Daily Insight

U.S. stocks, at least in terms of the broad market, rallied in final hour of trading after losing all of its opening session gains and spending most of the day in negative territory. The Dow Industrial Average only spent a brief time under the cut line as it was propelled by shares of Caterpillar and United Technologies – the two stocks accounted for nearly 90% of the index’s gain.

Tech stocks were the worst-performing sector, weighing on the NASDAQ Composite as the index shed all of its morning-session gains just 30 minutes into trading and was unable to make it back to the plus side. Mid and small-cap stocks also closed to the downside, but just fractionally.

The latest trade data out of China showed exports were up strong and imports surged 56% from December 2008 – that’s got massive Chinese stimulus written all over it even if the figures are relative to extremely depressed levels of a year ago – and was responsible for most of the day’s gains. Industrials jumped 1.17% and that’s a China story.

Utility shares also performed well, up 1.10% for the session. Although, the group accounts for a much smaller percentage of the S&P 500 than industrials do so it didn’t have much impact on the index. Comments from St. Louis Fed Bank President Bullard stated the Fed is likely to keep policy floored for longer than most expect and that’s a green light for higher-dividend paying shares.

Bullard also mentioned that the Fed’s quantitative easing (QE)campaign may be extended and increased, referring to the central bank’s mortgage-backed security purchases and possibly Treasury securities too. It seems the Fed is floating messages out there to see how the market reacts. The chances of Bernanke & Co. increasing QE is heightened in my view. That’s unfortunate. At some point they are going to have to make the economy to stand on its own, or at the least force it to use just one crutch. If they choose otherwise, it will create additional problems down the road – and they’re choosing otherwise.

Market Activity for January 11, 2010 Crude, Delinquencies, Printing and the Consumer

The price of oil for February delivery hit a new 15-month high yesterday as Chinese exports recorded the first year-over-year increase in 14 months, colder than usual temperatures continue to grip the U.S. and many other parts of the world, pipeline attacks returned to the Nigerian Delta (it was a brief respite), and a declining U.S. dollar that has now erased a three-week bounce. (Crude has pulled back a bit this morning after Alcoa’s disappointing earnings report but remains solidly above $80/barrel.)

The weather will turn warmer and an extraordinary level of Chinese government stimulus will dissipate, but what will remain in the near future is a Fed that holds monetary policy at emergency levels – the only thing that will outlast this is oil infrastructure attacks within troubled parts of the world. As a result, the dollar will remain under pressure -- barring some nasty event that causes a full-fledged run for safety – and this will add more fuel to possibly propel the price of oil higher.

It is obviously impossible to predict where oil is going. I could actually see all commodity prices pulling back for a spell as supplies have probably become a bit bloated as higher prices have encouraged production and an intensification of banking-sector troubles cause traders to worry about already weak demand to get hit again.

It is only prudent to expect mortgage-delinquency rates to increase in the coming months simply because of persistently high unemployment, a shadow supply of homes that can’t be held from the market forever, and high loan-to-value ratios (additional price declines will increase the percentage of underwater mortgages). Now we have Washington looking at adding fees to the banks as a way of raising government revenue. Bad timing boys and girls, but when is Washington’s timing ever on target. Populism is running wild and I’m not sure investors are properly assessing the risks involved with such behavior. That’s the problem with pedal-to-the-metal monetary policy though; it causes a gratuitous level of complacency.

The overall point is that the likelihood of higher delinquency rates along with other financial-sector issues may just cause another run for safety and that means transitory dollar support and probably a correction in commodity prices – unless, and this is a big caveat, the Fed immediately meets this trouble by announcing they will increase their mortgage-backed security purchases. In that event, such money-printing behavior may just keep the commodity train rolling and escape what would otherwise be a normal pull-back before trending higher again.

For now, crude is showing substantial momentum and if the Fed expands QE that momentum will increase, creating some issues for an already burdened consumer. The only thing that is likely to ultimately hammer the price of oil, not a transitory pullback but a prolonged hit, is when the Fed signals they’ll begin to unwind current policy and raise interest rates. When that occurs, Katy bar the door on the oil trade; but then again, it may just mean a run for the exits with regard to all kinds of assets. This seems to be quite a way off though as Bernanke & Co. understands very well the challenges we face. While I believe they should mildly remove some accommodation and rid the economy and the market of this state of dependency, the Fed sees things quite differently.

As I’ve stated many times now, the Fed is in a box. If they begin to move now, the housing market will show its underlying foundational cracks and that will obviously have an effect on consumer activity. Yet, if they continue to keep policy floored, commodity prices (namely energy for this discussion) are very likely to trend higher, also hitting the consumers’ pocketbook – draining real incomes.

(On the consumer, what I would watch for is those first-time home-buyers tax credits to begin to take hold in the spring. These checks, which will total up to $8,000 for new home-borrowers, will boost spending or at least help consumers manage around higher crude prices or another round of economic trouble. But the ameliorative effects of this housing subsidy will prove short-lived as it provides one-and done spending. What we’ll be left with is labor market trouble that is unlikely to meaningfully ease anytime real soon. We’re in store for more extend and pretend.)

This Time They Mean It

Fourth-quarter earnings season kicked off yesterday evening with Alcoa’s earnings release. Alcoa marks the traditional beginning of quarterly earnings results, but things don’t get going in earnest until a couple of weeks later when the bulk of releases begin to stream in The market will be watching for some degree of top-line improvement – sales growth. While S&P 500 profits (bottom-line results) have sucked wind over the past nine quarters (remaining very depressed even as of the third quarter as total profits fell 15.6% and ex-financial results declined 24.1%), they have been better-than-expected as massive cost-cutting via payroll slashing has assisted the bottom line.

Prior to third-quarter earnings season, analysts were stating they would have to see some sales growth in order for the market to rise. Well, we didn’t get it as sales fell 9.6% from year-ago results. Stocks, nevertheless, continued to climb, up another 10% since the previous earnings season effectively came to an end. This time they say they mean it. We shall see.

Have a great day!


Brent Vondera, Senior Analyst