you’ve always got this to fall back on – isn’t that sweet.

It doesn’t matter that carbon is a result of warming and not a cause – and this is the route proponents take, if we don’t reduce carbon emissions then the earth’s ecosystem will collapse and we’ll all be dead – or so they say. (This too is yet another reason I’m not terribly optimistic about the direction we’re going. The priories are all screwed up as we put an “environmental” agenda ahead of economic growth imperatives.)

Climate change is a function of solar activity, plain and simple; we’re seeing solar activity wane now after a decade-long period of increased activity, and thus the reason for the cooler temperatures. In a period of rising atmospheric temperatures ocean temperatures rise as well, which means carbon is less soluble. Thus more carbon is emitted instead of being absorbed into ocean water – it is a result, not a cause.

(If it were true that humans were the primary cause of higher temperatures, then how exactly were temperatures higher during the medieval warming period that ran roughly 900-1300, an era in which Vikings colonized Greenland -- which means they cultivated crops -- in what is currently a frozen tundra?)

Increasing costs on the economy by regulating, and therefore taxing, carbon in an attempt to reduce this emission is not only futile, it will destroy economic growth in the process. But when Congress is dead set on their command-and-control agenda, it sure as heck won’t let facts get in the way.

I don’t think the market is pricing in the fact that we may not be dealing with a President Clinton here. When Clinton swerved way left following the 1992 election, his political finger always remained in the air. When the public outcry began, he shifted to the center, and even right of center once the Gingrich Congress rolled in in 1995. The Obama administration, conversely, does not appear to be of the same mold to me, they are determined to lay the ground work of their agenda no matter what the public thinks; the coordinated release of the EPA’s carbon decision and the C&I bill last Wednesday illustrates a willingness to get around the normal legislative process.

We cannot burden the economy in these ways. It wouldn’t work well in any situation, but at a time in which the economy remains vulnerable the damage done will be particularly acute.

This Week’s Data

It is a light data week as we have no releases today. We’ll receive mortgage applications tomorrow, which is always something to watch but not a major data set. The big release will be consumer credit for August. This figure collapsed in July and is expected to fall again by a huge amount. Credit in general is declining as credit-card lines are being cut, banks are unwilling to lend to all but the highest credits, and consumer are repairing household balance sheets – thus the demand for credit is down as well.

Then on Thursday, we’ll get the jobless claims figure. We need this reading to fall below the 550K level and make progress toward 500K thereafter. The market is ignoring labor-market conditions right now but won’t be able to do so forever. Jobless claims is one of the few forward-looking indicators within the labor-market data. Average weekly hours worked is the other, and this reading returned to an all-time low in September. Without a substantial rise in average hours worked and a meaningful decline in jobless claims, no one should expect job creation to come back.

On Friday we’ll get same-store sales for September, expected to show its 13th straight month of decline – the declines have eased though from big negatives of 4-5% year-over-year results to -2% in August. September should show additional progress, but consumer activity is likely to remain subdued for some time due to a sky-high jobless rate and much less availability of credit to help us out of this hole.



Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review: BTU, CAT, GD

S&P 500: +15.25 (+1.49%)

Bargain hunters scooped up stocks following two weekly losses and an encouraging reading in the ISM Non-Manufacturing Index signaled a return to growth. Also boosting sentiment was an upgrade of bank stocks by Goldman Sachs. The day was otherwise light in news as the investment community gears up for 3Q earnings season.


Peabody Energy (BTU) climbed 4.09% in response to a story in this week’s edition of Barron’s, which suggests the stock could double as coal demand increases. The story makes particular note of the company’s Australian coal, which has 30% profit margins, and argues the market has not correctly valued Peabody’s Asian and American coal. Peabody also stands to benefit from rising Indian and Chinese coal demand.

Caterpillar (CAT) shares jumped 3.93% as the company announced plans to increase machinery prices as much as 2%, the smallest increase since at least 2006, citing “current industry factors and current and expected general economic conditions.” Caterpillar shares also benefited from Morgan Stanley analyst Robert Wertheimer raising his target price on the world’s largest maker of construction equipment citing a “slightly stronger economy.”

General Dynamics (GD) rose 2.68% as Morgan Stanley analyst Heidi Wood raised her rating on the company citing a recovery for Gulfstream business jets. Several weeks ago, the Chinese government announced changes that open up its airspace for business jets. Wood notes the changes effectively unlock the Chinese business jet market and could drive “substantial incremental demand.”


Quick Hits

• Fed Needs Goldilocks for Roach Motel Check-Out
• The end is nigh (again)
• Corporate finance: Thawing out
  
  
  

--

Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks held in very well on Friday considering the weakness of the September jobs report, and specifically the increase in long-term unemployment. Those jobless for at least 27 weeks (as a percentage of the total number of unemployed) jumped to another new record of 35.6% last month. The average duration of unemployment rose to 26.2 weeks – a record since this data began in 1948. The jobs report shouts the damage done to small businesses and their lack of credit availability – firms with less than 50 employees are the major job creator for our economy.

One would think stocks to sell off by at least 2% on this data, but after a 1% move to the downside right from the get go the broad market pared those losses, down just ½ percent by the close.

Still, the market has declined for four-straight sessions, and down for back-to-back weeks. The last time we fell for two weeks in a row was the beginning of July, which preceded another 20% jump to the highest levels in a year. Will this move exhibit the same move, or are we headed lower. It appears traders are unwilling to send stocks much lower right now, but we get some key data on the consumer this week and it all depends on how that goes; the market is probably the closest to cracking a bit since this surge from the March lows began.

The dollar came under additional pressure on Friday – strange since the only thing going for it right now is the safety trade, so one would think the greenback to have found a little support on the jobs data. I don’t know what to think about the dollar frankly, other than it’s going to be in a very tough spot. The only thing to keep it from plunging to new lows is the fact that foreign governments have to keep buying it otherwise their domestic currencies will strengthen to a point that hurts their export markets. The price of gold rose back above $1,000 per oz. as a result of the dollar weakness.


Market Activity for October 2, 2009
September Jobs Report

The Labor Department reported that payrolls declined 263,000 in September, which was a good deal worse than the 175,000 drop that was expected. The prior two months of data were revised down to show 13,000 more jobs lost that previously reported.

So over the past six months monthly job losses have averaged 307,000 per month, this is a big improvement from the previous six months in which losses averaged a super-high of 645,000 per month. Problem is, the latest month failed to show continued improvement, and in fact deteriorated, and this level of jobs losses remains above peak six-month average declines of every post-WWII recession except the 1974 contraction in which the six-month decline averaged 327K per month.

We have improved and yet we remain at or near the worst average levels of the past seven recessions/downturns. This cannot be ignored; those expecting consumer activity to begin a sustained rebound are living on another planet.

This is important to understand and I’m not sure the market has come to grips with it. We have lost 7.2 million jobs since December 2007 and that means we’ll need 1.5 million in job creation per year (beginning right now) to get these jobs back by 2015. Roughly 1.5 million in annual job creation is what we averaged over the past 25 years – a quarter century of amazing prosperity. If we don’t get a shift to pro-growth policies a couple of years from now (completely out of the question before then), total employment repair will take even longer.

(Heads up on the chart above came from Annaly Capital)

In terms of specifics, the goods-producing industries shed 116,000, an improvement from the 132,000 lost in August and a bit better than the three-month average of -121K. The construction segment cut 64,000, a bit more than the 60,000 in August and smack dab on top of the three-month average decline. Manufacturers cut 51,000 positions, up from the 66,000 subtraction in August and a mild improvement relative to the three-month average of -53K.

The service-providing industries shed 147,000 positions, vastly worse than the 69,000 cut in the previous month and lower than the three-month average of -135K. The trade and transportation segment cut 60,000 positions, worse than the 22,000 decline in August that seemed to show big improvement was upon us – three-month average is -55K. Retail slashed 39,000, much worse than the 9,000 cut in August – three-month average is -31K. The business services component did show nice improvement, down 8,000 vs. the -19,000 in August – three-month average is -19K per month.

Again, health-care and education remains the only segment that has yet to show a decline, supported by a 19,000 increase in health-care jobs as state and local governments cut teacher positions in September – which resulted in a 53,000 reduction in total government employment.

State and local governments are in terrible shape and the problems are being masked by the first leg of the stimulus spending injections. When the next leg of the stimulus spending goes from Medicaid and unemployment benefit supplements to infrastructure spending, state and local budgets will worsen. (We’ll see if the federal government extends jobless benefits, again, which we are hearing is gaining support in Congress. Right now unemployment benefits extend to 59 weeks, if we increase this number I might begin to wonder whether I’m living in the USA or Western Europe – and it’s even worse since we don’t have an autobahn.)

The unemployment rate rose from 9.7% to 9.8% as we’re headed for 10% plus and we’ll test that post-WWII record of 10.8% – the current jobless rate is the highest since June 1983.

The number that really shows the degree of labor market trouble is the U6 unemployment rate, the duration of long-term unemployment and hours worked

The U6 jobless rate continued it record-setting march, rising to 17.0% from 16.8% in August. This reading goes back to 1994 in its current form. In terms of the former way U6 was calculated this reading would sit at 13.5%, which remains below the peak hit in 1982 of 14.3%.

As many readers may remember, this U6 unemployment figure is defined as the regular unemployment rate, plus “discouraged workers” (those that didn’t look for a job during the survey period -- which the regular unemployment rate excludes), plus those working part-time because they can’t find full-time work.

The duration of long-term unemployment (the percentage of the unemployed that have been out of work for over 27 weeks) jumped to a new high of 35.6% after showing mild improvement in August (falling to 33.3% from 33.8% in July). This spells additional trouble for credit quality – consumer delinquency rates.

The average weekly hours worked data fell back to the record low (postwar) of 33.0 -- first hit in June -- from 33.1 in August. This is unfortunate as we need to see this reading move back to the high 33s on its way to 34 hours a week before we even think about expecting jobs to rise again. Firms will increase the hours worked of current employees for several months at least before adding to payrolls.

So that’s it, anywhere you look in this report it was ugly.

You know what this jobs report and the pretty much guaranteed march to the post-WWII record high jobless rate of 10.8% has me thinking? More government intrusion. Oh, sorry; I mean “stimulus.”

If the economy fails to create just some jobs over the next several months, which is highly unlikely since the largest jobs creator (small business) remains in a world of hurt, we will see Congress/Obama begin to freak out about the 2010 elections coming up and offer some new “fixes.” I have no idea what they’ll come up with but whatever it happens to be will be damaging. If they choose to extend unemployment benefits, this will only keep the jobless rate elevated and continue to mask the state and local government fiscal troubles. If they do something like increasing spending on infrastructure, it may very well help GDP in the near term, but there will be a price to pay in weaker growth a few quarters thereafter. And all of this spells higher tax rates, which already has the business community uneasy and they’ll continue to hold back on investment (both equipment and labor) as a result.

The Administration’s economists believe in an economic “escape velocity” – current government stimulus resulting in a sufficiently high and sustained level of growth so to enable it to withstand the coming tax hikes, higher interest rates and increased regulations. What I’m worried about is failing to escape the evils of Pandora’s Box. Intense government intervention is prying it open.



Have a great day!


Brent Vondera, Senior Analyst